The Cultural Foundations of Economic Reform

Ref. no. 681-18C

A central tenet of neoclassical economics is that human initiative arises from the incentives embodied in free markets. Yet other branches of economics, as well as branches of sociology, political science, and psychology, suggest that human initiative cannot be explained on the basis of economic incentives alone. As Adam Smith well understood, economic life is deeply embedded in social life, and it cannot be understood apart from the customs, morals, and habits of the society. In short, it cannot be divorced from culture.

As economists seek to explain differences in the economic achievements of different countries, many are turning to explanations centered on culture. One area in which culture might play an important part is in the way a society adapts to economic reform. Attitudes toward political, economic, and judicial institutions are deeply rooted in historical experience and are often slow to change. Yet such attitudes are essential to the success of reform because they form part of the foundation of public support both for reform and for the new institutions created as part of the reform process. When attitudes do not support the development and use of the new institutions, the sustainability of reform is called into question.

This research examined the effect of culture, as embedded in the attitudes of economic agents, on the progress of economic reform in Russia. It looked at the role of attitudes in two types of adjustment: adjustment to markets and adjustment to a rule of law. The analysis was based on three sources of information: data collected by the European Community on the attitudes of 470 enterprise managers in seven Russian provinces, data collected by the World Bank on the attitudes of 60 managers and legal experts in 15 Russian firms, and field research on the functioning of legal institutions in two Russian provinces.

The results indicate that attitudes do play an important part in the adjustment of firms to markets and to a rule of law. The study found that one reason that output stabilization in Russia has been delayed is the uncertainty about the duration of financial stabilization, a consequence of declining tax collections. Firms in Russia are actively engaged in informal profit seeking--the production of wealth that can be hidden from official view. The willingness and ability of enterprises to engage in such activities depend in part on managerial attitudes. A manager will be more willing to propose a strategy to earn informal profits if he is confident that most other managers do not consider tax avoidance or evasion to be unethical. Managers must also trust that their business partners will not behave opportunistically or reveal illicit transactions to authorities. Data suggest that the level of social trust in Russia is moderately high; it is only slightly lower than that in Japan, on par with that in Germany, and much higher than that in other countries in transition. Civic behavior, which is often correlated with rule obedience, is very low in Russia; of the 33 countries for which data are available, Russia ranks 31st, followed only by Hungary and Romania.

The study found that the use and functioning of legal institutions also depend on managerial attitudes. New legal institutions are being formed, mostly on the ashes of socialist ones. While many new laws designed to facilitate transactions in a market setting are being enacted, the institutions and people who will interpret and enforce them, as well as those who will use and benefit from them, have a distinctly socialist past. The socialist legacy includes no experience with a state restrained from intervening in the economy. Attitudes formed under socialism have a potentially profound effect on the willingness of enterprises to use legal institutions. The study found that two attitudes--market orientation and rule obedience--explain nearly all the variation in the use of legal institutions. Other factors, such as the firm's ownership, industry, size, and age and the manager's personal characteristics, have virtually no effect.

Responsibility: Policy Research Department, Finance and Private Sector Development Division--Randi Ryterman (rryterman@worldbank.org). With Peter Murrell, University of Maryland; Kathryn Hendley, University of Wisconsin; Barry Ickes, Pennsylvania State University; Barbara Weber, Harvard University; Alla Mozgovaya, Institute of Economics, Moscow; and Valery Makarov and other economists at the Central Economics and Mathematics Institute, Moscow. The National Council for Soviet and East European Research provided funding for data collection.

Completion date: June 1997.

Reports:

Hendley, Kathryn. Forthcoming. "Rewriting the Rules of the Game." Post-Soviet Affairs.

Ickes, Barry W., Peter Murrell, and Randi Ryterman. 1997. "End of the Tunnel? The Effects of Financial Stabilization in Russia." Post-Soviet Affairs 13(2).

Ryterman, Randi, and Barbara Weber. 1996. "The Role of Attitudes in the Performance of the Legal System: Evidence from a Survey of Russian Firms." World Bank, Policy Research Department, Washington, DC.

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