Understanding the transaction costs of transition: it's the culture, stupid.

In the early 1990s, Central and Eastern Europe countires (C&EE) began transition into free-market, private-property economies. Thirteen years later, the Index of Economic Freedom published annually by the Heritage Foundation and the Wall Street Journal lists only one country in the region as a free market country, seven countries are listed as mostly free, nine as mostly unfree, and two as repressive. The same initial objectives of transition have clearly produced different results in C&EE. The paper argues that observed differences in the results of institutional restructuring in C&EE are not accidental. It attributes those differences to the interaction between the formal institutions of capitalism and the prevailing cultures in dormer socialist states. The “interaction thesis” is summarized as follows: When changes in formal rules are in harmony with the prevailing informal rules, he incentives they create will tend to reduce transaction costs and free some resources for the production of wealth. When new formal rules conflict with the prevailing informal rules, the incentives they create will raise transaction costs and reduce the production of wealth in the community. The Interaction thesis suggests that better understanding of the results of transition in C&EE requires analysis of the following three issues: What are the most important formal institutions of capitalism? What kind of culture is in harmony with formal institutions of capitalism? What is the difference between that culture and informal rules in C&EE countries? The paper analyzes those three issues in some detail. The findings are that the transaction costs of transition are higher the farther east and southeast one travels. Finally, the paper provides several empirical examples in support of the interaction thesis.

Toward a theory of the effects of the interaction of formal and informal institutions on social stability and economic development: Prepared for The Conference on Formal Institutions and Informal Arrangements in Transformation Societies, University of Potsdam, Germany, October 7 - 9, 1998

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After socialism: where hope for individual liberty lies.

Institutional restructuring in West Germany and Eastern Europe is a consequence of the failure of two major socialist experiments, National Socialism and Marxism-Leninism. The paper addresses a number of issues such as: Why was the transition of West Germany in the 1950s more successful than the institutional restructuring of Eastern Europe in the 1990s? Why are the results of institutional changes within the former Soviet Bloc different from one country to another? Why do we observe no tendency in former Marxist-Leninist states for more efficient institutions to replace less efficient ones? The paper identifies the rule of law, the carriers of institutional restructuring and informal rules in the community as three critical factors upon which the results of institutional restructuring depend. The paper then demonstrates the interaction between those three factors is a powerful and perhaps necessary method for analysis of institutional changes and their causes, directions and consequences. To that end, analysis internalizes the effects of the interaction between the rule of law, the carriers of institutional restructuring and informal rules on incentive structures and the costs of transactions, and the effects of incentive structures and the costs of transactions on economic behavior. Finally, the paper addresses three issues: Why has the use of economic policies based on neoclassical economics contributed to the rising strength of pro-socialist parties? What happens to the transition from socialism to capitalism when the carriers of institutional restructuring have comparative advantage in running a state-centered economy? And finally, the paper suggests a primer for changes in informal rules.

On the privatization of "Stolen Goods" in Central and Eastern Europe.

Many scholars assert that the process of privatizing state-owned firms in Central and Eastern Europe has been a success because privatized firms are performing better than they did before. The assertion is an empty piece of poetry. To begin with, privately owned firms are more efficient than state owned firms. Hence, the evaluation of the process of privatization in Central and Eastern Europe does not depend on some measured efficiency of privatized firms. The evaluation of privatization should be based on the contribution of privatized firms to the attainment of two major initial objectives of institutional restructuring in post-communist Central and Eastern Europe: the acceptance of capitalism and the development of free-market, private-property institutions. The paper argues that the privatization of state-owned firms has failed to contribute to those two objectives. Analysis attributes this failure of privatization to the neoclassical model, the absence of de-communization in the region, and the unwillingness of new rules to assign the value of state-owned firms to their rightful owners.

Major Institutional Requirements for Successful Economic Development

Let me begin this paper with a quote from an article published in the Rhodesian Journal of Economics: “If one assumes an incremental capital- output ratio for Rhodesia of the order of 3 :1 and a desired rate of economic growth of six per cent per annum this would mean a desired rate of net investment of no less than 18 per cent of GDP.”' This statement, which is based on the Harrod-Domar model of growth, reflects all the properties of modern growth theories such as elegance, quantifiability and deterministic solution. Yet, it seems to be a historical fact that countries least concerned with the implementations of modern growth models have done as well if not better for their people as those countries which have embarked upon various planning schemes. In this paper I will argue that to consider the saving-investment relationship as a major determinant of the rate of growth, and an increase in the supply of investible funds as a major determinant of the increase in the rate of growth is at best misleading and at worst nonsensical. For faster rate of growth of wealth is achieved not merely by increased saving but by more effective institutions for organizing, co-ordinating and directing productive activity