Academic journal article Economic Inquiry

Shaping the Institutional Infrastructure

Academic journal article Economic Inquiry

Shaping the Institutional Infrastructure

Article excerpt

Certain types of laws and institutions shape economic behavior in market economies. In Eastern Europe these general rules and market institutions are often nonexistent, and a major problem is to create market economies while simultaneously building the supporting institutions. We describe the type of institutions inherited from Soviet-style economies and show institutional reforms and macroeconomic policies may have limited effects due to the interdependence and lack of complementary market institutions. Without a "critical mass" of market institutions, the benefits of markets are slow in realization. The advantages of reforming existing but distorted institutions over building new ones is stressed.


"Economics is about a game within rules. Choices are made by actors...constrained within specifically determined 'laws and institutions'" (Buchanan [1979]). Nowhere are we reminded of this dictum more clearly than in the countries of East Central Europe, trying to shift to the market economy while lacking the basic institutions of the market. General rules are often absent, market organizations nonexistent, policy instruments underdeveloped-with an adverse impact on the performance of economic agents and the economy as a whole.

Despite strenuous efforts at reform, the institutional infrastructure remains much too underdeveloped relative to the requirements of a "workable" market economy, let alone an efficient one. This deficiency will diminish only with the passage of time and many laws, which by their current absence limit the benefits of the stabilization and liberalization programs now underway in these countries.

The following section of this paper describes the type of economic institutions inherited from the Soviet-type economy and argues that even those few that can be transformed into market- style institutions will have a rather limited usefulness. I then discuss the process of institution building currently underway in Central Europe.

What I have tried to describe is the interplay between "getting the prices right," which is what all stabilization cum liberalization programs are really about, and institution- building. It has sometimes been erroneously assumed that the former is a short-run and the latter a long-run problem. But even the short run requires "getting (at least some of) the institutions right" to create room for the effective use of policy instruments in the (short-run) adjustment process. And the need to get macroeconomic policy-related institutions right dictates to large extent the institution-building agenda of the executive and the legislature.

The third section of the paper emphasizes the role of time, which emerges as the scarcest factor in the transition process. Two case studies are presented to show how important institutional reforms may have only limited effects due to the interdependence of various market institutions. A lack of complementary institutions may nullify or severely limit the expected benefits of otherwise radical market-type measures. The gap between the demand for and the supply of institutions will be narrowed only with the passage of time.

In the last section the main themes are reconsidered and certain conclusions drawn with respect to the Central European experience as compared to transition cases in Latin America or Asia. The advantages of reforming existing but distorted-- institutions over building new ones from scratch are stressed. Also, the relative importance of a set of well-developed market institutions obtained by Eastern Germany as a result of reunification is emphasized. I see this importation of market institutions as a more important advantage than the flow of financial resources that is commonly regarded as the most important advantage the former G.D.R. has over the other post-Soviet-type economies in Central Europe. I believe it is the presence of market institutions that ensures a smoother transition and an earlier realization of the benefits of higher efficiency. …

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