Righting Reform

Most economists now agree that institutional quality holds the key to prosperity. Rich countries are places where investors feel secure in their property rights, the rule of law prevails, private incentives are aligned with social objectives, monetary and fiscal policies are solidly grounded, risks are mediated through social insurance, and citizens have recourse to civil liberties and political representation. Poor countries are where these arrangements are absent or ill-formed.

Compare Russia and China. In Russia, an investor has in principle the full protection of a private property-rights regime enforced by an independent judiciary. In China, there is no such protection, because private property was not legally recognized until recently, and the court system is not independent.

Yet during the mid-to late-1990's, investors consistently gave China higher marks than Russia on the rule of law. That investors evidently felt better protected in China than they did in Russia is perhaps no surprise to anyone who has observed the evolution of Russia's legal system over the last decade. But the important point is the gap between rules and how they are perceived.

To be effective, a formal legal regime protecting investors' rights requires a non-corrupt, independent judiciary with enforcement power. Setting up such a judiciary is difficult and takes time. So the efficacy of enhancing property rights by rewriting domestic legislation - changing the formal aspects of the institutional environment - is naturally uncertain. That seems to have been the trap in which Russia's transition was caught for some time.