Institutional Barriers to Growth

 

...There was a long period of preparation for the collapse of the regimes in East Central Europe, during which nearly all authorities on socialist societies made a great error of judgement: confusing immobility and resistance to change with stability. The stubborn resistance to reforms and the conspicuous immobility of these regimes was viewed as stability, whereas in fact it created a self-destructive instability. The stronger the resistance to change became, the more stability declined. Institutions changed considerably over the years, but even if the reforms introduced in certain countries brought improvements in many fields, much of this change, against the expectations of political leaderships, went in the wrong direction; instead of mending the imperfections of the system, it aggravated them.
Very unexpectedly, Soviet-type systems collapsed relatively peacefully, in most cases without the bloodshed, civil wars, or violent revolutions associated with comparable radical changes in the past. The political, economic, military and cultural elite of the old regime for the most part not only abstained from open and violent resistance, but a significant part of the nomenklatura actively co-operated in the demolition of the old system. This shows the importance of the changes in institutions and mentality within the Communist leaderships. Without understanding the process of this change, one cannot explain the slowness and difficulties of the transition itself, and much less the likely direction of it.
It seems evident that the Communist organisations and their leaderships, which at the end of the 1980's helplessly and sometimes even willingly surrendered their power to the democratic opposition, bore little resemblance to the Communists who had violently seized power forty years earlier. The Communist elite gradually changed throughout the period of armed resistance against Nazism and occupation during the Second World War, through the short-lived democratic period when they monopolised power and overturned legal parliamentary systems, to the period of Stalinist dictatorship and subjecting their populations to terror. During this time, they nevertheless remained imbued by a revolutionary ideology with hatred against all values and attitudes seen as "bourgeois".

Privileges and changing mentalities

In the process of decentralisation and monopolisation, it could be observed that a wider acceptance of so-called middle-class values was gradually taking place. The demands to replace dictatorial rule-the hierarchical dependence on the powers "above"-with more independence for the firms and with their mutual interdependence were signs of this. These values were linked to the demand to replace a centrally regulated, egalitarian income policy with salaries and bonuses based on performance, both for the managers and for the work force. Influential groups of managers used their growing autonomy to extend their power and wealth. Their values and attitudes differed more and more from the revolutionaries fighting for Communist ideas; they paid lip-service to Marxism-Leninism and showed loyalty to the Communist Party, but their motivations were very different. Income differences between the managers and top bureaucrats and other employees were growing fast, and fringe benefits were increasing even faster.3 The privileges of the nomenklatura were extended to special import licences, foreign travel, scholarships and work permits in the West, etc.
The top leaders of the Communist regimes always enjoyed large privileges, but at the beginning it was a relatively small circle, which was lavishly favoured. The privileged nomenklatura class was gradually significantly extended and the income differences considerably increased. As ideological conviction and commitment diminished, Communist Party leaders realised that loyalty can be bought by money and power. This led to the development of networks of clients, linking managers of large enterprises, collective farms and officials of regional authorities supporting each other in power and career building.
In the last twenty years or so of Communist rule, in several of these countries significant personal wealth could be legally accumulated. In addition to the fast growing salaries and fringe benefits of the nomenklatura, the opportunities for enrichment through corruption, speculation and straightforward theft became widespread. Legal persecution of these crimes diminished and mutual indulgence increased among members of the higher echelon of the nomenklatura.
Legally and illegally accumulated wealth could be multiplied when and where certain private economic activities were authorised. Licences for private shops, restaurants and other profitable small businesses were obtainable through "good connections", which meant both more or less open corruption and profitable investment possibilities. As these private businesses needed capital, and since there was no financial market, the savings of the nomenklatura could be profitably laundered via more or less legal businesses.
Another important aspect of the privileges the Communist rulers and party members enjoyed was that they were beyond the law. While there were extremely severe penalties for ordinary citizens for even minor theft of "state property", party members, and especially higher-ranking officials were not, or very rarely, found guilty of corruption or fraud. Even criminal cases were covered up and the offender not brought to trial if a minister or Politburo member were involved. Police officers, attorneys and judges learned that they had to make a distinction according to party membership, or the rank of officials, both in the process of investigation and judgment. The fact that even after the transition, politicians and higher-ranking civil servants are sometimes treated differently by the police and the courts is an unfortunate heritage of the past. Equality of rights and an undisputed rule of the law are not evident in the East Central European countries-this will have to be learned and enforced.
It should not be forgotten that in most of these countries, pluralistic democratic ways were never able to develop, and there was no tradition of equal rights. On the contrary, respect and even submission to authority and servility was widespread, a traditional and rational choice for a large part of the population. While it was expected that citizens respect the law, the wealthy, the powerful and the state could violate the law without consequence long before the Communist regimes came into place. It is no surprise that on the collapse of such unequal and hierarchical systems, unlawful, Mafia-type organisations develop much more easily than democratic organisations and behaviours based on respect for the law.
Corruption and enrichment of a significant part of the nomenklatura can be morally condemned, and could have been legally prosecuted, but it did have a positive side that made the system more supportable. The dictatorial rule of fanatic Communists was far worse for everybody than the more liberal rule of those who cared for their own comfort and wealth or who were corrupt. The changes in behaviour were closely related to a generation change within the nomenklatura, the new generation avid for power and to replace the "old guard" was pragmatic, regarded themselves as technocrats and reformers, and started to question fundamental dogmas of the socialist system, including those regarding property rights.

Alienation from the state

... With free elections and the establishment of democratic political institutions, the disposition toward the state changed significantly. With liberation from Soviet rule, regaining independence and selfgovernment, enthusiastic support for institutional change prevailed. However, the consolidation of the new regimes did not satisfy the expectations of the citizens; on the contrary, it brought previously unknown high levels of unemployment and real-wage decline, and alienation from the state returned. State institutions are still regarded as outside or superior authorities, and they are generally not expected to serve the common interest or the well being of the population.
The ingredients of this process were not only the experiences of the past, the slowness of changes in mentality but, presumably, also the intentions of the political leaders. They do not seem to be in favour of letting voters, taxpayers, civil society, take part in decision-making. In dictatorial regimes not only in the ruling circle, but also among the opposition an "enlightened" view emerges. According to this, they know better what is best for the "masses" than the citizens do themselves.
The vast increase of the share of the state budget in the GDP is a worldwide phenomenon. It increased on average from 8 per cent to 20 per cent between 1870 and 1960-mainly due to the two World Wars.4 In the following 34 years, it grew to 40 per cent. In the ex-Communist countries, the proportion of state redistribution reached an impassable level, taxation could not be increased, and the budget deficit became large and enduring.
The strongly centralised hierarchical system gradually changed into the combination of monopolised special interest groups, but this process did not ease the alienation of the state. However, the only shield the citizens or consumers could count on against the ruthless behaviour of the monopolies were the central authorities. As no interest group represented their rights, only the central authorities could raise barriers to price increases, quality deterioration and pollution. As the state was the proprietor of all assets, it was difficult to be harsh with "its" enterprises; it was difficult to increase their efficiency, or decrease their subsidies. However, if the state were soft with its enterprises, it inevitably needed to be harsh with the consumers, who suffered from shortage, poor quality and inferior services.
The dissatisfaction with the state as proprietor led a great part of the population to accept the idea of privatisation. If they had regarded the state's property to be their own, or the community's, they would have protested against the dispossession of "their" assets. They realised that they had no right to the state's property, and saw how inefficiently and wastefully the state dealt with it. The will to be freed from the rule of the Communist Party therefore became intertwined with the will to be freed from the alienated totalitarian state and its property.
A very important feature of the Soviet-type systems was that the extremely large-scale taxation seemingly didn't exist: it stayed invisible to the population. There was no income tax, invoices did not show the size of sales tax, contributions to the pension and health care systems were paid by employers and their size was unknown to the beneficiaries. This was a perfectly adequate system for dictatorships as taxes not only remained "invisible" but were not linked to state expenditure and social insurance benefits either. This produced the impression that the employees do not give anything, while they received a lot: education, housing, police protection, health care, pensions, holiday resorts, subsidised consumer goods, etc. Where the state got the money to cover all these expenses remain-ed obscure. This seemed to be a real "pro-vident state", which generously offered many things, and asked little or no payment in return. If citizens did not pay taxes, it is obvious that they had no right to intervene in how the state spends "its" money...

Corruption and state capture

...It is much more difficult to measure corruption than the shadow economy, as in the first case both parties are interested in hiding the facts. The quantification methods used in research are usually based on estimates by agencies relying on the answers of consultants and experts. They all have the drawback of being subjective, therefore they contain a serious risk of reverse causation: performance perception may bias the rating of experts. However, as the correlation of corruption indices prepared with different methods by different consultants is very high, with the necessary reservations one can have a certain amount of confidence in their reliability.
For estimating the level of corruption in the transition countries, two kinds of corrupt behaviour are usually distinguished: administrative corruption, as present in illegitimate payments to public officials, and state capture, measured by the percentage of firms directly affected by the "purchase" of laws and regulations. In a recent publication Kaminski (2001) compared different estimation measurements on corruption in the transition countries, and found a relatively high level, a close relationship between the different measures of corruption and great differences by countries. It is remarkable that when both types of corruption are on a high level, it suggests that the system acts deliberately to set the rules of the game in ways that maximise rent-seeking behaviour for those enjoying political power. In such cases corruption feeds on itself by fuelling counterproductive, corruption-generating regulations.
Before corruption could be measured and compared, some researchers assumed that corruption might increase economic growth, as bribes may speed decisions by the authorities, and bureaucrats may work harder if they can expect a bribe. All of the empirical studies done in the field refute this "bribery-as-grease" hypothesis, and agree that corruption tends to lower economic growth. Mauro (1995), for example, found that the indices related to the judiciary system, red tape, and corruption are closely related and can be regarded as a good representation of the bureaucratic efficiency of a country. There is a strong association between bureaucratic efficiency and political stability, and fast-growing countries have a higher bureaucratic efficiency index than slow-growing ones. Legal systems obviously have a strong influence on corruption, but their effectiveness depends on the political and cultural setting in which they work. Triesman (1999) found that a system where the judiciary is not independent and judges have a broad discretion can even stimulate corruption, increasing the toll of bribery.
As far as the effect on growth is concerned, it was found that corruption is very negatively associated with the investment rate, and this is the main channel through which bad institutions lower growth rates. If corruption results in more tax-avoidance, as is the case in transition countries, it reduces public income and expenditures, including public investments. Public procurement contracts influenced by corruption can lead to exaggerated costs of construction,9 inferior services, or to the use of cheap and low-quality materials. Consequently, the loss caused by corruption is much higher then the bribe itself. Moreover, for the transition economies, the major loss can be the bad reputation of the country and the loss of confidence by foreign investors.
Corruption directly affects growth performance by leading to misallocation of investment. Corrupt government officials prefer those expenditures where they can collect huge bribes, which is frequent in projects such as the construction of bridges, motorways, hospitals, airfields, the purchase of medical equipment, etc. It is not surprising that corruption leads to high capital expenditure on useless ("white elephant") projects. Strong evidence was found that government expenditure on education and health are negatively correlated with higher levels of corruption, while both are key factors of economic development.
Politically motivated government spend-ing frequently leads to inefficient distortions of their sectoral or local allocations, as politicians frequently steer infrastructure projects towards certain locations. Alternatively, they may offer "free" infrastructure facilities (roads, electricity, communication, etc.) to attract investors to their preferred districts. Comparative investigations revealed that corruption in the host countries is negatively associated with foreign direct investment. As corruption is inherently secretive and arbitrary, the implicit contract between the briber and the bribed cannot be enforced, this uncertainty deters many potential investors...