How can this divergence in development paths be explained in standard economic terms? While history matters and the type of capitalism emerging in the long run is likely to differ across countries, there is a minimum set of necessary measures and means—the stabilization, liberalization, privatization, or "SLIP" strategy—that cannot be avoided if a country wants to be successful. It remains disputable whether historical and institutional legacies allow or prevent the "right" policy mix from being adopted or whether instead policies are dominant in shaping institutions.

Differences related to the role of the state, the role of special interest politics, and the manner in which policies and programs were implemented became important criteria that determined the diverse development of the two countries economies.

The Role of the State. The fundamental factor effecting other developments in the Russian Federation has been the ongoing erosion of the state, which has been discernible since the second half of the 1980s. In what contemporary analysts called "a confrontation between branches and layers of power," a dangerous game emerged. The failure of stabilization efforts in 1995–98 was essentially due to the unsustainability of the fiscal stance: no one could seriously believe that a government deficit in the range of 6–8 percent of GDP was sustainable at a time when the central government was collecting only 10–11 percent of GDP in revenues. Two thirds of tax revenues accruing to local powers and only one third to the central fiscal planners in Moscow change the distribution of tax revenues.

The rule of law could not be established on the ruins of communist lawlessness. (The basic law of the Russian Federation still does not include guarantees for private ownership of land, ensure that contracts are enforceable in the courts, or allow citizens the freedom to start any economic activity without licensing by the authorities.) As it did in the United Sates in the nineteenth century and Italy and China in the twentieth century, violent entrepreneurship, based on private enforcement, has gained the upper hand in Russia.

The collapse of the totalitarian state has not given way to the free market, as some naive reformers postulated. Instead, just as neoinstitutionalist theories would predict, informal institutions have come to dominate. Meanwhile, expectations that the state would be captured by the new business groups failed to materialize, as the financial oligarchs concerned themselves largely with their own businesses. Their involvement remained restricted to their areas of primary concern, such as limiting foreign penetration and securing various forms of rent.

In Hungary, where the share of public property declined from 75 percent of GDP in 1989 to 15 percent in 1999, traditional vested interests have withered away in all areas, except for the still overregulated farming sector.

In contrast to the Russian Federation, legal arrangements in Hungary ensure the smooth functioning of the state. The Constitutional Court was set up with essentially unlimited jurisdiction. It can overrule any law passed by the parliament if it is not consistent with the principles of the constitution, as interpreted by the Court. The national bank has also emerged as truly independent, earning a reputation as a nonpartisan institution concerned with monetary stability alone.

Under these circumstances the rollback of the state did not mean a disproportionate loss of revenue in Hungary. As a result of the reforms of 1987, the prevention of hyperinflation, and the continued strength of the administration, public dues continued to be collected. Whenever overspending occurred, corrective measures on both the revenue and expenditure sides became feasible (though not always popular). Hungary’s public debt, which peaked at 84 percent of GDP in 1995, fell to below 60 percent in 1999. The fact that business groups did not need the state for their purposes and foreign ownership was strong (foreign interests currently own more than 35 percent of Hungary’s assets) made bargaining with the state less and less relevant.

The Role of Special Interest Politics. Pluralism requires the formation and representation of special interests in an organized fashion. However, it makes a difference if special interests exert influence on policies or dominate the political system outright. The predominance of regional and sectoral interest groups is obvious in the Russian Federation. Local officials affect legislation, determine tax rates and regulate the trade in foreign currencies. Meanwhile, the formation of established political parties that reflect ideologies, lifestyles, and values rather than sheer interest—and which are typical of mature democracies—remains in its infancy.

In Hungary special interest politics used to be a dominant feature of "goulash communism." One major reason why the Kádár regime could survive decades without resorting to massive violence—and was easily brought to the negotiating table when it came time to eliminate the one-party system—was the strong presence of quasi-formal interest groups. During the system change, the entrepreneurial stratum with the managerial skills and aspirations to become owners aligned with the westward-looking intellectuals who headed the opposition movements. Since then a decline of special interest policies has been noticeable.

The blossoming of small businesses and the emergence of mass unemployment eroded the position of the unions in Hungary. With big business gradually handed over to foreigners, groups representing medium-size businesses and other local entrepreneurial interests found themselves fighting one another for an ever smaller slice of the cake. Operating an open trade regime since 1989 and gradually liberalizing the financial sector, Hungary created very tough competitive conditions across the board. What could probably not have been attained by any antitrust agency was secured by foreign competition. Since Hungary liberalized its trade no major defenses against foreign competition could be sustained. This took care of all the shortcomings of Hungarian regulations.

Special interest groups in Hungary can extract less and less directly from public authorities. The transparent regulatory framework, emerging in the context of OECD membership and EU accession, leaves precious little room for influencing policy. The transparent regulatory framework also facilitates the creation of a strong party system, in which political parties, rather than chambers or unions or informal groups, are the major channels of efficient interest representation.

Implementation of Programs. Economic reform in the Russian Federation has been characterized by a series of radical-sounding projects. From the 500-day program of Shatalin and Yavlinskii in 1990 to the Kiriyenko plans for achieving single-digit rates of inflation and a stable exchange rate in the economy, no Russian government could be accused of lack of ambition. Implementation, however, has been half-hearted or purely formal.

In Hungary, accommodating government language notwithstanding, tough economic measures were implemented in 1989, 1992, 1995, and 1998 (with the launching of the private pension scheme). Speaking softly while acting tough implies, however, very strong resistance by vested interests. It is hardly a coincidence that no reformist government could gain re-election over the past 10 years.

Conversely, the presidential regime in Russia allowed a degree of continuity that was useful for keeping the Russian Federation together as a federal state. It also allowed for political continuity under quite different economic policies, however, that has led to adhoc policymaking favoring expedient short-term actions such as granting a variety of hard-to-justify tax concession over more thoughtful longer-term measures.

Capital Formation. In Hungary improvements to the regulatory environment—and perhaps even more important, the perception that additional improvements will be made—have been recognized by hundreds of thousands of economic actors inside and outside the country, increasing the level of both foreign and domestic investment.

Positive expectations create bullish business moods, in which investors see cheap asset prices, think big and long term, and invest in research and development and fixed assets. The relocation by both General Electric and Nokia of some of their research facilities to Hungary is just as telling as the spread of new hypermarket chains, which make sense only if purchasing power is likely to grow steadily in the medium to long run.

In the Russian Federation the low investment ratio reflects a vicious development cycle: the credibility-regulation-expectations chain is at work here, too, but it is functioning in the wrong direction. If there is no prospect of economic recovery and stabilization, capital flight remains the only realistic way out. At least for now, the central government has very limited leverage over Russian resources, including financial resources. A government-led recovery—even a mild Keynesian anti-depression cure—would require a qualitative jump in the administrative capabilities and implementing power of the Russian state.

Many of the popular ideas about curing the Russian decay assume that the state is—or should be—able to collect revenues and plan priorities in ways that private markets cannot. The trouble is that market failure in the Russian Federation is a consequence of state failure. Public authorities are expected to harness capital that is fleeing essentially because of the state’s arbitrariness and expropriatory practices.

The Soviet legacy and traditions left their mark on Russia’s development path. The large share of military-related industries and technologies in Russian GDP has rendered any adjustment painful, and lengthy. Lack of meaningful reforms produced the possibility of gaining experience in such basic concepts as the size of information flow that can be centrally managed, the difference between rent-seeking and profit-seeking, and the benefits of free prices, not to mention the market valuation of assets.

The public perception of privatization as theft is only partly explained by the manner in which privatization was handled in Russia. Ties between banks and companies were close in South Korea and Japan, but capitalism there has certainly not earned the bad reputation it has in the Russian Federation. The perception of equity and of what is legitimately to be expected from public authorities does play a fundamental role in the way abstract economic concepts are translated into policy practice.

In Hungary years of exposure to reform helped form the public’s perception of what is to be expected from the state, what role risk premiums on property play, what entrepreneurship means. It also increased the attractiveness of nonbureaucratic careers in the eyes of bright young people. The period of reform served as a training ground.

Bringing inflation down is by and large a technical job, which could be mastered under quite different historic conditions.

Following the East Asian crisis, the importance of institution building, transparency, and an adequate regulatory framework in bringing about appropriate forms of market behavior has been increasingly recognized. One of the few consensus points in diagnosing the Russian disease is that those factors played too subordinate a role in the reform theories—and even less of a role in the course of policymaking—during the entire transition period.

The outcomes in the Russian Federation do not prove the failure of the theoretical framework of transformation economics. The very fact that by and large the same recipe could be implemented in Hungary is a counterargument. The outcomes in the Russian Federation reflect path dependency and policy mistakes, not the need for new theories. Highlighting the role of institutions and governance does not invalidate the need for sound macroeconomic policies. Acknowledging the role of history and institutions does not justify poor policies. The question of whether policies form institutions or institutions shape policies or both remains open for further reflection.