Peter J. Boettke(1)


George Soros has been the single most influential Westerner throughout East, Central Europe and the former Soviet Union with his philanthropic activities. The Open Society Foundations that he financed throughout the region have done tremendous work in opening up these formerly closed societies. But, Soros has also come to the opinion that unfettered capitalism is the ruination of the modern world, and the largest threat to the Open Society (see, e.g., Soros 1997). Managed world capitalism, Soros contends, is necessary to maintain macroeconomic stability, and a progressive social order. Without proper management, and the global order risks devolving into a chaotic and degenerative process of survival of the fittest where the majority suffer and few reap tremendous gains.

Casual empiricism from the transition economies is often invoked to justify opinions like Soros's. The west is said to have failed at the crucial moment to provide the appropriate aid, and now the Russian people are left to fend for themselves in the reckless world of "wild-west" capitalism. Intellectuals and scholars who abide by this argument explain Russia's problems as the logical outcome of the disregard for the common interest that follows from uninhibited pursuit of self-interest. Russia since 1992 has experienced large capital flight as citizens seek to funnel money out of the country as quickly as they can get their hands on it to reap higher returns. During 1996, for example, it is estimated that capital flight amounted to about $21 billion (Russian Economic Trends, May 1997, June 1997). Capital flight reflects not only legal and political uncertainty, but also the desire to escape taxation. In fact, the picture rendered by official economic statistics reveals an economic system which has continually contracted since 1989 so that at the end of 1996 the economy was basically half the size it was in 1989 -- a steeper fall than what the US experienced during the Great Depression of the 1930s. There are good reasons to doubt the official statistics, namely that the 1989 figure overstated economic growth, and the 1996 understates economic growth by failing to account for the expansion of the black market. Nevertheless, there can be little doubt the Russian people have had to endure great economic hardship over the past decade, with an estimated 22% of population now living below the official poverty line. Thus, the period of so-called "market reforms" in Russia do not show obvious improvements in the well-being of citizens.

This has led to an emerging consensus within the professional and popular literature which argues that the "triple transition" - transforming the economy, the polity, and the national psychology - is too difficult to be left to the market. Three separate arguments have been put forth. The first line of argument asserts that the laissez-faire model is an inaccurate picture of even the 18th century, and is completely incompatible with conditions in the late 20th century. Instead, it is asserted, the East Asian model of government guided industrialization is a more accurate model. The second line of argument asserts that the laissez-faire model is conceptually mistaken. The market is always enmeshed within an interventionist state. The question is not intervention or no intervention, but rather which intervention. Again, the East Asian model and the literature on state-led development is advocated against the so-called laissez-faire model currently in fashion in the former socialist economies. Finally, a third line of argument does not attempt to challenge the laissez-faire model as such, but rather questions whether it is up to the task that the former socialist economies present. Economic adjustments within a market economy move by marginal adjustments, but the changes required to the system at the current moment are not marginal but require a one-time leap to a new system. The legal-political environment must be changed before market forces can be unleashed.

In contrast to these arguments, I contend that it precisely because the transition is so complicated and so important that market forces must be allowed to play the crucial role in the transition. To argue the opposite is to reflect the continuing appeal of the command and control approach to public policy that has dominated 20th century affairs, and thus the "fatal conceit" which Hayek warned was evident not only in central planning, but in models of managed capitalism as well.



We are now almost a decade into the post-Communist experience in East, Central Europe and the former Soviet Union. Obviously some countries have done better than others in terms of handling the dual transition in politics and economics.(2)

Political uncertainties and economic half-steps still characterize the situation throughout most of the region. In many ways this is the natural course of history, and only a non-historical attitude would have expected that the transition from an authoritarian political structure and the administrative command economy to a democratic government and a market driven economic system could have been accomplished in a matter of a few years, months, or days. This is not an argument against "shock therapy", but it is an argument against the type of rhetoric offered by political agents, such as Boris Yeltsin, who stressed in 1992 that the difficulties of the transition would last only 6 months.(3) The heady days of late 1989, when the dissidents in Prague could speculate from inside the Magic Lantern Theater that what once took ten years, had become ten months, and then ten weeks, and now perhaps just ten days, are now gone. Historical perspective on the Glorious Revolution of 1689, the American Revolution of 1776, or even the post-WWII reconstruction of Japan warns against collapsing the time from introduction of change to successful transition from the previous state of affairs to a matter of years. Actually, it is a matter of decades. In 1989, many of the former communist economies looked to Japan as the success story of modern industrialization, and wanted to be Japan, but they did not look at Japan in 1945. But Japan of 1989 is not possible without the political/economic choices made during the decade after 1945.(4)

We are still in the middle of the "buzz" of affairs that define the post-Communist world, and our conclusions concerning current affairs are inherently limited in this regard. Theoretically we can conjecture some propositions about the general relationship between the polity and the economy, but the applicability of any one of these propositions to the current situation can only be gleaned in the more humbling task of interpretation and the "art" of applied political economy. The overzealousness with which some economists have moved from statements of theory to statements of advocacy has caused a backlash among some critics (not that these critics don't also make this leap as well!). From scholars of high theory to political pundits, the idea that the market metaphor has met its match in East, Central Europe and the former Soviet Union has gained currency as a counter-reaction to the confidence with which some economists pronounced on the virtues of "shock therapy". Whereas the dogma of Soviet-style communism was the scourge of the Cold War era, the dogma of laissez faire is said to represent the largest threat to our current age.(5) Amsden, Kochanowicz, and Taylor (1994) sum up these sentiments when they state: "After an initial period of euphoria, the transition to capitalism is proving an unparalleled challenge to the market mechanism." The main problem is that the reforming economies have embraced a simplistic capitalist model derived from the 18th century. "This laissez-faire model may have succeeded in overthrowing mercantilism and creating a cottage industry in rural England, but it has incurred high social costs and low rates of return when applied to the project of restructuring industrial Eastern Europe under the competitive conditions of technologically advanced, twentieth-century capitalism" (pp. 1-2).

In terms of economic analysis and advice, the change in the intellectual climate of opinion is reflected in demands that the Nation-State play a large role in the economic transition.(6) Since the transition to the market implies that public policy steps must be taken, and public policy in the modern world is often the responsibility of the Nation-State, this is a truism on some level since we are not talking about an anarcho-capitalist revolution.(7) The "liberal" conception of political economy is just as cognizant of the Nation-State as alternative conceptions of political economy. In fact, the Nation-State is already playing a large role in all the transitions. Macroeconomic stabilization, fiscal reform, trade liberalization, and even privatization are being guided by the respective governments and not left to the market by any stretch of the imagination. It is simply difficult to understand what "reality" is being discussed by critics of laissez-faire, such as Amsden, Kochanowicz and Taylor.(8) Moreover, recognizing the importance of "bringing the state back in" does not necessarily imply a non-liberal conception of the state. There are now many varieties of scholarship within political economy that emphasize the importance of institution building, and there is no legitimate reason to privledge apriori only those approaches which emphasize an activist role for political institutions within the capitalist process of exchange and production.

There are many policies within the transition from state socialism to democratic capitalism. The concentration here will be on privatization mainly because it is that aspect of transition policy which most directly addresses the issue of whether the transition it too important to be left to the market. Privatization policy is the attempt to transfer decision making away from government officials and toward private property owners, and as such it requires the State to take steps to eliminate its role in economic decisions. This is (at least on the face of it) a different affair than either monetary policy or fiscal policy.


The collapse of state socialism in the late 1980s ranks with the Great Depression of the 1930s as one of the two defining political-economic events of the 20th century. As with the Great Depression, interpretation for the exact reason for the collapse and the implications for social theory vary. We still debate in economics whether the Great Depression was caused by government folly or inherent market instability. Already the competing hypothesis on the causes and consequences of the collapse of socialism have been circulating: inherent contradictions of socialism, Western military pressure, bad luck (and corruption) in the selection of leaders, and poor economic management which could be repaired head the list. Of course, except for the hypothesis that socialism suffers from inherent contradictions, the implications for transition vary greatly. Even with regard to the first hypothesis, the idea that socialism suffers from inherent contradictions is not automatically interpreted to mean that all forms of government planning must confront certain systemic issues -- only central planning runs into the problem. I want to look at the problem slightly differently.

The socialist world of East, Central Europe and the former Soviet Union was simply not socialist as that word is technically defined in the history of ideas as the abolition of commodity production and thus the absence of private ownership of the means of production. This is not because of some perversion of the ideal in Soviet practice, but because the idea is conceptually incoherent in a world of advanced material production. Socialism failed in the Soviet Union, but in 1921, not in 1991.(9) The long period from the 1920s to the late 1980s was the muddling through of basically a heavily distorted military economy in which the "market" served to fill in gaps within and outside the plan. The key point to stress for present purposes, however, is just that the system that was rejected in the late 1980s did not resemble the theoretical model of central planning or even decentralized planning as a contrast to the "market". The system was "embedded" in the market, but one that itself was "embedded" within a social ecology wholly different from Western conceptions of capitalist markets. As such, the major challenge for reforming the political-economic system is to recognize what it is that is being reformed -- the 20th century version of the Ancient Regime.(10) Certain explicit "brute" facts can be recognized to be common across the Soviet-type political-economic systems:(11)

1. Political monopoly of the Communist Party;

2. Industrial structure of the economies can be defined as literal monopoly (in terms of an actual government dictate that there be only one producer in an industry);

3. Shortage of consumer goods and poor quality of goods and services;

4. Repressed inflation (reflected in the long lines and the so-called rouble overhang problem);

5. Fiscal imbalance (as a consequences of industrial, military and consumer subsidization and the persistence of problems associated with "soft budget constraints");

6. Welfare system is tied to the industrial workplace (reflected in the employment incentive problems).

The socio-economic consequences of this constellation of facts under state socialism are now widely recognized. Production inefficiency, consumer frustration, political repression, and worker alienation within the workers' state were the norm. It is obvious that a path of reform must repair each of these situations if the transition is to be judged successful. But these explicit facts (and others that could be added to the list) are the consequence of underlying factors -- often implicit -- which have to be exposed if we are to get at the root cause of the "irrationalities" that were experienced. It is one thing to simply say that where there was political monopoly, replace it with democratic competition; where there was economic monopoly, replace it with competitive firms; where there were shortages, free prices to clear the market; where there was inflation, replace with a tight monetary policy; where there was fiscal imbalance, replace with fiscal responsibility; and where there were disincentives to work, institute high powered incentives for work. But this is much easier said than done.(12)

James Buchanan has stressed that work in political economy must begin with the "here and now" and not just postulate whatever start-state of analysis might be desired to make the model tractable if the goal is to retain a level of realism and relevance in political economy (see, e.g., Buchanan 1975, p. 78). Unfortunately, models of the transition that have been developed often fail to appreciate the de facto organizing principles which governed life in the Soviet-type system. Concentration instead was on the de jure statements of what constituted the system.(13) It is this misidentification of the underlying conditions, I contend, which has caused the major problems for economists devising strategies for reform.

The Soviet system (I will use the former Soviet Union exclusively throughout for illustration) was made up a series of interlocking "contracts" and "vested interests", and any attempt to change the system must being with this institutional inheritance. If the Soviet system actually was a land without any ownership claims, then post-communist reforms would be immeasurably simpler than they are -- even given the cultural conditioning often invoked to explain the resistance to reform. The social fact is, though, that many limited -- though tacitly legitimated -- ownership claims had been established through the economic system. The implication for the transition of this is that what is required is the divesture of some interests, the legitimation of others, and the creation of conditions so that others can be determined in the new social arena of politics and law.

Markets are like weeds, they crop up anytime there exists an opportunity for individuals to improve their condition through exchange. Also like weeds, markets are amazingly resilient. Attempt to stamp them out here, and the grow over there. The market in some fundamental sense is inescapable. In other words, the market is omnipresent -- including in so-called command economies.

The socialist regime did not abolish the market anymore than the prohibition on alcohol in the 1920s stamped out the buying and selling of liquor. We know from historical examination of the War Communism period (1918-1921), that even during the height of the campaign against all forms of capitalist relationships (and the threat of death) some individuals still found it advantageous to enter the "black market". Of course, in both the attempt to eliminate commodity production in the Soviet Union and the attempt at prohibition in the United State, the nature of the market was transformed by the de jure structure, but if we want to understand how the market operated the de facto rules have to be the focus of our attention.(14)

At the time of the introduction of radical market reforms in Russia (January 1992), there existed an array of ownership claims. The right of ownership constitutes a claim to (1) a right to use the asset, (2) the right to appropriate the returns from the asset, and (3) the right to change the asset's form and substance (see Furubotn and Pejovich 1974). By institution I mean the formal and informal rules governing the social intercourse under discussion. In this regard, when discussing the institution of ownership we are attempting to specify those formal and informal rules which govern the use, transfer and capitalization of an asset. In a world where formal rules are absent or defined in an incoherent manner, informal rules emerge to provide a governance structure within which economic decisions will be made. How effective or ineffective this system of governance will be is an empirical matter. Both formal and informal rules can imperfectly define rights and lead to social conflict. In pre-Yeltsin Russia, private property was not abolished despite the formal rules which said so. As Yoram Barzel has put it: "The claim that private property has been abolished in communist states and that all property there belongs to the state seems to me to be an attempt to divert attention from who the true owners of the property are. It seems that these owners also own the rights to terminology" (1989, p. 104, fn. 8).

The idea of collective property is incoherent. Within the ambiguous social arrangement created by the demand for observance to a incoherent formal rule, informal rules evolve to govern social affairs and ward off collapse.(15) "The distinction between the private and public sectors," Barzel states, "is not a distinction between the presence and absence of private property rights. Such rights are necessarily present in both systems. The distinction lies instead in organization, and particularly in the incentives and rewards under which producers tend to operate" (1989, p. 107). Comparative political economy is a research program which attempts to shed light on the effect on economic performance of alternative political and economic institutional arrangements. But that requires that the analyst correctly specify the alternatives being compared.

The path from "here to there" requires then not only an idea of the "there" intended, but also the "here" from which one is starting, before an appropriate strategy for the path can be determined. With regard to the question under examination (i.e., the transfer of ownership) the steps required for the divesture of property from some owners, the legitimation of property held by others, and the establishment of conditions for the attainment, use, transformation, capitalization, and transfer of assets for new owners are the focus of attention. The appropriate policy path is necessarily multidimensional, and grounded in the previous historical pattern of ownership. As David Stark (1992) has argued that postcommunist developments are following a path-dependent trajectory, and that therefore it is more appropriate to view postcommunism as a process of transforming existing institutions, rather than a transition to new economic order lying outside of history.


In addition to the multidimensional aspects of ownership transfer, once the de facto property claims of the previous system are specified it becomes clear that reform must tackle the issue of "embeddedness" as discussed in the economic sociology literature.(16) The usual implications drawn from analysis of social transformations when concepts such as "path dependency" and "embeddedness" are introduced is one which cuts against laissez-faire.(17) Yavlinsky and Braguinsky are but one example of this trend. They argue that the postcommunist era in Russia has been plagued by "various old diseases, including continued misallocation of resources due to distorted market signals and sharp social divisions based not on the true market value of individuals but on their access to bureaucratic levers or inside information, as well as from several new ones, among them a general breakdown of law and order and hyperinflation amid dramatic falls in investment and output" (1994, p. 90). As they point out, in 1993 the inflation rate in Russia stood at 20-30% per month, and the budget deficit was 20-25% of GDP. In combination with fall in production and investment, the government was forced to retain its bureaucratic structure of economic management and its high level of involvement within the economy despite the laissez-faire ideological rhetoric. "The failure of shock therapy was partly due to bad policy implementation, but the main reason consists in the deficiencies inherent in the approach itself. Those deficiencies, not yet fully accommodated by mainstream analysis, arise from the failure to take into account the strong institutional hysteresis in almost all market and government activities. Overcoming this hysteresis would require what we call policy-led transformation design and implementation. In other words, the laissez-faire approach cannot free the economy from its inefficient structure. Instead, it frees this inefficient structure from itself" (Yavlinsky and Braguinsky 1994, pp. 90-91).

Arguments from embeddedness are often used to challenge the idea of limited government in modern economic life. The Nation-State plays a necessarily active role in industrial transformation because the government provides goods and services that are essential for economic development. Without the Nation-State, the argument goes, the market and other institutions of modern society cannot work. This argument is an important one. Markets are indeed embedded within (and operate on the basis of) a governance structure -- the formal component of which has in contemporary history been the domain of the Nation-State. But the Nation-State is itself embedded within a set of underlying cultural beliefs. The center is rarely, if ever, truly uninhibited -- even within a totalitarian system. Pockets of civil society (perhaps sub rosa) emerge to challenge the legitimacy and power of the all-powerful. The center is inhibited, not only by formal rules of limited government, but by the legitimating authority of civil society. Successful political and economic transformation, however, requires the development of transparent formal rules to subordinate the center to the rule of law, and the key issue for this transformation is how to work through the indigenous institutions of inhibition to legitimate formal rules of subordination.(18) The contrast is really not between the State vs. the Market, but rather the State vs. Civil Society, within which market activity and non-market voluntary association co-exist. In an ironic twist, the public space required by civil society for political voice might only be possible when the private space of market competition is guaranteed. Looking at the issue slightly differently leads to widely different implications for the manner in which privatization (and transition policy in general) is to be pursued.

In Embedded Autonomy (1995), Peter Evans provides a comparative historical political-economic-sociology of the industrial transformation. His empirical work is derived from cases studies of the information technology industry in Brazil, India, and Korea. The framework adopted is one which emphasizes both the need for the Nation-State to productively provide the "collective good" infrastructure of modern industrial society, yet at the same time prevent interest groups from transforming the state into a force of predation. Moreover, in framing the question in this manner, Evans moves beyond the "sterile" ideological debate and highlights the central role the State has come to occupy in modern industrial transformations.(19) But Evans in attempting to overcome the State vs. Market rhetoric, falls into two misconceptions. First, in stressing the necessity of the Nation-State in industrial transformation he fails to distinguish adequately the role of the state in its protective capacity, its productive capacity, and how "the protective state must ride herd on the possible excesses of the productive state that is its complement" (Buchanan 1975, p. 105). In failing to distinguish between these separate roles of the state, Evans is led to argue that both the communist and the post-communist experiment with the "withering away" of the state led to undesirable consequences, as if the experiments had something in common with each other. Second, because Evans mischaracterizes what he terms "neo-utilitarian" political economy, the Madisonian dilemma of first empowering and then constraining the state is lost in the analysis. Though he repeats acceptable arguments against standard neoclassical theory, the theorists which Evans believes he is setting his position off against agree with this critique. In other words, the new institutional authors, of which public choice scholars are but a variant (especially the constitutional political economy of Buchanan), fully recognize the givenness of the Nation-state in modern economic life. The critique of Granovetter and others is actually an attack on the text-book model, which is far removed from the center of modern research in political economy.(20) In fact, a plausible claim could be made that modern research in economics is dominated by market failure theory (e.g., Stiglitz), rather than the text-book perfect competition model. The interconnection between these ideas (i.e., that imperfect competition is actually a derivative of the model of perfect competition and not an examination of the empirical world of economic life itself) should actually be a cause of concern for those who believe the theory of imperfect markets to justify their claim for interventionism. Both perfect market and imperfect market theorists in economics, by confusing the model with the world they are supposed to study, suffer from the problem of misplaced concreteness.

New Institutionalist scholars have always recognized the role of the Nation-State in economic life, and in economic development in general. But they tend to stress, as Douglass North has put it, the dilemma that "The existence of a state is essential for economic growth; the state, however, is the source of man-made economic decline" (1981, p. 20). In North's analysis the puzzle to be solved is why property rights structures which promote economic development have been so seldom selected in economic history. The answer he offers is that the moments when the coincidence between the ruling class's interest and the property rights arrangement which would generate sustained economic growth are rare. Yet, there is a persistent pressure for the ruling class to establish more efficient property rights arrangements, and modify the pre-existing arrangement in a more efficient direction or lose out to more efficient neighbors in the competition between Nation-States (not the least is a function of the revenue raising methods adopted to finance the war-making capabilities of the Nation-State).

To reiterate my earlier point, the question is not the absence of property rights in one regime and the establishment of them in another. De facto property rights are claimed across regimes. The primary question is one of specifying what institutional configuration emerges to correspond with the de facto property rights system organizing social affairs. Once a correct specification is made, then the question turns to adjustment and modification of the existing system. The economist's stricture that history does not move in giant leaps, but in marginal adjustments is as accurate for institutional change as it is for market clearing adjustments.

Applied microeconomics (understood at least in some traditions) is all about the context of decision-making, and how that context affects perception of costs and benefits, and how changes in the context lead to adjustments on the margin of decision. Only a hyper-formalism of the mid-twentieth century could result in an economic analysis which denied that the institutional context of choice mattered for economic performance.

Douglass North is not the only scholar to emphasis the embeddedness of economic activity within the State. Warren Samuels has been one of the most persistent critics of analysis which fails to recognize the fundamental interconnectedness of polity and economy. "There is," Samuels (1971, pp. 143-144), "an ineluctable set of choices with which government -- the state, law, the legal process -- is inextricably bound up: choices as to relative rights (whose rights are to be effectively paramount to whose?), choices as to the visitation of injury (who will be allowed to injure whom, or who will be sacrificed to whom; and when is an injury to be recognized as such in law) and choices as to who will be exposed to whose coercive power. In all these matters the state must and does choose." The upshot of this fact of social processes, according to Samuels, is that "Market forces emerge and take on shape and slope only within the pattern of iter alia, legal choices as to relative rights, relative exposure to injury and relative coercive advantage or disadvantage." In a more recent article, Samuels has put the point as follows:

There is a legal-economic nexus in which it may appear that government and economy interact as separate social processes but in which what actually happens is that each is fundamentally involved in the (re)determination of the other and thereby of social reality. This happens at the margin of social evolution, and it is to the (re)definition and (re)construction of this margin through legal change that selective perception operates and competing ideologies are brought to bear. At that margin, the economy is an object of legal control - change in the service of economic actors and the law is an instrument of economic advantage, but through selective perception such is either passively or actively obscured (1989, p. 161).

Samuels, like Evans, pushes the discourse beyond the "intervention" vs. "non-intervention" debate. But, Samuels also emphasizes how the state can be employed as an engine of redistribution for some at the expense of others. In other words, the state is by nature non-neutral. However, Samuels -- like Evans -- tends to see the laissez-faire argument as one dependent on the insistence of not only a conceptual separation, but an actual separation, of the polity and economy.

But the goal of non-neutrality of the State must not be confused with the assumption of non-neutrality.(21) The government by its nature cannot be neutral. In designing rules of governance, however, we can strive for neutrality. The liberal theory of the state is grounded in this attempt to square the circle of empowering, yet constraining against the dominance of factions within political economy. The steps necessary for empowerment of government create the opportunity for the use of the government to advantage some over others. How this can be accomplished is not only a question of constitutional creativity, but must also recognize the underlying ideology of the history in question. The question is not one of contrasting ideology vs. interest, but instead of examining the interrelationship between ideology and interests.

Constraint on actions come not just from formal rules of governance, but the informal rules rooted in "culture". Hayek (and others) have stressed the tacit presumption which undergird the formal adoption of law. In this sense, law is seen as a codification, as opposed to creation, of rules of the social game which already attained a level of legitimacy through de facto observance. Attempts to impose rules unconnected to the pre-existing social practice, are limited.

Markets are indeed embedded in the Nation-State, but the Nation-State is embedded in the culture of global commercial civilization, if only because the Nation-State must raise revenue to compete in the laissez-faire setting of international relations. The arrow runs in both directions. Governance is required for the market to operate in a manner conducive for modern industrialization, but governance is also a function of market forces. Rules of the game engender patterns of exchange and production, and the emerging pattern of exchange and production aid in the selection between different rule regimes.(22)

This double embeddedness challenges both theories of the transition which assume that we can begin the world anew, and theories which see the necessity of the State to guide the transition process because the transition is too important to be left to the market. The pre-existing property rights have to be recognized as the beginning point of transition policy, and the empowering, yet corrupting, role of the Nation-State must be the focal analytical puzzle.

The implications for social theory of "bringing the state back in" go far beyond the practical issues involved in the transition from state socialism. As Peter Murrell (1995, pp. 170-171) points out:

Questions of how property rights are established, secured, and efficiently reassigned are often downplayed when examining stable capitalist societies, or they receive mundane technical answers. These questions generate new interest and new forms when examining a society that has only informal, unclear, and tangled property rights. There is need to understand which formalization of stakeholder rights affords the highest probability of efficient bargains being struck in the future. Clarification of the role of customary property rights in economic activity is essential. One must grasp exactly why politically inspired intervention (or corruption) reduce economic efficiency. Reformers must ask which process is likely to lead to the formation of a social consensus that endorses a system of secure property rights. These are all issues raised most directly by the transition, but reflection upon them will surely lead to advances in our understanding of capitalist societies in general.


The industrial situation prior to the fall of the Soviet Union was that of state-sponsored monopoly. It was estimated by Gosnab in 1990 that 80% of the volume of output in the machine-building industry was manufactured by monopolists, and that 77% of the enterprises in machine-building were monopoly producers of particular commodities. Locomotive cranes, tram rails, sewing machines, coking equipment, hoists for coal mines, and sucker-rod pumps were produced by pure monopolists within the Soviet economy. About 2,000 enterprises were sole producers of specific products throughout the Soviet Union (see Kroll 1991, pp. 144-45). In the Soviet context discussions of market share or even natural monopoly are not the issue, the monopolistic character of the industrial economy was a result of a conscious and active effort by the government. In addition, many of the monopoly producers were often encouraged to vertically integrate as much as possible.

Privatization was conceived as a form of demonopolization/depolitization policy. As Boycko, Shleifer and Vishny (1995, p. 11) state: "The goal of privatization was to sever the link between enterprise managers and politicians ... so as to force firms to cater to consumers and shareholders rather than politicians." Boycko, Shleifer and Vishny claim at one point in their narrative on Russian privatization that depolitization of firms was the most important objective of the privatization policy, and that the strategy chosen was to concentrate control and cash flow rights in the hands of enterprise managers and outside investors in order to speed the transition and minimize opposition (see 1995, p. 69). Contrast this with the European Bank for Reconstruction and Development's 1997 Transition Report which claims that the purpose of privatization programs are to stimulate economic growth by enhancing the performance of former state firms. One approach to privatization focuses on depolitization and creating conditions for entry, the other focuses on improvement in the efficiency of the pre-existing industrial structure through improve incentives and accountability.

As I have tried to argue above, the decoupling of the state and enterprises need not imply a rejection of the analytical importance of issues of embeddedness of the economic process (nor does a recognition of embeddedness favor a normative endorsement of intervention). Rather, one is simply calling for putting the political back into political economy. This exercise commences with recognizing that the pre-existing set of arrangements (represented in this case in control rights and limited cash flow rights) will not be redefined costlessly. Along these lines, Tollison and Wagner (1991) have offered realist insights into the political economy of reform, which are to be contrasted with the romantic vision often adopted. They postulate an existing situation of monopoly (it does not matter whether the monopoly was acquired by accident or by intention). The question raised is to compare the benefits and costs of reform when dealing with (1) a passive monopolist, and (2) an active monopolist, on the one hand, and a (1) utilitarian reformer, and (2) factional reformer -- who can either be a consumer oriented reformer, or a producer oriented reformer, on the other. The passive monopolist will do nothing in the face of reform activity, the active monopolist will expend resources to fight reform. The utilitarian reformer will seek to implement policies which will increase national income. The factional reformer will be concerned that benefits fall to the "right" people.

Tollison and Wagner introduce a standard textbook model of a monopoly that could alternatively be configured to be a competitive industry for point of comparison. The textbook approach to this issue assumes that the reformer is a utilitarian and that the monopoly position was obtained unintentionally. In this familiar framework, the cost of the monopoly is said to be H (named after Harberger), which reflects the "deadweight loss" due to the monopolistic situation -- gains from trade are going unexploited. The transfer of surplus from consumer to producer (T) is not a cost to the utilitarian reformer, it is a cost to the factional reformer. To a consumer oriented reformer, T+H would be the cost, to a producer oriented reformer T would be a benefit, so the cost of monopoly would be H-T (in other words, there would be no cost, just benefit).

To the utilitarian reformer, the benefit of demonopolization is H, irrespective if the monopoly position was achieved by accident or by intention. The costs of instituting the reforming must be balanced against the benefits. And it doesn't matter whether the monopoly position was achieved by accident or intention, once achieved the transfer of T provides an incentive to fight against attempts to redistribute T. In short, the monopolist will not be passive. And, when this is taken into account it is evident within the one-short game that if T exceeds H, then the cost of reform outweigh the benefits. Overtime, repair of the economic deformity through reform might yield sufficient benefits to warrant the effort. But what they demonstrate is that this is result does not automatically follow from the model. "Our analysis ... argues that there is no socially beneficial reform of the rent-seeking society, at least with respect to reforming past deformities" (1991, p. 67). Within the rent-seeking society, reforms yield benefits only because the factional reformer does not pay attention to the cost-benefit structure in general, but only to the benefits yielded to the favored faction.

The implication of their model is particularly relevant to the topic at hand -- Russian industrial restructuring. Once it is recognized that the Yeltsin government inherited an existing property rights structure and not a system absent property rights, then attempts to redefine those rights will meet with resistance. Reforming the pre-existing deformities entail costs, costs associated with what Tullock has terms the "transitional gains trap" (see Tullock 1980). The rent-seeking society is one where the benefits from government granting monopolistic position to producers yields only short-term and fleeting gains to the producers. After the original transition, the monopoly rent will be fully capitalized in the competition for that rent (or in the opportunity cost of existing beneficiaries). Supernormal profits will no longer accrue to the monopolist. However, while no one would be currently benefiting as was the case when the privileged position was first instituted, a large number of people would suffer transitional losses is the position was eliminated.(23) The transaction costs associated with constructing the appropriate "buy out" are usually seen as prohibitive. For this, and other reasons, effort might be better spent concentrating on establishing rules of the political game which prevent future deformities, rather than attempting to eradicate post ones.

A major issue of concern to some scholars on privatization is the issue of corporate governance (see, e.g., Frydman and Rapaczynski 1994, pp. 46-74). And, there is little doubt that the evolution of a corporate governance system is an essential component in the discipline of the market which compels economic actors to discover betters ways to arrange their production plans so as to satisfy consumer demands. Corporate governance, though, is a resultant of the market process, not a cause.(24) Establishing effective rules of corporate governance on the pre-existing firms is a backward looking approach to reform. As Boycko, Shleifer and Vishny (1995, p. 65) put it: "controlling managers is not nearly as important as controlling politicians, since managers' interests are generally much closer to economic efficiency than those of politicians. Once depolitization is accomplished, the secondary goal of establishing corporate governance can be addressed."

There has been too much emphasis placed on fixing the past, rather than concern with the future. Again, there are costs -- sometimes quite high -- associated with attempting to restructure an existing system, and these costs might outweigh the benefits sought if we only look at that particular industry. The great benefit of privatization in the Russian context, is not efficiency gains, but the basic redefinition of the relationship between the economy and polity. Transformation requires credible commitments to limit the influence of the polity on future economic decisions. If one looks at matters this way, then privatization no longer is seen as either a vehicle for efficient industrial restructuring or social justice. Instead, it is but a part of a package seeking to establish a credible commitment to a new political-economic order.


If the discussion presented in the last section can serve as the basis for a realist political economy model of industrial reform, then the emphasis on privatization and corporate restructuring (however laudable) may be judged as misguided. The social transformation required will not come from restructuring existing industry, but from creating conditions which lead to the introduction of new industry and competition from both below and abroad. Obviously, competitive entry will compel the pre-existing structure to mutate, but the metamorphosis of the old system is not the point of policy -- it is a by-product.

Entry of new competitors from below and abroad bring in benefits beyond the improvements in organizational efficiency. Competition compels individuals and firms to employ the existing stock of technological information in the most efficient manner possible. But new competition also prods economic actors to discover new technological knowledge which expands economic possibilities. In addition, competition from abroad, in a situation where the previous regime was closed and highly regulated, imports not only improved technology and management practices, but a pricing structure which is more or less determined by market forces.

As competition from below and abroad challenges the old order, one can expect that the old order will attempt to use its position to stave off the threat. The not-so-subtle difference between policies which protect competitive entry and those which protect against competition are usually wrapped in a policy rhetoric which is more subtle and difficult to decipher.(25)

When the attempt to leap into communism failed, for example, the Bolshevik regime re-introduced private ownership and above ground market transactions.(26) This was a decidedly pragmatic move on the part of the party elite to maintain political control. It was a decision which did not sit well with the ideologically pure of heart. But theorists, such as Nikolai Bukharin, reasoned along Fabian lines to assuage doubt. Socialist firms were supposed to be able to out compete capitalist firms in satisfying consumers simply because they would be able to price equal to cost, rather than concern themselves with profit. Thus, while limited private enterprise could be introduced, there was no need to worry among socialists. But the socialist competition promised was never allowed to take place within certain key economic sectors.

The result of the industrial reorganization of the economy that took place under the New Economic Policy (industrial plan released August 9, 1921) was that by 1923 of the 165,781 enterprises accounted for in an industrial census 147,471 or 88.5 percent were owned by private persons, 13,697 or 8.5 percent were state owned, and 4,613 or 3.1 percent were cooperative enterprises. Although private enterprise amounted to 88.5 percent of the total enterprises, they employed only 12.4 percent of the total number of workers employed in industry, while the state-owned enterprises, which comprised only 8.5 percent of the total enterprises, employed 84.1 percent of employed workers. Thus the state was freed from administrating small enterprises, while at the same time holding fast to the industrial base of Russian society. The "commanding heights" of industry remained state property (see Boettke 1990, p. 116).

But despite (or perhaps because) the still obvious domination of the government in economic decisions, the New Economic Policy failed in the end to provide the economic recovery that was hoped for, and in 1928, the collectivization and industrialization drive (and the institutionalization of the Five-Year Planning System) put an end to the NEP. For present purposes, what is of concern is to focus attention on the empirical magnitude of transition efforts (either during NEP or during the Yeltsin post-communist period). If 8.5 percent of industrial enterprises, which are state-owned, employ 84.1 percent of the work force, then I'd say that the magnitude of the industrial restructuring away from the previous ownership structure had not progressed very far (despite the 88.5 percent of firms being private).

Looking at the empirical information on current Russian privatization we must keep this point in mind. It is my contention that successful transition will be evidenced not by the transfer of former state-owned firms to private hand (however important that might be), but through the establishment of institutional conditions such that private newly created firms come to dominate the economic scene. The industrial reallocation necessary will not come from putting old wine in new bottles, but from the production of new wine, so to speak. If most measured economic activity remains in either the state sector or in mixed ownership structures, then despite privatization activity we could be witnessing a process similar to that experienced under the NEP, where the main organs of economic life remain outside of the entrepreneurial rivalry of transparent market competition.(27)

The restructuring of existing economic entities, or macroeconomic stabilization policies, or for that matter, technological change are not the sources of economic development and prosperity. Neither entrepreneurship nor technological innovation are the source of economic development alone. Entrepreneurship, for example, exists across different economic circumstances and can be said to exist whenever individuals are alert to opportunities to benefit from activity that hitherto had been overlooked. But for entrepreneurship to generate generalized prosperity, rather than particular prosperity certain rules of the economic game must be in place so as to channel individual rationality in a manner which leads to public benefits. The institutional configuration which enabled this "translation" of self-love into public benefit was termed "the system of natural liberty" by Adam Smith, and as Buchanan has pointed out, the Smithian claim amounted to a scientific demonstration that individual autonomy, generalized prosperity and peaceful international relations could be acheived simultaneously under the system of natural liberty.

To realize the benefits in terms of more efficient production within the given state of technological knowledge, and even more importantly, the increases in productive capacity and exchange efficiency due to the discovery of new technologies and new opportunities, policies that enable entrepreneurship and risk taking must be adopted. "The policies must be such that entrepreneurs and merchants are willing to take risks and find the financing to bring these risks to life. When entrepreneurship is discouraged, the opportunities technical know-how provides stay unexploited. The state can offer the stability necessary for entrepreneurship to flourish, smoothing the way for opportunities to be discovered" (Brenner 1994, p. 52). A preoccupation with the past, or on aggregate measures designed to convey knowledge of the economic health of the Nation-State as a unit, misdirects attention from the appropriate issue of building institutions which allow novelty to come to life. As Marshall Goldman has stated with regard to the postcommunist efforts in Russia: "Under the best circumstances the reform would still have required decades to undo the damage inherited from the decades of central planning. Nonetheless, Yeltsin and Gaidar and their associates and Western advisers can and should be faulted for concentrating so much on monetary, fiscal and price reform and not enough on new investment and institution and infrastructure building. Had they done the latter, there would still have been difficulties, but there might also have been a few more success stories" (1996, p. 144).


After the failed coup of August 1991, the path was cleared for Yeltsin to pursue a radical approach to economic reform. The era of Gorbachev and the reform communism was over. In November of 1991, a reform government was formed and Anatoly Chubais was named minister of privatization and chairman of the State Committee for the Management of State Property. Throughout 1992 a debate over the strategies and goals of privatization took place. A figure of 70% of the economy was targeted for privatization. Obviously, the political battles over privatization were intense as the various vested interests maneuvered to protect themselves from change. In the Summer of 1992, Yeltsin chose to wrap the privatization campaign in the rhetoric of "people's capitalism" and with that the voucher privatization program. The basic idea was to distribute to each citizen a privatization voucher worth a nominal value of 10,000 rubles. As of October 1992, Russian citizens could pick up their voucher for a fee of 20 rubles. Once in hand, citizens could do one of three things: (1) sit on the voucher until June 1994 [the original date was December 1993] at which time they would become void; (2) sell their vouchers to others at a market price [by February 1993 the price had fallen to 3,900 rubles, though the price did rebound to 10,000 by June 1993]; and (3) swap the voucher for shares in a joint stock company. In the wake of voucher distribution mutual investment funds emerged. In exchange for vouchers, citizens would receive shares in the mutual fund. The funds would take the vouchers obtained and purchase shares in newly privatized enterprises. Investors, on the other side of the exchange, were able to diversify their holdings. The idea caught on, and there was an explosion of mutual funds. The MMM scandal was the most notorious of the failures of this by product of voucher privatization, which promised unrealistic returns and was able to pay off to early investors by relying on flow of resources from new investors (in other words, a classic pyramid scheme). Despite the troubles, by March 1994 it could be claimed by Chubais that: "the promised crash has not occurred and it can no longer occur. More than half of our gross national product is already produced outside of the state sector" (as quoted in Åslund 1995, pp. 265-266).

Measuring the effect of privatization on the transformation of the Russian economy is not easy. Given the theoretical conjectures offered above concerning the (1) costliness of restructuring pre-existing deformities, and (2) the relative role of entrepreneurship and novelty in economic development, I would look at issues like the growth of new enterprises and the percentage of the labor force in new industry as opposed to privatized firms. In addition, it is important to be clear exactly about what privatization means in this context. Hybrid forms of enterprise, which are actually some mixed ownership type, do not constitute privatization though by some accounting they do. And, to the extent that hybrid forms come to dominate the political process this would be suggestive that conjecture concerning the political economy of restructuring possess predictive value.(28)

It must be admitted that at first glance the privatization program in Russia has been significant. The following table reflects the magnitude.

Russian Privatization

End of Month Total number of privatized firms Industrial workers in private enterprise


March 1992 1,352
April 2,995
May 5,855
June 8,933
July 12,015
September 22,572
October 29,235
November 34,932
December 46,815 0.2
January 1993 54,243 1.1
February 57,989 2.0
March 59,495 4.6
April 66,000 8.6
May 68,000 11.3
June 72,000 15.5
July 78,000 19.1
August 81,000 22.9
September 82,000 26.8
October 83,000 30.9
November 86,000 35.1
December 89,000 40.0
January 1994 91,000 43.1
February 93,000 49.1
March 95,000 54.0
April 98,000 59.8
May 99,000 65.0
June 102,000 81.8
July 104,000
August 106,000
September 108,000
October 109,000
November 110,000
December 112,000
January 1995 113,000
February 114,000
March 115,000
April 116,000
May 116,000
June 117,000
July 117,000
August 118,000
September 118,000
October 119,500
November 120,800
December 122,000
January 1996 122,400
February 122,900
March 123,400
April 123,900
May 124,200

Source: Russian Economic Trends (September 1996), table 12.

While these changes are impressive, we must be willing to look behind the numbers. State and municipal enterprises are counted as privatized provided there is a decision to transform the enterprise into a joint stock company, and there is an approved plan for privatization. So the level of activity recorded may overestimate the actual privatization. This is reflected in the numbers when we look at the allocation of enterprises by ownership type in the Russian economy. According to data from Goskomostat (1996): state-owned firms constitute 10.7% of all economic organizations in 1996; federal property, 6.3%; property of the Federation, 4.4%; municipal property, 8.8%; public associations, 4.2%; private property, 63.4%; and other mixed property and others types of ownership, 12.9%.

It is also useful to look at employment information to gain some perspective on the economic developments in Russia over the past few years.

Employment by Ownership, 1990-1993


1990 1991 1992 1993
Total Employment 75.3 73.8 72.0 71.0
State and municipal sector 62.2 55.7 48.2 41.5
Enterprises of mixed ownership 3.0 7.5 8.3 12.1
Social Organization 0.6 0.7 0.6 0.5
Joint Ventures 0.1 0.1 0.2 0.3
Private sector 9.4 9.8 14.7 16.6

Source: Goskomostat, 1993.

By 1994, it is estimated that 60 % of the labor force was working primarily in the private sector. However, even this might underestimate things because much private activities still tend to go unreported in order to evade taxation and registration. Goskomostat estimated that in 1993 there were already 700,000 small enterprises, and accounting for 11.5 per cent of all employment. From reported figures, 58% of Russian small enterprises are in trade, and 75% of retail trade is estimated to be accounted for by new private firms (see Åslund 1995, pp. 263-264).

What is significant for my purposes, however, is how difficult it is to report on the activity of new private enterprise. From reports we have both "unprecedented" privatization -- ninety percent of industrial output is said to have passed into private hand -- yet state control remains in a large share of supposedly privatized firms. As Blasi, Kroumova, and Kruse (1997) report:

The market is risky, it is unpleasant, it is not egalitarian; and it tempts the Russian state -- whoever possesses the state power at the end of each election -- to try to tame and control it in the interests of politicians. The fact is that the Russian state still owns more than 10 percent of about a third of all the already privatized corporations in the country and more than 20 percent of a quarter of them. On average, according to recent estimates, the state owns over a third interest in the top 50 corporations in the country and may own a modest interest in the next 250 large corporations, which may help determine who ultimately controls those companies. The state and existing owners or aspiring owners will struggle over what happens to this residual state interest -- which does not include several thousand firms that were never privatized in areas as diverse as coal, precious metals, health and communication services. The partial or full state role in these firms suggests a continuation of subsidies, a drain on the state budget, and ongoing attempts to combine economic and political activity (pp. 168-9).

The Yelstin years have witnessed a continuation of what was already prevalent under the Gorbachev regime, the continuation -- in fact, the expansion -- of the black market activity (or at least unrecorded economic activity) at a time when the policy regime is supposedly favorable toward the development and expansion of markets. This is because registration and taxation remain impediments to the development of new enterprise and the discovery of better ways to satisfy consumer. Ambiguity and poor enforcement of property and contract by the official government has led to the rise of alternative enforcement mechanisms --- some desirable, some not. Compare the situation in Moscow and Warsaw for setting up a private shop, as reported in table 3 of the April 1997 issue of Russian Economic Trends. The average time for registration (in months) is 2.7 in Moscow, but only .7 in Warsaw. The average number of inspections conducted last year at a private shop were 19 in Moscow, and 9 in Warsaw. In Moscow the percentage of shops fined by inspectors last year was 83% compared to 46% in Warsaw. Finally, 39% of private shops in Moscow report being contacted by the Mafia in the last 6 months, while only 8% of the shops in Warsaw report similar contact. The steps taken over the past few years have been drastic, but the further development of the Russian economy will rest with the ability to establish institutions of governance which reduce political uncertainty and maintain the balance in the political economy between tradition and novelty -- which is essential for the entrepreneurial process of development.


The political scientist Russell Hardin (1993) has argued that economic and political liberalism have an interesting history. Economic liberalism was a practice in search of a theory, while political liberalism was a theory in search of a practice. The double transition in postcommunist Russia is attempting to bring into coincidence these two liberal doctrines. But as Hardin's historical quip should remind us, while economic liberalism is not a result of constructivism -- political liberalism might require a form of constructivism (a fact Buchanan has also stressed in opposition to Hayek).And what is most important to emphasize is that the form of that construction of the polity is not benign with regard to the operational properties we can attribute to the spontaneous order of the market. Privatization policy is but one example of the transition process which highlights this tension -- as models of privatization from above may actually impede the privatization from below.

If the Soviet and postcommunist experience can teach us anything it is that we must, as Richard Ericson has put it, " abandon the Faustian urge to control, to know in advance, and thus to allow economic outcomes to arise naturally as the unpredictable consequences of market interaction" (Ericson 1991, p. 26). At the same time, we have to redirect our efforts to questions of the institutional framework within which activities beyond our control will take place.

It is not a question of policy-led or laissez-faire policy, if by that one means no constructivist impulse is to be followed. Rather, the question is one of cultivating the free play of economic forces by constructing the appropriate institutions of the state. Economic performance is a consequence of the social ecology within which it is embedded, but the trick is that this social ecology is made up of forces which are exogenously given by history, endogenously generated by commercial interaction, and the interaction between these two forces which mutate both the formal and informal rules of governance and how they are interpreted and legitimated. The analyst of social processes -- brought so much to the forefront in transition discussions -- must possess the keen sense and wise judgement to know the potential and limits of rationally organized social relations. In other words, evolution and design (both in terms of design within evolutionary processes, and evolutionary selection between designs) must be accounted for. Analysts of the privatization process have committed an error with their preoccupation with design (represented in restructuring of the old industrial base) in policy discussion, when the social process itself (independent of economists) has actually proceeded along evolutionary designs as new entrants have attempted to emerge to exploit the profit opportunities that await those who can satisfy consumer demand. These efforts, however, have to a large extent been directed underground, rather than above ground, so as to avoid private and public predation. Thus, Russia still lags behind what could be achieved precisely because designs of policy are in conflict with above ground long term investment (both domestic and foreign) in new industrial enterprises.



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1. Department of Economics & Finance, Manhattan College and Senior Research Associate, Austrian Economics Program, New York University. An earlier version of this material was presented at seminars at Dickinson College, Manhattan College, Villanova University, New York University, the Institute for Humane Studies (George Mason University), the Institute for Economic Affairs (London), and the "Civil Society and Social Capital Working Group" Woodrow Wilson Center, Kennan Institute (Washington, DC), Max Planck Institute for Research into Economic Systems (Jena, Germany) and I would like to thank the participants at these seminars for their comments. Financial assistance from the J.M.Kaplan Fund, and the Sarah Scaife Foundation in support of the Austrian Economics Program at NYU is gratefully acknowledged. Responsibility for errors is my own.

2. The following macroeconomic data conveys something of this difference in the transition. The proxy for reform employed by Sachs and Warner is trade liberalization.

Growth Rates of the Transition Economies

---------------------------------------------------------------------------------------------------- ---------------------------------------

Strength of Year of Cumulative Growth

Country trade reform trade reform growth 1989-94 1994

---------------------------------------------------------------------------------------------------- --------------------------------------

Strong Reforms

Hungary 4 1990 -17.94 2.00

Poland 4 1990 -09.23 5.00

Bulgaria 4 1991 -26.41 1.40

Czech Republic 4 1991 -15.49 3.00

Slovak Republic 4 1991 -19.53 5.00

Slovenia 4 1991 -13.26 5.00

Albania 4 1992 -22.89 7.00

Estonia 4 1992 -29.15 5.00

Romania 4 1992 -30.79 3.00

Croatia 4 1993 -31.04 1.00

Latvia 4 1993 -39.52 3.00

Lithuania 4 1993 -55.44 2.00

Average -25.89 3.53

Moderate Reforms

Kyrgyzstan 3 1994 -42.30 -10.00

Russia 3 closed -47.29 -15.00

Average -42.61 -12.50

Weak Reforms

FYR Macedonia 2 1994 -51.30 -07.00

Moldova 2 1994 -54.30 -25.00

Armenia 2 closed -61.60 00.00

Kasakhstan 2 closed -51.01 -25.00

Uzbekistan 2 closed -11.75 -03.00

Average -45.99 -12.00

Weakest Reforms

Belarus 1 1994 -35.93 -22.00

Azerbaijan 1 closed -54.32 -22.00

Georgia 1 closed -85.35 -35.00

Tajikistan 1 closed -70.37 -25.00

Turkmenistan 1 closed -38.29 -20.00

Ukraine 1 closed -51.36 -23.00

Average -55.95 -24.50

Source: European Bank for Reconstruction and Development as reported in Sachs and Warner (1995, p. 62).

3. I have made my own argument for a version of "shock therapy" in Boettke (1993, pp. 106-131). However, see my cautions against a "constructivism" which does not account for the embeddedness of system within a history in the transition process in Boettke (1994). "Shock therapy" need not be contrasted against evolutionism. Rather, the design of the therapy must be rooted in an understanding of the past and the institutional imprint that implies.

4. For an interpretation of post-WWII Japanese development which emphasizes the political economy choices see Naka, Brough, and Tanaka (1994). This interpretation directly challenges the thesis that it was wise industrial planning that is the cause of Japanese development in the post-War period. In particular, Naka, Brough and Tanaka places great weight on the political-economic institutions which limited the rent-seeking game in Japan. An encompassing, as opposed to narrow, interest characterized the economic horizon.

5. The former liberal political thinker John Gray has used the example of the difficulties of the post-Communist transition to explain his change of mind from classical liberal to post-modern conservative. Gray argues that the ideas of liberal thinkers, such as Hayek or Buchanan, cannot provide guidance for the post-Communist transition due to the historical and cultural specifics of the region. See, for example, Gray (1994).

6. I should state the my phrase "change in the intellectual climate of opinion" is probably mistaken. Given the time frame we are discussing, 1989-1996, there is no way we had a shift in the climate of opinion among professional economists. Rather, opinions on the benefits or limits of the market are rather fixed throughout the period and different interpretations of events flow from these prior fixed beliefs. The confidence with which individuals assert their position, however, might change depending on the general interpretation of the facts. In other words, if you were to ask Alice Amsden in 1989 whether former Communist economies should eliminate all state involvement with economic decisions should we council against such a move, just as Milton Friedman would council for such a move. And, both would hold that same opinion today. Where Friedman sees the unleashing of the market as the spur for progress, Amsden sees the wise council of the state in guiding production. Neither scholar, it should be pointed out, deny the state a role. The argument is over what role. And, this is an argument that has been taking place for several centuries and I would safely conjecture will not be over in any foreseeable future. There was not a change in the intellectual climate of opinion, it is rather just a matter of to which different voice one listens. But this paper is not about the contemporary history of economic ideas so I will not concentrate on the clash of visions which are the backdrop for the different analysis of the situation that is being offered.

7. Weingast (1995) has developed a modern political economy argument in favor of federalism in which discretionary economic regulation is limited to the local level and the federal level simply assures freedom of competition between the local government. This is an argument with which I have great sympathy, but for the present purposes what is important to note is that it represents a theory of the Nation State -- even if it is a limited one compared to the more activitist conception often offered by critics of liberalism.

8. According to Amsden, Kochanowicz and Taylor (1994, p. 18, n. 2) by the late 1980s there emerged a "Washington consensus" influenced by the economic writings of Mises and Hayek. This in an incredulous interpretation of the intellectual landscape. Leaving aside the issue of whether the advise is solid or not, Jeffrey Sachs's approach and policy prescriptions are far removed from the approach of Mises and Hayek to issues on economics and public policy. Sachs, in fact, is a Keynesian economist of some sort or another. The transition to the market policies are to create a market quickly so there is a base with which macroeconomic policy can fine-tune. The typical policy prescription from the "Washington concensus" emphasized macroeconomic stabilization, sequencing of reforms, microeconomic regulation, etc. Far removed from the laissez-faire prescription associated with Mises, or even the more moderate position of Hayek. When I was a visiting professor at the Central European University in Prague in 1993, I had to explain to the scholars and students why a bust of Mises had been given to the school. Moreover, the standard educational approach to economic study at both Center for Economic Research and Graduate Education (Univ. of Pittsburgh and Charles University) and the Central European University was modern neoclassical economics as it is taught in the US -- which is far from free-market in orientation and instead more often than not driven by theories of market failure (e.g., Stiglitz's work). The same was true in Moscow when I visited as a guest of the Academy of Sciences in 1993. Translations of key works by Mises and Hayek, Buchanan and Tullock, and Coase were in progress, but McConnell was already translated and a widely adopted text-book for economic education. Moreover, the translations and publications of the works by free market scholars were being done outside of the academic establishment.

9. On the development of this thesis see Boettke (1988, 1990 & 1993). Also see Jeffrey Friedman (1989 & 1990) who takes the historical thesis developed by Boettke and pushes the argument in a unique way to challenge both the socialist and liberal project. Boettke's historical thesis is influenced by the earlier scholarship of Boris Brutzkus, Michael Polanyi, and Paul Craig Roberts. Recent historical works which pick up on the historical thesis concerning War Communism in Soviet Russia (1918-1921) to some degree are Martin Malia (1994) and Andrzej Walicki (1995).

10. The hypothesis that the former Soviet Union was really a modern version of mercantilism is developed in Anderson and Boettke (1997).

11. For a description of the political economic system as Yeltsin inherited it see Leitzel (1995, pp. 15-45). Also see Frydman, Rapaczynski, Earle, et. al. (1993, pp. 1-82).

12. Just to mention a few of the problems that prevent a smooth step from recognition to implementation: (1) the issue of simultaneity in policy choice; (2) the issue of establishing credible commitments to the reform process; and (3) the issue of legitimation of the new institutional structure.

13. An exception to this was Ed Hewett (1988, pp. 94-220), where he explicitly contrasts the system as it was supposed to work with how the system actually worked.

14. Murray Rothbard made a very pregnant statement along these lines back in the early 1960s when he stated: "the extent of socialism in the present-day world is at the same time underestimated in countries such as the United States and overestimated in Soviet Russia" (1962, p. 830). As Rothbard insisted, while the Soviet economy was a centrally "prohibited" economy, it would be difficult to accurately portray the system as a centrally planned economy. The total calculational chaos of a fully established socialist economy -- rather than the partial "socialism" actually instituted -- would not just be reflected in waste and error, but in collapse of the social system of production.

15. While it is important to stress that de jure pronouncement not withstanding, the system operated on the basis of de facto property rights claims. It is also vital to understanding the systemic inefficiencies that we recognize how the lack of de jure status to these claims attenuates these claims and thus produce incentives for behavior that while individually rational fail to generate an economically efficient social order. By efficient here I do not mean the typical Pareto-Efficient state of affairs, but rather the adaptive efficiency associated with theories of the market process and tendencies for plan coordination among economic actors. Boycko, Shleifer and Vishny (1995, p. 36) make the point about the existence, yet limits to the property rights arrangements: "The structure of ownership under Soviet socialism was thus both different from the textbook model and highly inefficient. The politicians had almost all the control rights, and no cash flow rights. The managers had some of the control rights, but no cash flow rights either. The objectives of the politicians who possessed the control rights were very far removed from the public interest. The virtually complete political control without countervailing cash flow rights to moderate political temptations did not constitute an efficient ownership structure."

16. On the general issue of embeddedness see Granovetter (1985). The argument I am making is obviously taking this literature in a different direction.

17. However, see the analysis of the theory of path dependency by Liebowitz and Margolis (1995) and the implications for policy relevant research in political economy.

18. As I argued above markets exist everywhere and always, but illicit markets cannot serve as the basis for which advanced industrial production. Among the reasons for this limiting factor of illicit markets is the inability to translate the lure of profit in this sector into long term investment. For longer term investment certain institutions are required, and these institutions are associated with above ground markets governed by transparent rules of the game.

19. I say "sterile" because it appears that both sides to this debate often mischaracterize the other side. Industrialization advocates are not central planners, though they do push for a policy-activism for governing the market. On the other hand, market-oriented scholars do not believe that the Nation-State is unnecessary. Rather, the key issue is the limits and potential of the organization of political economy. Of course, on both sides of this debate there are advocates of the extreme position, i.e., some industrialization advocates do want to replace the market with planning, and some laissez-faire advocates do want the state to disappear. But, the debate usually proceeds without accounting for the more subtle positions that are actually being offered. Also, recognizing the historical accuracy of the claim that the state has played a role in modern industrialization in a manner much different from the role played in earlier transformation should not imply an endorsement of the modern method. Additional argument would be required for that (something akin to a complexity or urgency of modern life type argument). It is just as plausible that a scholar could offer a challenge to modern industrial transformation and critically assess the outcome of the NICs experience (e.g., as Krugman has sort of done). The step from historically compelling scholarship to normative endorsement of a set of political economy policy propositions is far from easy, though both sides of the argument tend to do so.

20. It is also a critique which resonates with new institutional theorists, and ironically with Austrian economists perhaps the most -- though Granovetter would no doubt balk at the idea that the core of his critique can be found in the objections of Mises and Hayek to the direction of neoclassical economics in the post-1930s.

21. In the 1930s Hayek advocated neutrality as a goal of monetary policy. His monetary theory of the trade-cycle, however, was built on the foundation of a theory of economic processes which insisted on the inherent non-neutrality of money. When in the 1970s, the New Classical Macroeconomics emerged and insisted upon the non-neutrality assumption many commentators were misled into believing that this modern form of theorizing was an accurate formalization of Hayek's pre-Keynesian theory of business cycles. Laissez-faire, the critics contend, was inexorably tied to the assumption of non-neutrality. But this step is wrong as a historical interpretation of the argument, Hayek's case for laissez-faire in money and macroeconomics was built on the theoretical foundation of a non-neutral understanding of money's role in economic processes.

22. Buchanan has introduced the language of pre-constitutional and post-constitutional levels of analysis in political economy to capture this tacking back and forth. At the pre-constitutional level, the discourse can be thought of as one concerned with alternative rules. At the post-constitutional level, the discourse shifts to one of the alternative strategies to be employed given the rules. The effect on the social game of the choice of strategies feedbacks to influence our discourse over alternative sets of rules, and the different rules engender different strategies that are chosen.

23. The Soviet case of political authoritarianism compounds the problems because the relatively limited access to the political game of special interests means that the rents are not completely competed away in the political struggle. However, as some revisionist political science pointed out (e.g., Jerry Hough) competition among interest groups within the former Soviet Union was much more intense than the usual picture of centralized politics would suggest.

24. Frydman and Rapaczynski start their analysis of corporate governance with an observation completely in line with the argument presented here: "markets function well ... only when they have embedded in them a system of institutions that provides a socially desirable internal coordination mechanism, including a complex set of incentives for individuals to respond in a particular way to the information conveyed by the market environment." They observe that in Western capitalist societies this is accomplished by a complex set of institutions of corporate governance. But they move from that argument to one which states that "it is the rational structure of corporate governance that the state enterprises in Eastern Europe are lacking, and the main task of privatization is to introduce it. Without it, no amount of deregulation and decentralization will produce a well-functioning market economy" (1994, pp. 47-48). In other words, a system of corporate governance has to be established before privatization, and this represents a genuine paradox: "the most important aspect of the transition to a spontaneously functioning market economy cannot be initiated by market forces themselves. Indeed, the only force powerful enough to set the market forces in motion is the very state that is supposed to remove itself from the picture" (ibid., p. 57). Compare this, however, with the argument in Rapaczynski (1996) where it is emphasized that property rights are themselves the result of spontaneous market forces, rather than government fiat. Rapaczynski does not challenge his earlier interpretation of the transformation process, but he does state that the issue of corporate governance does not constitute a major issue with regard to the dynamic new private sector. Instead, the issue of corporate governance as creation (rather than evolution) is an issue related exclusively to the large former state enterprises and the hybrid state-private firms that have emerged in the postcommunist period.

25. This is why Ministries of Ownership transfer ought to be looked at with some suspicion. Not only do they confront the problem of actually being in the business to put themselves out of business, which provides an incentive for those within the ministry to find additional tasks, including perhaps serving as industry regulators, but there is also strong incentives for those within the newly emerging market structure to turn to the ministry to protect them from the rigors of competition rather than promote the conditions necessary for rivalrous competition and entrepreneurship.

26. See Boettke (1990, pp. 113-146) for a discussion of NEP.

27. Mises (1966, pp. 357-379) and Kirzner (1973, pp. 88-134) argue that even in situations of resource monopoly (extremely rare), there would be no need for government anti-monopoly policy to correct the situation. The competitive-entrepreneurial market process surrounds and impinges on the ability of the monopolist to enjoy the quiet life he had hoped for in achieving his market position. It is the conditions of competitive entry that ensures that competitive turbulence will discipline the behavior of even a resource monopolist. It is this insight into the market process, in combination with the earlier point made concerning the political economy of reforming monopolies, that leads to the hypothesis that successful institutional transformation will be evidenced by the growth of new firms, rather than either restructuring or privatizing the existing industrial base. This is not an argument against privatization, but it does challenge the preoccupation with privatization as opposed to creating the social environment for risk taking, new investment, and long term projects.

28. On the role that hybrid ownership forms play in the transition economies see Pistor and Turkewitz (1996).