Transforming Post-Communist Political Economies (1998) / Chapter Skim
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Underground Activity and Institutional Change: Productive, Protective, and Predatory Behavior in Transition Economies
Underground Activity and Institutional Change: Productive, Protective, and Predatory Behavior in Transition Economies
Pages 19-34
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II Institutional Change, Property Rights, and Corruption
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suggests that the outcomes of revolutionary changes will depend on "the ongoing tension between informal constraints and the new formal rules." Formal institutions have indeed changed radically in the transition economies, but informal institutions much less so. What then can we learn from a closer examination of the informal conventions, particularly when these include norms of noncompliance with the formal rules?
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When formal and informal institutions clash, noncompliant behaviors proliferate, forming various underground economies. Many of the centrally planned economies suffered from fundamental inconsistencies between formal and informal institutions.
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The linkage between institutions and economic performance depends critically on the incentive structures that flow from property rights. Efficient institutions provide incentives to minimize the sum of production and transaction costs.
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Since institutional change is the defining feature of transition economies, any inquiry into the causes and ultimate consequences of the transition must include an analysis of the incentives and sanctions governing various types of underground economic activities. Indeed, the perception, nature, and consequences of noncompliant behaviors depend on the particular rules being violated.
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The extent, nature, and consequences of underground economic activity will affect the impact of institutional change on economic outcomes. The study of noncompliance in transition economies is likely to yield the most revealing view of the effective prevailing incentive structure, of the critical strategic behaviors induced by that structure, and thus of the outcomes of policy changes.
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At the same time, organized crime and corruption are seen as a growing menace to new business establishments and as a major barrier discouraging foreign capital investments. The extent of noncompliance is also an important factor when threshold effects dominate the dynamics of institutional change.
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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 "secondeconomy" behaviors induced by its perverse incentive systems (Grossman, 1992~.
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Permitting a pervasive underground economy served as a means of controlling political dissension, rewarding elites, and buffering the hardships imposed by the inefficiencies of central planning. The resulting regime of arbitrary discretion was the antithesis of the rule of law.
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Privatization legitimated the personal appropriation of state property by placing previously amorphous property rights to state assets directly in the hands of private actors. Privatization created the opportunity for privileged elites with information and network advantages to convert limited de facto use and income rights into more valuable de jure alienable rights.
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In the absence of effective state institutions that can protect and enforce newly created property rights, these rights will remain uncertain, and their exercise will involve high transaction costs. In this effectively stateless environment, organized crime can provide a locus of authority for contract enforcement and the adjudication of contested property rights.
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When public officials are granted authority to licence, prohibit, tax, or subsidize economic activities; allocate favorable exchange rates; enforce trade restrictions or price controls; and distribute valuable property rights and natural resource endowments monopoly powers are created in the public domain. Thus, corruption, which involves noncompliance with the rules governing appropriate conduct in public office, is a form of government failure that occurs when public officials, acting as the agents of the state, exploit the state's monopoly powers for their personal advantage.
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Under these circumstances, the rule of law typically secures property rights, reduces uncertainty, and lowers transaction costs. In regimes of discretionary authority where formal institutions conflict with informal norms, noncompliance with the formal rules becomes pervasive, and underground economic activity is consequential for economic outcomes.
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The formal rules in most of the former Soviet republics are still very far from being incentive compatible, and many aspects of the old system persist unchanged. Regulatory burdens and the number of regulatory agencies have ballooned, yet the legacy of noncompliance prevails, and independent monopolists willfully exploit property rights that remain in the public domain.
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From page 34... ...
Reprinted in The Road to Capitalism: Economic Transformation in Eastern Europe and the Former Soviet Union, David Kennett and Marc Lieberman, eds. Fort Worth, TX: Dryden Press/ Harcourt-Brace-Jovanovich, Inc.
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