TRANsITIoN TO A MARKET ECONOMY

AnatolyA. Sobchak

The SovietUnion isfacinga choiceofwhich path to follow to promoteeconomicdevelopment.Today,virtually everyone—theeconomistswho for decadeshaveinsistedon the needfor transitionto amarketeconomy,the politicians who asrecentlyas six monthsago deniedthe necessityandthe possibility of sucha transition,and the over-whelming majority of the population—seemsto havearrived at thesameconclusion:The transitionto a marketeconomyis inevitable,asnight follows day,andis the only wayto economicrevitalizationfor this country.We haveno currentalternative.Thestrongestargu-ment to supportthis conclusionis the roadtraveledby a numberofcountriesin thepost—WorldWar II period: the roadfrom dictator-ship,fromtotalitarianstatesandtotalitarianeconomies,tothemarket.Unique as this roadmayhavebeenfor eachcountry—Spain,China,South Korea—theend result has beenthe same: rapid economicdevelopmentandeconomicprosperity.That is to say, eachcountryreachedthe goaltowardwhich our country is now striving.

Conditionsfor a SuccessfulTransitionThere is, however, far lessunanimity concerning the problem of

how to makethe transitionto a marketeconomy.Yet this transitionquestion—theproblem of defining the mechanism;the ways; andthe forms of goingfrom total statemonopolyof ownership,produc-tion, and all economicactivity to a marketeconomy—isthe mostfundamentalquestionof all. How this questionis solvedwill deter-mine whetherwe succeedor fail in accomplishingthe transition,whetherthis transitionwill bepossible,andin whatwaysit will bemade.

Cato Journal, Vol. 11, No. 2 (Fall 1991). Copyright © Cato Institute.All rightsreserved,

The authoris Mayor of St. PetersburgandProfessorof Law atSt. PetersburgStateUniversity.

195

CA’ro JOURNAL

Yet the programproposedby the governmentin May 1990 wasessentiallynota programof transitionto the marketeconomybut aprogramintendedto discreditthe marketeconomy.The only thingaboutthisplanthatthepopulationclearlyunderstoodfromthereportofPrimeMinisterNikolai I. Ryzhkov wasthegovernment’sintenttoraiseprices—prices,moreover,on basicfood staples,especiallyonbread.The very idea of a price increaseimposedby directive isincompatiblewithamarketeconomyin whichpricesaredeterminedby supplyanddemand,thatis, byagreementbetweenproducersandconsumers.The governmentcanintervenein this processonly byexertinga certainkind ofinfluenceon pricing andpricebalancestoprotecttheeconomicwell-beingof themajority or of certaingroups;it certainlycannotfix pricesfrom aboveby fiat. Indeed,suchpricefixing is characteristicof the economiesof the administrativecom-mandsystemandofbarracks-stylesocialism,notof themarketecon-omy. What is it thatwe are beingofferedtoday?In my view, theconditionsunderwhich I believethetransitionto amarketeconomyis possiblein this countryarenotvery clearly definedeitherin theprogramproposedby the governmentor, thoughto a lesserextent,intheprogramproposedby theShatalinteam(theprogramcoordinatedwith the 500-DayPlandevelopedby the groupof economistsandpolitical leaderswho supportBoris N. Yeltsin).

In my opinionfive conditionsarenecessaryfor asuccessfultransi-tion to a marketeconomy:(1) economicstabilization, (2) a marketinfrastructure,(3) propertyownership,(4) a changein mentality,and(5) public support.Let usconsidereachof thesein turn.

EconomicStabilization

First,amarketeconomymustbeprecededby aperiodofeconomicstabilization. In acrisis, whenthe economyis deterioratingdrasti-cally, it is impossibleto switch atonceto amarketeconomywithoutfirst arrestingthe economicdeclineand securinga period of eco-nomic stabilization, Such economicstabilizationcanbe securedtodayprimarily by activatingbothadministrativeandeconomiclev-ersthat I would characterizeasemergencymechanisms.We couldgo so far as to spendcertain governmentreservesand stockpiles,includingsomeof our gold reserve.We mustalso drasticallycurbgovernmentspending—bothdomesticspendingand expendituresto maintainour government’soffices abroad,reviseour foreignaidpolicies,stopgovernmentspendingon large-scaleeconomicprojectsthatdo notyield immediatebenefits,sell off “frozen” uncompletedunitstoprivateowners,andsoforth. In otherwords,weare describ-ing a comprehensiveprogramof economicactionwhosecontentis

196

TRANSITION TO MARKET

fairly well known.This programis meantto secureaperiodof moreor lesscertaineconomicstabilizationfor the next 12 to 18 months;itshouldsaturatethemarketto the pointof meetingthe basicsurvivalneedsof thepopulation.Onlyagainstthebackgroundof suchrelativematerialwell-being can the transition to a marketeconomy—theaccomplishmentof the essentialtasks that are the goal of such atransition—becomepossible.

Market Infrastructure

Second,parallelto economicstabilization,wemusttakemeasuresto createthe marketinfrastructure.The Soviet economytoday isextremelyprimitive. It is representedby huge,monopolisticstateenterprisesandamalgamations.But it doesnot havethe infrastruc-turerequiredfor amarketeconomytofunction.WhatI havein mindis a labor market, a capital market, and,as a necessarycondition,numeroussmallandmidsizeenterprisesthat will fill thegaps in theeconomyandcreatethepossibility of competitionamongproducersand,mostimportantly,the possibilityof economicmaneuvering.Therecentbreadandtobaccocrisesarea good exampleof a primitiveeconomy.Theyoccurredmainlybecausemostofthe state-runfactor-iesproducingbreadandtobaccoproductshaveobsoleteandshabbyequipment.Eithermostof theseenterpriseshadto beshutdownforrepairsor retrofitting, or they are facing the threatof a shutdownbecausetheirequipmentwill breakdownorneedpreventiverepairs.

Stepsmustbetakento preventsuchcrisissituationsfrom regularlyoccurring.However, we mustnote that today thesecrisesarealsocausedpartly by conservativeforcestrying to sabotagedemocraticchangeandto subvertthe work of new local governmentsin largecities such as Moscow, Leningrad, Sverdlovsk,and Chelyabinsk.The main problem,however,is the absenceof room for economicmaneuvering.Let us imaginethat thesesamecities not only havestate-runbreadfactoriesbutalsohaveanextensivenetworkof smallbakeries,which areowned by cooperativesor individuals andarecapableof takingovermosttasksfor producingthesevitally neededstaplesif statebreadfactoriesgrind to ahalt.The samearrangementgoesfor all otherbasicfoodstuffs.

We needa programdesignedto createsmall andmidsizeenter-prisesthat are both collectively and individually owned. Such aprogramcouldestablishanetworkof enterprisesthatcouldcompetewith the statesectorand,most importantly,couldtakeovermostofthe work if stateenterprisesspecializingin the sameproductsshutdown.

197

CAT0 JOURNAL

Moreover, creationof a market infrastructurerequires efficienttransportationandwell-developedinformation networkswith ade-quatemeansof communication,which wedo not currently haveona sufficient scaleor on a modernlevel.

Among otherthings,the decisionhasalreadybeenmadeto openfinancialandcommodityexchangesin MoscowandLeningrad.This,too, is a necessaryelementof the infrastructurewithout which themarketcannotexist.Butfor exchangesto function,weneedanexten-sivenetworkofjoint-stockcompaniesandassociations.Thoseorgani-zationsdo notyetexist, nor do we haveeffectivelegislationonjoint-stock companies.We needto return to an extensiveturnover ofsecurities. This change,however,will taketime. There will havetobe a period of adjustmentto a marketenvironment,which, alongwith the period of economicstabilization,shouldlasta yearandahalfto two years.Without our goingthroughthis stage,it is naivetothink that the marketeconomycanbe introducedby an order fromabove.

Property OwnershipThird, the transition to a marketeconomyrequiresa well-devel-

opedstratumof commodityproducerswho ownpropertyin differentforms. To demonopolizeandgetthestateoutof the main sectorsofthe economy,we shouldcreatea multitieredeconomyprimarily byprivatizingtrade,eateries,householdservices,andamajorpartofthestate-runindustry.Weshouldalsoprivatizeagricultureasanecessaryconditionforprovidingthecountrywith adequatefood supplies.Theprogramof privatization andthe establishmentof mature sectorsof collective; including cooperative,ownershipand of individualprivateownershipwill take time.

As canbe seenfrom the experienceof the MoscowandLeningradCity Councilswhentheyattemptedtoprivatizetradeandhouseholdservices,such a program of privatization cannotbe carriedoutquickly for a numberof reasons.First, credit resourcesareneededto encouragesmall entrepreneursandworkers’ collectives.Today,we do notcommandsuchresources.Our only hopeis the establish-ment of investmentbanks,which would attractforeign investmentthat would allow us to securethe creditsneededfor privatization.Giventhat this processbringsquickprofits andthat the loanswouldsoonbe repaid, this prospectis quite promising. But, again, thisprocesswill requireno lessthan 18 monthstotwo years.Therefore,from this angleaswell, the immediatetransitionto a marketecon-omy, which has beenproclaimedby the authorsof programsnowunderconsiderationin thecountry’sSupremeSoviet, is impossible.

198

TRANsITIoN TO MARKET

Changein Mentality

The nextconditionfor the transitionto a marketeconomymeansa profound,fundamentalrevolution in morethanjust the industrialand economicconditionsof our society.What is necessaryis a far-reachingchangein the structureof life itself, in our way of life, inpeople’sthinking, andin the waythey seetheir placein the systemof socialproduction.

For decades,we havefostereda beggarmentality:The statewillprovideanddecideeverythingforyou—poorly,perhaps—butit willprovide equally for everyoneandsupply all the basicnecessities.Thisparasiticmentalityis verywidespreadhere.In contrast,amarketeconomy,in orderto function,requiresa verydifferenttype ofmen-tality: responsibility.Everypersonmustbe responsibleand solvehis or herown problems.Thegovernmentwill do nothingmorethancreateconditionsin which one can use one’s own initiative andenterprise;the restwill be up to the individual. The governmentwill maintaina social safetynet for the indigent, for large families,for the disabled,andfor the aged—butits interferencein economiclife will be limited to that. That is, government’srole in economiclife mnstbedrasticallyreduced,or therecanbeno marketeconomy.Butthis changerequiresarevolutionarytransformationin themindsof people,in theirpsychology.Obviously,sucharevolutionarytrans-formationcannotbeaccomplishedovernight.Any programof transi-tion to a marketeconomythat doesnot takeinto acconntthis socialand psychologicalatmosphereis doomedfrom the start.

Public SupportThe last condition is perhaps one ofthe most important. A change

as fundamentalas thetransitiontoa marketeconomycanbe accom-plishedonly whenit is carriedoutby a government that enjoysthefull support and confidenceof its people. Without such support,one can say in advance that any programof transitionto a marketeconomy—nomatter how good it may look in theory and in theabstract—isdoomedto failure.

More thanoncein our recenthistoryandduring perestroika,wehave found that the most logically correct, theoretically well-grounded,and seeminglyimpeccableprojectsturned out to beabsurdinpracticeandled toabsnrdresults.Letusrecall,for instance,the campaignagainstunearnedincomeandthe waron alcoholism;orconsiderwhathashappenedto cooperatives.Weknow the negativeconsequencesof all thesemeasures,whichseembasedon impecca-ble theoreticalconstructsand aremotivatedby lofty idealsthat, Iwould say,evenhavea certain romanticappeal.

199

CAT0 JOURNAL

The failure of all theseefforts was largely due not only to themethodsor meansby which theywerepursuedbutalso to the lackof necessarytrustandsupportby the people.

Anotherimportantfactor is foundin thenegativeattitudesof gov-ernmentbureaucracies,particularly at mid- and lower-level, that

pushed all theseinitiatives to an absurdextreme—deliberatelyinsomecasesor out of incompetenceand ignorancein others.Buttoday,we mustbe very clearas to who is goingto executeall theseplans.On the onehand,theremustbe agovernmenttrustedby thepeople.On the otherhand,it is essentialthat mostofficials in themachineryof the statesupportandimplementthesemeasures.Oth-erwise,asbefore,thisbureaucracy,mostlystaffedby pastor presentfunctionariesof the Communistparty, will be hostile towardtheseefforts, will try to turn them into their own opposites,will reducethemto absurdity,andwill discreditthemin theeyesof thepublic.

Creatinga Legal Foundationfor a Market Economy

In additiontothepolitical, socio-psychological,andeconomiccon-ditions neededfor the transitionto amarketeconomy,therearealsolegal conditionsthat mustbemet.To createthe legalfoundationforthe functioning of the marketrequires a fundamentallydifferentapproachto the legislative regulationof the economythanwe havehad in Soviet legislation up to now. Until now, the major shareof legal norms hasconsistedof administrativerules,that is, directregulationfrom aboveofall economicrelationsandall economictiesin the country.

It is natural that the transition to the marketeconomyshouldrequirea fundamentallydifferentapproach,a transitionto economictiesbasedon horizontalrelations.If oureconomytodayis dominatedby vertical relations,that is, legal-administrativeregulation, thentomorrowwe musthaverelationsof a civil andlegal nature.Theseare horizontal relations,that is, economicinteraction betweenindependenteconomicagents—betweenfreeproducersof commod-ities. This changerequireseliminating the existinghierarchyofenterprises,so that enterpriseswill not be subordinateto Union,republican,or localauthorities.

We mustmakechangesin the way thatenterprisesare launchedandcloseddown.If the overwhelmingmajorityof enterprisesin ourcountry today are openedand closedby administrativedecision,tomorrowit shouldbedoneon acontractualbasis.Thatis, enterpriseswill be createdby agreementbetweeninterestedpartiesandwill

200

YES! Iwantto subscribe to theCATO JOURNAL.

Pleaseenter aGIFT SUBSCRIPTION

for the person(s)named below.

Pleasestart asubscription for

the LIBRARYnamed below.

fl 1 year fl 2 years 0 3 years 0 1 year 0 2 years 0 3 years fl 1 year j1 2 years D 3 years($24.00) ($48.00) ($72.00) ($24.00) ($48.00) ($72.00) ($50.00) ($100.00) ($150.00)

fl Newsubscription ~ Renewal LI New subscription El Renewal 0 New subscription 0 Renewal

My name____________________Gift to Library

Address_____________________Address_____________________Address_____________________City City CityState Zip State Zip State Zip

(Forforeignsubscriptions,pleaseadd$5.00peryear 0 1 year 0 2 years 0 3 years Total: $ 0 Checkenclosed.regulardeliveryand$10.00peryearairmaildelivery.) ($24.00) ($48.00) ($72.00) Pleasebill my: fl Visa0 Mastercard

0 Newsubscription El RenewalMy commentson theJOURNAL:

Giftto Exp. date _________________Address SignatureCityState Zip

JOURNAL

No Postage

Necessary

if Mailedin the

UnitedStates

BUSINESSREPLY MAILFIRSTCLASSPERMITNO. 13690 WASHINGTON, D.C. 20024

Postage will be paid by addressee

t~~CATOJOURNAL

224 SecondStreetSEWashington,DC 20003

TRANSITION TO MARKET

ceaseto function,onceagain,by agreementbetweenthesharehold-ers, or, in the eventof incompetence,by a court decision.

In the matter of economicregulation,thereshouldbe certainchangesin the relationshipbetweenUnion andrepublicanlegisla-tion. Up to now,the legislationthat is currently in effecthasgivenpriority to Union lawsoverthoseofrepublics.However,thedeclara-tions of sovereigntypassedin the Union republicshavecreatedafundamentallynew situation.If yesterdaythe axiom wasthatUnionlaw took precedenceover republicanand local legislation, todaydeclarationson the sovereigntyof all Union republicsarestatingthat Union laws are effectivein a republiconly whenthey do notcontradicttherepublic’sown legislationandonlyif thisUnion legis-lation is ratified by the republic—orby the appropriatebody ofrepublicangovernment.In suchconditions,therewill be a naturaldownwardshift of economicregulation,to the level of republicanandmunicipallegislation.Thisshiftisabsolutelynecessarytoenablevariousregionsandrepublicsto showtheirown initiative in solvingtheir own economicproblems.

Thusa fundamentallynew approachis neededwhenwe preparethe new civil legislation. If yesterdaythe Basic Civil Law of theUSSR,as well as a numberof Union codes,dealtwith questionsofregulatingthecountry’seconomiclife, todaythe centerofeconomiclegislationmustshift to the republicanandmunicipal level. As anexample,onecanpoint to this processin the free enterpriseor freeeconomiczones.

In July 1990,the SupremeSovietof Russiacreateda numberoffree economiczonesin the country: Sakhalin,Leningrad,Kalinin-grad,andanumberof otherregions.The notion of a free economiczone, asapplied to the Leningrad region, is understoodas givingregionalauthoritiesthe necessarypowersto run the local economyindependently;to regulatethe creationof enterprises,joint-stockcompanies,andnewbanks(includingforeignones);to attractforeigninvestments;to conductforeign trade;andto handlecurrency,tax,andcustomsissues.The advantageof a free economiczone,overother regions of the country, is that it providesan opportunity todevelopthe mechanismsof transition to a marketeconomymorequickly on a municipal or regionallevel.

Therights that will now existin free enterprisezones,grantedasexceptionsto the governmentsof theseareas,musteventuallybeextendedtootherregionalgovernmentsaswell. Thus,today’sexperi-ment in developingmarketmechanismswill becometomorrow’swayofeconomiclife on theregionallevel.Only thisapproachto free

201

CAT0 JoURNAL

economiczonesappearspositiveand realistic in the conditionsofthe Sovieteconomy.

It is importantthatthe centerof legislativeregulationofeconomicactivity in a free economiczoneshift completelyto the regional(ormunicipal) level.Theappropriateauthoritiescreatedby theadminis-tration of freeeconomiczones,alongwith theappropriatemunicipalor regionalbodiesof government,musthavethe powerto regulateeconomicactivitiesindependently.Shifting thecenterof legislativepower (with regardto economicmatters) to the republicanandmunicipal levelmustalso manifestitselfon anumberof otherissues.

The transition to a marketeconomywill require a fundamentalchangenot only in civil andeconomiclegislationbutalso in laborlaws.Thistransitionwill befrom a systemofblind universalguaran-teesfor any worker,evena lazy one,to a contractualsystemunderwhich a worker who doeshisjob poorly or sloppily will lose hisjob.

Thereis also aneedtooverhaulfinancial,tax,andlandlegislation.Virtually every law dealingto any degreewith regulatingeconomicrelationsmustundergosignificantmodification.Andthechangemustaffectnotonly detailsbut the mostbasicquestions.I think the mostimportantdirectionof legislative changeis to purge the outdatedadministrativerestrictions,plus the endlessinstructionsandcircu-lars, and to switch to a limited numberof laws and sophisticatedmunicipal legislation.Theselawsshouldcompriseall necessaryreg-ulations to protectthe environmentandto balancethe interestsofproducersandentrepreneurswith thoseof the city, the region,andthe republic—thatis to say, of societyas a whole.

If we compareour currentregionalandmunicipallegislationwiththesophisticatedmunicipallegislationin otherdevelopedcountries,the contrast—bothin volume andin the legal qualityof the statutesin question—isstaggering.

Thereis yet anotherquestionof extremeimportancerelatedto thetransition to a marketeconomy. We havejust takenthe first steptowardinstitutionalizingpropertyrelations.A law on propertyallow-ing for avarietyof formsof ownershiphasbeenadopted.This basiclegislation mustbe carefully developed,andmore work is neededon all the secondarylegal statutesthat would give propertyownersfull rights of control,possession,anduseoverpropertythat belongsto them.

Thelegal mechanismof privatizationalsoneedswork. It is on thisquestionthat I would like to dwell. Privatizationis amongthe mostpromisingof the processesneededfor transitionto a marketecon-omy. Privatizationanddestatificationessentiallymeanthe creationof amultitieredeconomywith a varietyof propertyownersandwith

202

TRANSITION TO MARKET

competition, thusensuringthat the consumercan choosebetweenproducersandtheir goods.Today,privatizationfacesmanyobstacles.Someoftheseareof alegislativenature,suchasrestrictionsimposedby law. Therearealsoeconomicobstacleshavingto do with insuffi-cient funds and a lack of resourcesfor credits and loansto smallentrepreneursand workers’ collectives. There are also socialandpsychologicalobstacles.

EncouragingForeign InvestmentTo overcometheseobstacles,we mustwork on legal mechanisms

for attractingforeigninvestorsandforcreatingjoint ventures,aswellas foreign-ownedfirms, on Sovietterritory. Today, the regulationofsuchrelationsis quitecomplicatedandis mostlyleft to thediscretionof variousadministrativebodies,suchastheMinistry ofFinanceandthe Ministry of ForeignCommerce.To give this processa push,aswitchto republicanandlocalregulationis needed,alongwith, mostimportantly, removalof this legal tangle of regulationsgoverningsuchcontacts.

Whatis to bedone?Thereareseveraloptions(givenanonconvert-ible ruble) to attractfunds of Westerninvestorsinto our economy,allowing us to ensurethat they would get adequatereturns.

Oneoption is to createan investmentbankor get Westernerstoinvestin joint-stockcompaniesthat buy backenterprisesandtheirpropertiesfrom the state.As investorschanneledmoneyinto enter-prises,therewould be funds to rebuild andto changeproductlinesto goodsthat are in demandandare competitivein domesticandforeignmarketsalike.This schemewould allow a fastertransitionofenterprisesfrom state to collectiveor privateownership.

Another option is for Westerninvestors,throughSoviet banksorinvestmentbankscreatedwith thehelpof investors,togive loanstosmallenterprisesandto workers’collectivesthatwantto setup newenterprisesorbuy backexistingonesfrom the state.Investorsdo notacquiresharesin theseenterprisesbutratherextendloansatinterestratesthatwould be attractiveto investorsandwould notbe prohibi-tive to small enterprises.Interestmustbe at a fairly highrate.How-ever,makingsmall enterprisesor collectivestax-exemptfor the firsttwo yearsandgiving them substantialtax relief in thefollowing twoor threeyears—whichwould help the privateandcollectivesectorof theeconomygeton its feet—wouldmakeit easierfor themto payback the interest.

A third option is also possible:The Westerninvestorgives thenecessaryfunds to Sovietbanksor to a governmentbody, suchasa

203

CAT0 JOURNAL

municipal council.Thelatterusesthesefundsto investin privatiza-tion andrepaystheWesterninvestoron abarterbasis,throughsalesof goodsmanufacturedby the region’senterprises,or throughothermeans.Profits in rublesobtainedby investorsfrom joint venturesorfrom salesof importedgoodsin Sovietmarketscanalso be investedin the touristbusiness.This optionwould allow foreigninvestorstoreceivehard-currencyprofits from eachWesterntouristwho usesthehotels they have helpedbuild or renovate—thatis, to profit frominternationaltravel.

Thus,evenwith anonconvertiblecurrency,thereare fairly attrac-tive conditionsfor foreignbusinessesto investcapital in the Sovieteconomy.To ensurethesecurityoftheseinvestments,it is necessaryto institutionalizespeciallegal guaranteesprotectingthe interestsofforeign investors—particularlywith regardto free economiczones,where attractingforeigncapital investmentsshouldbe spedup asmuch aspossible.

ConclusionGenerally,legislationin effect in the SovietUnion today already

createsanadequatelegal basefor establishingjoint ventures,joint-stockcompanies,andforeign investment.It doesnot,however,pro-vide adequateprotectionfor foreigninvestments;it makesestablish-ingjoint ventures,licensingforeigntrade,andso forthacomplicatedprocessthatdependsprimarily on administrativewhim. Weneedamajor revisionof customsregulationstowardmorefavorablecondi-tions for foreign investors.Thus, the necessarylegal conditionsforsuccessfulcapital investmentin the Sovieteconomyhavenot yetbeenachieved.

To be fair, however,I mustpoint out that an entirepackageoflegislationhas beenprepareddealingwith joint-stock companies,foreign investments,and entrepreneurship.These laws weredesignedto createa systemof legal guaranteesprotectingthe inter-estsof foreign investors.Therefore,our conclusionshouldbe opti-mistic, and the prognosisis encouraging.Only yesterday,it was

extremelycomplicatedto work with SovietenterprisesandSovietpartners,which are representedmainlyby statecompaniesor func-tionariesof variousministriesandagencies.Yet evensuchcontactsallowed opportunitiesfor profit-making and successfulcapitalinvestment.

We areenteringa new stagewhenwe mustcreateand,to someextent,havealreadycreatedthe necessaryconditionsfor a climatemost favorableto attractingforeign investmentinto our economy.

204

TRANSITION TO MARKET

The fasterwe completethis processof creatingthe legal andeco-nomic conditionsfor foreigninvestment,the fasteroureconomywillgrow, the greaterour chancesof successwill be, andthe fasterwe

will achieveeconomicprosperity.

205

PEREsTRoI~&AND THE LIMITS OFKNowLEDGE

Henry G. Manne

The possibleintroductionof economic,social,andpolitical freedomto theSovietUnion andits peopleis oneofthemostdramaticeventsin modernhistory. Toparticipate,evenintellectually,in thisprocessis anenormouslyexhilaratingexperience.Scholarsandpublic affairsexperts in the Westhavebeengalvanizedinto a near “feedingfrenzy” of papers,conferences,seminars,and colloquia on thissubject.NoraretheRussiansthemselvesimmunetothissameexcite-ment from travel,meetings,bold proclamations,and newfriends.

As might be predictedfrom all this intellectualsocializing,acon-sensushasbegunto emergeas to the “proper” solutionto Russia’sproblem.Thetypical Westernacademicswho acceptthe prevailingideologicalorthodoxywill notwantto miss the boatandthechanceto become“recognizedexperts” in the field. Therefore,it is notsurprisingthat this emergingconsensuslooks a greatdeal like thedominantacademicview of whatis neededfor WesternEuropeandthe United States:well-regulatedmarkets,a bit of socialism,andagenerouswelfareprogram.

Be that as it may, it would be extraordinarilysurprisingif theRussian“experts” did not jump on the samebandwagonand forsomeof the samereasons;afterall, they like good meetingstoo andinvitations to the “right” universities.

It is refreshingthen to hearthis subjectaddressedby someonelike Mayor Sobchak,whoseviews are somewhatless likely to beinfluencedby this academicprocess.He is, afterall, a seriousplayerin the realpolitical process,andhe seemswell informedaboutthemore sensibleacademicproposalsas well. Not surprisingly then,there is evidently in Mayor Sobchak’sremarks a certain realism

Cato Journal, Vol. 11, No. 2 (Fall 1991), Copyright © Cato Institute. All rightsReserved.

The author is Deanof the Schoolof Law and Chairman of the Law and EconomicsCenter at GeorgeMason University.

207

CAT0 JOURNAL

(or is it wistfulness?) ashe proclaimsthe fundamentalnecessityofchangingpopularattitudes,a notion I stronglysecond.At the sametime, however,Sobchakhas proposedpractical,detailedplans foraction,suchashisvariousalternativeproposalsforeffectivelyfinan-cing privatization of state-ownedfirms. Such details coming fromsomeoneofMayorSobchak’sexperienceandsophisticationcertainlydeservegreaterattentionthan comparableproposalscoming fromindividuals lacking detailedexperiencewith the Russianlegal andpolitical system.

Butevenfromsoimpressivea source,detailedpolicy prescriptionsshouldperforcebe addressedwith considerableskepticism.Someof Sobchak’sremarks,for instance,may be a bit premature;he iscertainlyoverlyoptimisticinassumingthatchangesofsuchprofoundimport couldbe accomplishedin 18 monthsto two years.

I propose,therefore,that for startersweall stepbackandattempta more generalized,less-specificapproachto Russianreform thanhasbeenpopularthus far. Let us seewhat lessons,if any, can belearnedfrom the long-termlegal,economic,andpolitical history oftheWest.Thisexercisemayprovemoreeffectiveatthisjuncturethanany effort to emulatespecific existingWesterninstitutions whereemulationis almostcertainto fail.

Evolution of EconomicLiberalismIn themain,theWest’sdevelopmentof capitalist,privateproperty,

free-marketinstitutionshas beenunplannedandunself-conscious.The systemhas evolved from historic origins little understoodorrecognizedtoday.And it representsanincrediblycomplexintermix-ture of political, economic,cultural, religious,legal,andtechnologi-cal factors.Indeedthesubjectofhowthe systemdevelopedhasbeenso complex that mostWestern,and especiallyAmerican,scholarshavelargely despairedof evendealing methodicallywith it. Theworks of such classic figures as Locke, Smith, Hume, and otherintellectualgiantsare little studiedtoday in the UnitedStates.As aresult,much discussionof theseissueshasa heavyideologicalandpolitical cast.

Thereare certainfactorswithin theacademythat havereinforcedthistendency.ThedominantKeynesianthinking from thelate 1930sto the mid-1960seclipsedthe older, morephilosophicallyorientedapproaches,and the developmentof mathematicaleconomicsandeconometrics(especiallyas aided by the introduction of the com-puter)did nothingto promoteintellectual considerationsof marketinstitutions.Addedto this, of course,was the heavyflirtation—in

208

COMMENT ON S0BcHAK

many casesa conjugal relationship—ofmany Westernacademicswith Marxianandother socialistideas. Ironically, however,it was

during this sameperiodthat someof the most importantdevelop-mentsin our intellectual understandingof free-marketinstitutionsoccurred,andit is largely to these,as well as to someof the afore-namedclassicalwriters,that scholarsandpeopleof practicalaffairsare now turning.

TheAustrianSchoolThefirst of thesemajordevelopmentsoccurredin the 1930s(with

recognitioncoming severaldecadeslater) in the work of what arenow referredto as “Austrian” economists,particularly Ludwig vonMises and Friedrich von Hayek. Out of this work has come suchimportantconceptsasthesubjectivetheoryofvalue,theevolutionarynatureof manysocialandlegal institutions,andthe impossibilityofsocialistcalculationbecauseof our inability to determinecorrectrelative prices. Hayek’swork is also important in the developmentof modernconstitutionaltheory, a subjectwhosestudyhadlan-guishedfor at leasttwo centuries.

Public ChoiceTheoryClosely relatedto this Austrian development,thoughwith very

different origins, is the modern public choice school, the firstmethodical,analyticaltool availablefor explainingthe behaviorofpolitical agents.While still in its infancy (or perhapsits pubescence)today,andalwaysbesetwith incrediblydifficult problemsof empiri-calproof(traditionaleconomicssuffersthis too, butnotnearlytothesameextent),public choiceoffers usa first insight into the relation-ship betweenprivate andpublic behaviorthat goesbeyondmeredescription,rhetoric,andexhortation.

PropertyRights TheoryPerhapsthe mostimportantwork for ourpresentpurposesis what

we now term “property rights economics,”largely associatedwiththe namesof AmericaneconomistsArmen Alchian, RonaldCoase,Harold Demsetz,and Oliver Williamson, Early tracesof thisapproachto economicscanalsobefoundin themajorworkof Ludwigvon Mises.Modernpropertyrightseconomicsgoesbeyondthesim-ple labelingof thingsas “public” or “private” propertyandinsteadlooksatthevariousrights,powers,andentitlementsindividualshaveunderdifferent legal rules.While the focusof this work haskept it

within the traditional domainof economics,it hasalso spawnedanextremelyimportantby-productcalled“law andeconomics,”or the

209

CAT0 JOURNAL

economicsof law. Obviously, public choice theory, constitutionaltheory,traditionalmarkettheory,anda varietyof othernotionscomeinto play in this field as well. It remainsto be seenwhetherlaw andeconomicswill becomeascomprehensivein its coverageas 18th-centurypolitical economywas.

This introduction is by way of suggestinghow ill-preparedweare to deal confidentlywith an effort to converta Marxist-Leninistsocialisteconomy into a private-property,free-marketsystem. Stillwe arenot bereft of all knowledge,andthe recentscholarshipisenormouslyrelevantto the task at hand.Whetherit is sufficient isanotherquestion.But it is clearthatno onewould havesupposed15yearsago that this contemporaryAmericaneconomicsscholarshipmight eventuallyhavea larger role in the remakingof the Sovieteconomythanit didin thederegulation,for example,oftheAmericanairlines.So, with considerablehumility, I would like to exploreabitmore deeplysomeof the complexities involved in the processoflegal/economicdevelopmentand seewhat wemay concludeaboutthe issueat hand.

Legal and EconomicDevelopment

Oneoverarchingdifficulty needsto be establishedat the outset.There is no simple, magical way to achievea complexfree-marketsystemquickly. TheU.S. economy,with its attendantlegalrules,hasevolvedoveraperiodof atleast500years,beginningespeciallywiththe protectionof privatepropertyaffordedby the EnglishCommonLaw andthevariousrelevantprovisionsoftheU.S.Constitution,nowover200 yearsold. This long, largely evolutionary,andpragmaticdevelopmentmustbedramaticallydistinguishedfrom whatis beingfacedin the SovietUnion today. No one everhad to plan for theUnited Statesan entire system, all of whosepiecesfit togetherinsomesortofsocialandeconomicequilibrium,thathadpopularpoliti-cal support.Someof the mostsignificantchangesin the Americaneconomyover its 200yearshavecomeaboutbecauseof a complexinteractionbetweenexistinglaws,technologicaldevelopments,andlegal responses.The regulationof privately owned real propertynicely illustratesthis, especiallysincemuchof theAnglo-Americancommonlaw hadits origins in propertyrules.

Externalities,or third-party effects, weretreatedat common lawmainly throughthedoctrineof “nuisance”or in somecasestrespass.But with the developmentof moderncities with high populationdensities,traffic congestion,andpollution, this approachgraduallygave way to a regimeof comprehensivelocal and in many cases

210

COMMENT ON S0BcHAK

regionalregulation.This regulationhasremainedeconomicallytol-erable—evenif frequentlyundesirableandcostly—forthegoodrea-sonthat it is so local in scope.Anotherwayof talkingaboutthis is topointout that a lot of Americanregulationis, fortunately, only veryweaklyenforceable.Factoriescould simply be shiftedto lesscostlysites,developerscouldbuild residentialcomplexeswherethe regu-lationswerelessonerous,andcourtsdo occasionallydeclareparticu-larly badregulationsunconstitutional.Thecumulativeeffectof thisregulationhasunquestionablybeennegative,but the relationshipbetweenpolitical demands,developmentinterests,privatepropertyideals,constitutionallimitations, andevenemergingtraffic patternshasby andlargenestledinto a relativelystableequilibrium pattern.Thereis at thismomentno strongmovementin the United Statesforderegulationof local zoningplans—neitheris thereany clamorforan expansionof the presentrules.

Wehave,throughanenormousamountoftrial anderrorandadjust-mentandreadjustment,reachedthispragmaticposition.To aninno-centoutsiderit may look like a wonderful “system,”but the truth isthatthis endpointhasno intrinsicmerit or justification. It is merelythepointwehavereached,startingwherewedid with the rulesandinstitutions we had.The processis, of course,a continuingone,sono onecouldreasonablyadvocatethat theprecise“logic,” suchas itis, of American zoning regulationshould be exportedto anotherregime.Nor is it likely to happenthatcompletelyunregulatedlandusecanemergein sucha thick political atmosphere.It is probablyimpossibleto guesswhatwill be theeventualequilibrium situationin MoscoworotherSovietcitiesastheybegintheprocessofadjustingto new political pressures,to someversion of privateownershipofland,to markettransfers,andto newtechnology.It will notbe Hous-ton, evenif it will also not be a planner’sutopia.Who couldbe sonaiveas to try to predict whatwill ultimately emerge?

This exercise,of demonstratingthe modernevolutionof complexpartialequilibria in variouscomponentsor institutionsof theAmeri-caneconomy,could be repeatedat greatlength in many fields andin incredibly vasterdetail. But theseareonly piecemealpictures.Obviously, the ideaof then assemblingall of thesevaried institu-tional arrangementsinto one relatively stablegeneralequilibrium(loranentirenation)isafeatthatnotonlydefiesourability toperformbut evenour ability to describe.

Thatleavesusthenwith the annoyingandfrustratingquestionofwhatcan weprojectintelligently asthe mostdesirableprogramfortheSovieteconomy?I do notbelieveit is politically (or intellectu-ally) feasibleto move to a moreliberal free-marketsystemthan is

211

CAT0 JOURNAL

presentlyfound anywherein theWest.Suchdreamingcanevenbedangerousif it is notrecognizedaspurely idealistic. But therearecertainprescriptionsof ageneralnaturethatcanbehelpful, andthemore widely understoodandacceptablethesegeneralizationsare,the morelikely is the Sovieteconomyto achieveasomewhatstableequilibrium at a high level of humanwelfare.

A Frameworkfor ReformThefirst of my recommendationsis fora massivepublic education

programto dispelthe misunderstandingsandprejudicesaboutpri-vateproperty, profit, freedomof contract,private enterprise,andcompetitivemarketsthatarestill endemicin the SovietUnion today.While ideologicalbrainwashingby the stateis generallyanathematotheliberalvalueswein theWesthonormost,I believethatbroaderpopularunderstandingis a necessary,thoughnot sufficient, condi-tion for liberalizationofthe economicregime.Forthemorepopularsupport thereis for the various institutions of a private propertysystem,theshorterwill be the periodrequiredfor equilibratingallthe variablesinvolved and the less easyit will be for demagogicreactionto form.

Relatedto this is a secondnotion,perhapsasquixoticas the firstandto somedegreerelatedto it. There musteventuallybe explicitconstitutionalprotectionforprivatepropertyandfreedomofcontract.While constitutionsmustof necessitybe generalenoughto allowflexibility in more specific lawmaking,they mustat the sametimeputsomeconstrainton the inevitableeffort ofpoliticiansto suppressprivatefreedomof the useandtransferabilityof property.

Somewhatrelatedto theideaofconstitutionalprotectionis anotherideathatcantremendouslyassistin facilitating socialadjustments.Ihavereferenceto somesortofdisputeresolutionmechanismthathasthe confidenceandsupportof thepublic. Thisclearlydoesnothaveto be preciselylike thecourt systemgenerallyutilized in Westerncapitalistcountries.But theremustbe somemechanism,ultimatelywith the force of the statebehind it, that allows privateindividualsto resolvetheir disputeswithout resortingto violence.

At aminimumthis is whatis meantby a“rule of law.” Themediat-ingagenciesneednotbe institutions ofthe state.Certainlyin manycommercialsectorsof capitalistcountries,privatedisputeresolution(whetherarbitrationor mediation) is widely usedandoften morerespectedandhonoredthan the alternativejudicial systemofferedby thegovernment.Butin Russiatodaythereisno independent,non-political judicial apparatusin place,andprivatedisputeresolution

212

CoMMENT ON S0BcHAK

mechanismsmight takea long period to develop.Probablysomecombinationof privateadjudicationwith ultimatestateauthoritytobackup its decisionsis themostthata rapidlyemergingfree-marketsystemcanhopefor.

Oneaspectof anyworkabledisputeresolutionsystemthat is oftenoverlookedis that its decisionsmusteventuallybe enforceable.Thisimplicatessomeuseof political power,andthisby itself is sufficientto explain the necessityfor the developmentof a systemof criminallaw.Thus,borrowingfromtheAmericanlegalmodel,if a civil decreeis nothonoredby oneof the litigants,criminal proceduresmay beused to punish the recalcitrantparty. Of course,criminal law isneededin aprivatepropertysystemforotherreasonsaswell. Protec-tion of private propertyand personsagainstprivate interferencescannotbe completelyignored by the government.Thus a regimeof private propertyprobably requiresthat rules againsttheft andintentionaldamagebeenforcedby somegovernmentalagency.Butthe morelocalizedandcircumscribedthis authorityis, the lessdan-gerthereis of an abusivepolice authority emerging.Thus a systemof governmentprotectionof privatepropertythroughcriminal lawalso implicatesthe strongdesirabilityofaconstitutionallyrestrainedfederalistregime(which is not the sameas a merelydecentralizedlaw enforcementauthority).

I am now close to a level of specificity that I openedthis paperby decrying. But somethingmuststill be saidaboutthe definition,specification,andprotectionofprivatepropertyrights. Modernprop-erty rightseconomicsmadeusrealizethat theconceptofa “propertyright” is bestviewednotasaspecificentitlementorright butratherinagenericsenseasrepresentingthoseparticularrightsor entitlementsthat the “owner” in fact has.

Ultimately, a thoroughgoingprivate propertysystemis one thatmaximizesindividual freedom.The two ideasare fundamentallyoneandthe same.To the extentthat “property rights” are clearlydelineatedand enforced,they areworth more in a marketsystemthantheywould be if thesematterswerelessclearor certain.I amnothereprescribinganyspecific setofpowersandrightsthatgo intomakingwhatwemightcall “private property”; ratherI amsuggestingthatwhateverkindofprivatepropertyrightis allowedandprotected,it will be worth moreto the extentthat theserulesare clearandarewell understoodby participantsin themarketplace.Thussomeformof public or privatetitle registry,or otherkind of “proof” of owner-ship, is highly desirable.This protection is a low-costdevice formakingall propertymorevaluablethan it would otherwisebe. Oneofthe manyinherentinefficienciesof anysocialistsystemis the fact

213

CAT0 JOURNAL

that no onerecognizesor understandswho really owns a largepartof the goodsandservices.Thus cultural attitudesdevelopof disre-spectfor anyproperty,andno effort is madeto safeguardpropertyorhusbandit. Thissituationleads,in turn,to iron-fistedpolicingby thestateif socialismis insistedupon,andeventuallythat too fails.

Relatedto this ideaof clearlydefining propertyrights to increasepropertyvaluesis the notion of developingotherpublic andprivateinstitutions in order to minimize transactionscosts.An apartmentthatcanbetransferredwith asimplecontractregisteredwitha“title”agencymakestheproperty“worth” morethanit wouldbeina systemin which a largenumberof bureaucraticpermitshaveto be securedbeforethis transfercanbeaccomplished.The sameis true with anypermits a governmentmay require for what would otherwisebea private transaction.The greaterthe time and cost required foraccomplishingany agreedupon transfer, the less the property isworth.

Trial andErrorI haveno doubt that perestroikawill result in a large amount

of trial-and-errorexperimentation,and I haveno doubtthat manyWesterninstitutions will be copied in a vain hope that they mayperformaswell in the Russiancontext.Butthereis probablyno wayto avoid an upheavalof sorts in replacingan almosttotally plannedeconomywith amarketsystem,establishinga voluntaryandprivateproperty regime where an authoritariansocialistperspectivehasdominatedall thinking, andwherepolitical accountabilitywill per-hapsnow substituteforadominantideologicalparty’sedict.No oneshouldbelievethat this canbe doneeasily,and I believethat it isfoolhardy to proposemeasures,like the so-calledcold turkeyapproachto perestroika,that will necessarilyleadto public turmoil,chaos,andeventuallytragedy.

Someaccelerationofthe usualslowevolutionaryprocessthathascharacterizedthe developmentof Westerninstitutions of privateproperty is probablythe bestthe SovietUnion canhopefor now, acompromise,if you will, betweenproductivityandsecurity.Andtheoptimalspeedof the processcanonly beguessedat. Oddly enough,thelesscopyingthereis of specificforeigninstitutionsandthe morecopyingthereis of a foreign ideology, the betterchanceperestroikamay have.

214