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1995; Shelley, 1995; Tanzi, 1994; Anderson, 1995; Mauro, 1995). Analysis of noncompliance under the Soviet regime suggests that the circumvention of price and production controls contributed to a more efficient system and served to buffer some of the most costly consequences of allocation by administrative control. The buffer function may have extended the lifetime of the Soviet regime by ameliorating some of the costs of misallocation. But, as discussed below, the pervasiveness of noncompliance under the Soviet regime has had a pernicious effect on subsequent economic reforms.

The Legacy of Noncompliance

If we are to understand the severe adjustment costs sustained during the transition process, particularly in the NIS, we must examine the institutional structure of the earlier Soviet regime and the legacy of noncompliant "second-economy" behaviors induced by its perverse incentive systems (Grossman, 1992). The Soviet Union's criminal code prohibited most of the private economic activities regarded as normal in Western market economies. Despite heavy penalties, however, noncompliance with the formal laws was the rule rather than the exception. Handleman (1995) describes the Soviet Union as the "world's most heavily policed state." Yet paradoxically, it functioned as an essentially lawless society.

Grossman (1992) has pointed out that if one were to attempt to characterize the conditions likely to "maximize the scope and size of a country's underground economy," one would effectively describe Soviet-type socialism. A shortage economy with state-controlled prices well below black market prices created significant incentives for internal arbitrage and speculation. Similar gaps between world prices of tradeables and controlled domestic prices encouraged international smuggling. The prevalence of amorphous property rights and lax controls over state assets made the theft of state assets a pervasive predatory activity. Low administrative salaries combined with powerful governmental authority created rent-generating opportunities for bribery and corruption to flourish. In short, the economic incentives to engage in economic crimes were substantial, but so were the penalties.

Fedbrugge (1989) describes how the formal legal system treated economic crimes. Economic activities regarded as normal in market economies not only were prohibited under Soviet law, but also carried heavy penalties. Private enterprise and commercial middleman activities carried a maximum penalty of 5 years in prison, while speculation drew a 7-year term. Bribery and theft of state property were punishable by 15 years' imprisonment and death. Despite this stiff menu of punishments, these activities were common-place, and indeed virtually necessary to maintain minimum living standards.

In fact, economic crimes were broadly tolerated by the Soviet regime. They served to buffer the economy from the misallocation failures of the



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