The dissolution of the Soviet empire in Central and Eastern Europe and the demise of the Soviet Union have created unprecedented opportunities for social, political, and economic change in Europe and Eurasia. Current reforms will alter fundamentally the way post-communist societies, political systems, and economies function and interact. More than 5 years into the process, what do we know about social change at this pace and scale? What do we not know that we should know? What should we be tracking and analyzing in order to improve our understanding of this unprecedented transformation?
In 1994, the Joint Economic Committee of the U.S. Congress, the U.S. Agency for International Development, and the Office of Research and Development of the Central Intelligence Agency brought a series of issues relating to the post-communist economic transition to the National Research Council (NRC) for investigation. In response, the NRC established a Task Force on Economies in Transition. The task force's main charge was to improve understanding of the economic transformation in Central and Eastern Europe and the New Independent States, and to determine what we know about the interdependent economic, political, and social processes currently taking place in the region. The NRC also asked the task force to develop a research agenda that would direct efforts and funding to those areas, issues, and methods most likely to improve understanding of the complex and interrelated socioeconomic processes encompassed by the terms ''transition" and "transformation." This volume responds to that charge.
From its inception, the task force doubted that present versions of any existing theories—including various theories preferred by its own members—
could adequately encompass these extraordinarily complex processes and explain the very different rates and patterns of transformation across the post-communist world. Most established economic theory aims to explain marginal and incremental changes. It is therefore at best partial, and at worst misleading, in the context of sweeping, rapid changes in entire systems. More-over, conventional theory assumes the existence of underlying formal and informal institutional arrangements that are radically different from those pre-vailing in many parts of Central and Eastern Europe and the New Independent States. Similar difficulties beset our explanations of political change: models that fit more or less adequately the representative systems of capitalist democracies leave unstated both the underlying institutional forms and conditions for drastic transformation.
At the outset of the transformation, these shortcomings of Western theory and knowledge were compounded by the widespread assumption that these societies would "naturally" evolve into systems closely approximating those of the industrialized West. These teleological and deterministic assumptions are not inherent in existing theories, but nonetheless have had a powerful influence on policy advice and action in the post-communist world. The ascendance of neoliberal economic philosophy during the 1980s, both in the industrialized West and in poorer regions of the world, seemed vindicated by communism's collapse in Central and Eastern Europe and the New Independent States. For a brief period, many observers and advocates believed that Western models of market economies and democratic polities were the wave of the future, and that the post-communist world was embarking down the same road to the same destination (though some countries were expected to move more rapidly than others). Moreover, many people thought that road was plainly marked: stabilization, liberalization, and privatization would transform highly bureaucratized, statist economic systems into dynamic, competitive capitalist economies. Similarly, contested elections, political parties, and decision making by representative assemblies would provide the path to democratic stability.
Experience during the 1990s has confirmed the crucial importance of certain (mainly macroeconomic) policies as necessary, though far from sufficient, underpinnings to resumed growth. But the failures and disappointments of initial efforts at transformation in parts of the post-communist world and the varied patterns and ongoing problems in even the most successful cases have led most thoughtful reformers and analysts to back away from single-track assumptions. There is now much greater recognition that different paths of transformation, and different destinations, are likely to be generated by different histories (before and during the communist era); the different ways in which communism collapsed; and contrasting geography, social structure, ethnic composition, and cultural values. Some of these destinations may look similar to one or another of the multiple models of mainly market economies
already established elsewhere in the world, while others may look quite different from any existing market or communist model. Some of each group may thrive while others prove unworkable.
The task force began its work roughly at the same time that the initial phases of the transformation process were yielding to later phases, with different goals and emphases, in much of Central Europe and the Baltic states. Initially, the overwhelming priorities were stabilization and liberalization—particularly the dismantling of old controls on prices, trade, and investment. As these measures took hold in Poland, the Czech Republic, Slovakia, Hungary, Slovenia, and the Baltic states, the attention of policymakers and advisors shifted to the much more diverse and complex tasks of creating new institutions and frameworks for effective governance and economic growth, while continuing to keep a watchful eye on macroeconomic management. Elsewhere in Eastern Europe, and in most of the New Independent States, the early phases of transformation, characterized by the struggle for stabilization, liberalization, and privatization, has taken longer and been much less decisive. In these areas, the challenges of designing institutional reforms and creating new regulatory and social-sector frameworks appropriate to mainly market economies will be more difficult, and will have to be tackled simultaneously with the yet-to-be-completed initial phase of transformation.
As more post-communist countries move into later phases of transformation, the policy guidance provided by neoliberal economics becomes more limited and partial. While there are criteria for restructuring financial sectors consistent with the requirements of market economies, there is no single template from which one can draw the precise outlines of any of the components of an economic system (including central banks, monetary policies, investment incentives, monitoring systems, and savings institutions) that will foster both well-being and economic growth. Still less is there a single formula, or even a great deal of technical agreement in the West, regarding how to design new pension or educational systems or the most appropriate labor market institutions. Indeed, many semi-industrial and industrial nations outside the post-communist world continue to grapple with similar issues. Far from being able to apply a well-understood model to achieve predictable outcomes, analysts and practitioners are groping at the frontiers of knowledge, seeking better insights and ways of grasping the complex, dynamic, and interacting processes of transformation.
In seeking to contribute to these efforts, the task force looked for innovative ways to determine what is occurring in these diverse systems, to unravel some of the unexpected consequences of policies, and to trace the strategies and networks different actors are using to cope with the uncertainties of transformation. The task force recognizes that many approaches are useful and that no single approach will be adequate in such a complex endeavor. It has, however, chosen to emphasize one approach in this volume—the analysis of
institutional change. It has done so for several reasons. First, task force members and those who participated in the workshops conducted for this study found this approach both thought-provoking and fruitful. Second, many of the papers included in this volume demonstrate the utility of the approach. Finally, this approach has been largely neglected to date in analyses of post-communist transformations. Rather than surveying all possible interpretations of current changes in post-communist economies, together with all possible objections to their major arguments, this volume aims to stimulate thought and discussion, identify crucial gaps in current knowledge, and motivate new research.
To address the challenges posed by its mandate, the task force:
Commissioned a series of reports from specialists in East European and Eurasian social change and the processes of economic transformation, ranging from broad conceptual surveys to investigations of developments in specific sectors of particular countries.
Organized a series of five workshops at which practitioners, analysts, and policymakers could debate those reports.
Produced a set of critical syntheses of the results, including the essays that introduce each section in this volume and the overall framework essay by Douglass North.
Four different components of the task force's mandate should be distinguished: (1) setting goals, (2) identifying potentially useful conceptual approaches and methodologies, (3) explaining current changes, and (4) identifying research priorities. For all four components, the stakes are high, and sharp disagreements exist among analysts, policymakers, and citizens as to the best course of action.
With respect to goal setting, for example, most observers and participants would welcome the eventual establishment of productive, prosperous, self-sustaining economies and democratic regimes throughout the zone of former state socialism. Disagreement begins, however, with the extent to which such economies and regimes must imitate existing Western models; whether the pursuit of economic growth and democratization conflict in the short run; the extent to which the social services and rights established under state socialism should be preserved; the relations post-socialist economies should have with the evolving international capitalist system; and the extent to which even long-run goals should differ for, say, Uzbekistan and Estonia. Among our contributors, the variation in views with regard to these issues is striking. Some think the immediate adoption of Western economic models is both desirable and feasible. Others argue that the future economies and polities of post-communist regions will inevitably differ significantly from those of present-day Western, capitalist democracies. The analyses included
here help identify and probe these goal-setting issues, but do not attempt to resolve them.
As noted earlier, many of the chapters and essays included in this volume stress the value of institutional analysis for understanding economic transformation and social change in Central and Eastern Europe and the New Independent States. To recognize the significance of institutions is not to announce a list of precisely six (or six hundred) social arrangements that underlie functioning markets or market systems, but to see that all systems of production and exchange rest on organizations, routines, guarantees, relationships, and understandings that are not themselves obvious elements of production and exchange. It should be understood at the outset that the term institution is used differently here than in common parlance or, for example, in the field of political science. The institutional approach defines institutions as the indispensable framework within which human interaction takes place—as the "rules of the game," the humanly devised constraints, that determine incentives and shape human interactions in all societies (North, 1990:3-4). Some institutions, such as laws, tax regimes, and the explicit operating rules of organizations, are formal, while others, such as cultural norms and established conventions, are informal. Formal rules are only a small subset of the constraints that govern choices and human interaction, while informal constraints and conventions are so pervasive that one is often misled into underestimating their role and importance. Institutions, both formal and informal, reduce uncertainty, structure incentives, define property rights, limit choices, and ultimately determine transaction costs (North, 1990).
Economic and political liberalization has dismantled a great many of the formal communist institutions—the laws, regulations, and organizations characteristic of the communist era. At the same time, however, informal institutions from the communist as well as the pre-communist past, including relationships, norms, and rules of behavior, persist in varying degrees and continue to shape expectations, incentives, and behavior. Moreover, new informal institutions are emerging alongside the new formal laws and organizations. While reformers and policy advisors are attempting to design and introduce new, formal institutions, it should be understood that these measures will confront and interact with remnants of old arrangements and spontaneously developing informal institutions (North, 1990). Conflicts and inconsistencies between formal and informal institutions can produce unanticipated consequences, including noncompliant behaviors and underground economic activities. No one has a formula for setting the optimum level of institutionalization, or even the certainty that a single such level exists. To the contrary, the task force wishes to emphasize the great diversity of institutions and institutional patterns that have existed, currently exist, and are emerging in the course of transformation.
Analyzing transformation in terms of institutional change alerts policy-
makers and scholars to the critical need for market infrastructure, without which markets can not form or function. It focuses attention on the necessity for secure property rights without which investors are unlikely to invest, and capitalists are unlikely to undertake the risks of entrepreneurship. It emphasizes how transaction costs—the costs associated with measuring, monitoring, protecting, and exchanging property rights—affect incentives for the production, trade, and use of goods and services. Finally, it highlights the importance of path dependence—the ways in which cultural norms and inherited ways of conducting business and governing societies structure a society's institutions, setting the parameters within which, and the stock of knowledge with which, change will occur.
The path dependence of economic, institutional, and political change means that major processes—such as monetization of exchanges, privatization of property, and integration into international markets—will operate differently in different socioeconomic systems as a function of previously existing social arrangements. Just as a skyscraper's lightning rod acts as a conduit for electrical discharges from storm clouds, established social, economic, and political connections and routines channel economic transformations. As a result, changes may sometimes proceed with unexpected rapidity, with an entrenched and previously clandestine second economy suddenly becoming a relatively unfettered legal vehicle of exchange. Changes may also move more slowly than reformers anticipate, encountering obstacles created by the old system. Path dependence governs the itinerary more than the speed of economic change.
Analysts concerned about institutional change and path dependence have no choice but to take concrete histories seriously. Starting with the synthesis provided in North's framework essay, many of the authors in this volume step back to examine the longer-term implications of the transformation taking place in underlying social and economic institutions. Most critically, they raise questions about which institutions are likely to impede, promote, or prove irrelevant to the emergence of productive economies and self-sustaining democracies. These inquiries examine changing property rights, transaction costs, power structures, household coping strategies, and interpersonal networks. They call attention to the paths and sequences by which institutional transformation actually occurs, with an eye to the likely perverse effects of attempts to install replicas of specific Western organizational forms where the necessary institutional contexts have yet to emerge.
Effective economic change depends on changes in formal noneconomic organizations, such as courts, schools, and hospitals. But it also depends on webs of understanding, expectation, and social relations that cut across formal organizations: norms of honest work and decent pay, networks of friends and relatives who pass on news of economic opportunities, devices for pooling capital, and much more. These arrangements constitute the informal and only
partially visible side of institutions underlying economic activity and change. They increase or decrease the likelihood that the performance of markets, investments, monetary flows, and producing firms in rapidly changing economies will be similar to that of their counterparts in long-established capitalist economies.
Authors in this volume display an acute awareness of institutional effects, both formal and informal. Rather than dismissing such pervasive and striking phenomena as official corruption, theft of government property, pyramid schemes, rising mortality, and mass emigration as obstacles or temporary misfortunes on the road to economic transformation, they seek to explain and trace the implications of ostensible setbacks, obstacles, and perverse effects. Such changes, properly understood, provide valuable signals concerning the extent to which post-communist economies and polities are actually behaving as conventional theories of market expansion and democratization would lead us to expect. Even more important, individuals' short-run responses to economic and political change depend heavily on their societies' inherited, and often entrenched, institutional arrangements. Their responses may be constrained or facilitated by patron-client networks, ethnic and religious solidarities, organized access to government resources, incentives for short-term profit taking rather than long-term investment, and social structures that facilitate the evasion of taxes. Therefore, actual behavior provides crucial information about institutional constraints on the array of possible choices and policies.
In each of the five workshops conducted for this study, the task force sought explicitly to integrate macroeconomic and microeconomic levels of economic analysis, while building bridges across the disciplinary divides between economics and the other social sciences and between Western and post-communist scholarship. Beginning at the base, the task force focused initially on transformation at the level of the individual household and the coping strategies employed by different actors to survive and surmount the challenges of change. Although the interrelationships between health and the stresses induced by socioeconomic change and uncertainty were discussed at the first workshop, papers addressing these issues were excluded from this volume in view of the fact that the NRC has just published a volume of papers on Premature Death in the New Independent States. Similarly, although the task force recognized the potential for ethnic and religious solidarities to influence the course of transformation, the NRC's recent work on Balancing and Sharing Political Power in Multiethnic Societies encouraged us to focus our attention elsewhere.
Progressing to increasingly complex levels of socioeconomic interaction, the task force examined the transformation of management, labor, and production; institutional change, property rights, and corruption; social trends, household behavior, and social-sector policies; and the transformation of the role of the state. The choice of topics was not intended to be exhaustive, but to direct
attention and research to key elements of transformation. This work plan also enabled the task force to highlight the complex interactions among processes that are frequently analyzed separately, or with other things being held artificially constant. For example, the opportunities for rent seeking created by privatization are integrally related to the criminalization and corruption of state structures. Similarly, while the appearance of extensive quasi-currencies in Russia and some other countries is a creative (though not necessarily constructive) response to the strains of transformation, it contributes to the alarming erosion of central government authority and revenues.
The task force's series of workshops provided opportunities for social scientists, policy analysts, legislators, and development specialists to confer, debate, and refine their preliminary understanding of critical aspects of the transformation process. This in turn enabled them to transfer insights gained at the workshops to contemporary policy issues without awaiting the publication of the volume
The volume opens with both an introduction and a framework essay. This introduction explains the task force's mandate, outlines its program of work, and provides a brief guide to the materials included in the volume. North's essay outlines the broad contours of the new institutional economics, demonstrates the analytic utility of the approach, and applies it to the study of economies undergoing transformation. His essay is followed by four substantively based sections: II "Institutional Change, Property Rights, and Corruption;" III “Management, Labor and Production;” IV “Social Trends, Household Behavior, and Social-Sector Policies;" and V "The Changing Role of the State." The chapters in each section were initially presented at one of the task force workshops, where they were subjected to intense debate, and were subsequently revised for publication. Compelled to make its selection from an extraordinarily strong and diverse group of papers, the task force chose to include those papers which provided cross-national and comparative analysis, addressed major problems of explanation, provided new conceptual approaches, connected explanations with policies for intervention, and shed the most light on institutions and institutional change.
Just as the volume opens with a framework essay, each section opens with a task force essay. These essays not only set the context for the specific papers included in each section, but, more important, provide an opportunity for the task force to synthesize the insights gained over the course of the project and elaborate their own views concerning the processes of transformation. In the final section of the volume, "Research Priorities for Post-Communist Economies," the task force raises a series of questions about the transformation. These questions include conventional issues such as how labor markets are forming and what is happening to capital accumulation, but they also emphasize:
Analysis of evolving incentives and transaction costs in the course of institutional transformation.
Careful monitoring and explanation of what might seem to be short-term disturbances.
Singling out of responses—successful or otherwise—to deliberate policy interventions as privileged evidence concerning the causal processes operating in post-communist countries.
Treatment of current changes as evidence about the plausibility of competing explanatory models.
Identification and explanation of different change trajectories within the post-communist world.
In general, the research agenda outlined in the final section of this volume stands as a warning against the straightforward application of models based on a stylized description of the world's richest economies, the assumption that the expansion of markets and private property will suffice to move post-communist economies to prosperity, and the use of checklists to gauge the approximation of any particular economy or polity to an idealized portrait of capitalist democracies. It also calls for broader and more penetrating efforts to identify and model the political, ethnic, and economic forces channeling institutional changes, and to determine the effects of these changes on incentives, perceptions, and relationships. What sorts of institutions, for example, guarantee contracts, promote productive long-term investment, discourage rent seeking and capital flight, give priority to state-backed legal tender, and encourage tax compliance?
The processes currently unfolding in the post-communist world challenge our capacity to limit the human costs and promote the potential benefits of this unprecedented transformation. They also offer a unique opportunity to expand our limited grasp of the kinds of changes that underlie economic restructuring and development more generally. Both the challenge and the opportunity demand broader and more flexible conceptual approaches than those which have dominated to date. This volume provides examples of such approaches, and marshals a formidable range of unanswered—and for the most part previously unexamined—questions for a larger and more probing program of research.
North, D.C. 1990 Institutions, Institutional Change and Economic Performance. Cambridge, England: Cambridge University Press.