The widespread predation and insecure property rights that have characterized Russia during these past 12 or so years have depressed capital formation in all its dimensions. The elimination of the conditions that gave rise to predation and insecure property rights is a necessary condition for the kind of sustained economic growth the Russian government anticipates in its new economic strategy, promulgated June 29, 2000.

Revolutions are destructive, cataclysmic events. The established mechanisms of political and social control are destroyed. The state is weakened, sometimes fatally. As a result, everything is up for grabs. Title to the wealth of the nation is insecure. So are claims to rank, status, prestige, and privilege. Established entitlements become contestable. Possession becomes rather more than nine-tenths of the law.

The "theft of the state" in Russia began early in the perestroika process. While formal privatization did not occur until the end of 1991, well before that time managers of state enterprises used a loophole in the law on cooperatives to set up within-enterprise cooperatives—private firms in all but name—that contained the potentially profitable bits of these state enterprises. Gorbachev’s attempts to decentralize political and economic control led to systemic collapse because they allowed lower-level bureaucrats to circumvent supervision by their superiors. Gorbachev’s decentralizing reforms, openness, and political democratization coupled with economic liberalization, set in motion centrifugal forces that caused a systemwide collapse of authority relations and permitted large-scale theft of state assets by opportunistic and entrepreneurial officials, almost all of whom were drawn from the existing elite, the nomenklatura.

Later stages of the privatization process contributed further to the current extreme inequality in the Russian distribution of wealth. The voucher privatization of the early 1990s was followed by a rapid concentration of voucher ownership by members of the old nomenklatura—often the directors and managers of the former state enterprises, who obtained these vouchers at bargain basement prices.

By now, most state assets have been privatized (outside of infrastructure enterprises, utilities like Unified Energy Systems [UES], and a few financial institutions). There is a widely held view, going back at least to Coase, that economic efficiency requires only that private property rights be assigned unambiguously and that the specifics, including the perceived fairness of the allocation, do not matter. (Editor’s note: The Coase Theorem states that when property rights are clearly assigned, private transactions can result in a socially optimal solution.) An extension of this view is the proposition that yesterday’s thief is today’s staunchest defender of the sanctity and inviolability of property rights. The policy implication is that it is best to grandfather the existing distribution of property rights (in other words, make it legally valid), no matter how outrageous the manner in which it came about.

There are many qualifications to Coase’s "distribution does not matter for efficiency" proposition. Private information severely weakens its applicability. So do transaction costs, including (re)negotiation costs. More important, Coase’s proposition requires property rights to be unambiguous and secure. The legitimacy of any distribution of property rights—and therefore the security of those rights—cannot be independent of the manner in which those property rights were acquired or assigned.

The fact that the redistribution of state property in Russia since 1988 is unlikely to be viewed as legitimate by the vast majority of Russians who did not share in the free-for-all (or rather free-for-some), cannot but be an obstacle to the efficient utilization of those assets in productive enterprise. Extreme inequality and widespread poverty coexist uneasily with secure property rights. This creates a dilemma. The existing distribution of property rights lacks legitimacy. Yet any serious attempt to redistribute improperly acquired property rights would itself create uncertainty about the security of all property rights, now and in the future. Most of the successful raids on the assets of the state were at best conducted under ambiguity about the exact legal status of these assets; at worst they took place in a legal vacuum. Renationalization followed by yet another round of privatization would in all likelihood be pursued in an arbitrary, selective, and politically motivated manner and could end up being viewed as evidence not of a belated attempt at justice but of further degradation of the rule of law. There is no elegant, efficient, and fair solution to this problem. We cannot undo history’s earlier throw of the dice. Probably the best we can hope for is that a combination of sustained growth, efficient and equitable government tax, and expenditure programs and economic reform aimed at eliminating monopoly rents throughout the economy will gradually diminish the significance of the initial distribution of property rights.

Today, with the transition process almost a decade old, Russia and the other successor states of the Soviet Union, continue to suffer from chronically weak legal cultures and severely defective mechanisms for contract enforcement. Discretion, in the negative sense of opportunistic behavior, characterizes legal procedures and law enforcement. The rule of law is the exception rather than the rule. Real negotiations start after a contract is signed.

The Russian state, at all its levels, has a dismal reputation as a guarantor of property rights. Domestic and foreign investors’ confidence in the enforceability of their rights has been weakened by inadequate laws and, even more prominently, by a continued failure to enforce what laws are on the books. Legal rights of creditors and minority shareholders are routinely trampled. Even a majority ownership stake is no guarantee of control. Entrenched managers, often backed by local or regional authorities, restrict access to information and ignore the wishes of the legal owners. Insiders strip enterprises of their valuable assets and leave the legal owners with a shell containing the liabilities and the unproductive and nonperforming assets.

Several comparative studies of corruption rank Russia, and most of the other former Soviet states, as among the most corrupt in the world. According to a 1997 EBRD study, Russia does not score particularly high on the administrative (or petty) corruption index. It is on the two grand corruption indices that Russia’s performance is most worrisome. Grand corruption includes public procurement-related kickbacks and state capture (the efforts of firms to influence the contents of legislation, rules, laws, decrees, regulations, or judgments through unofficial payments by private actors to public officials).

Since the public good of secure property rights, enforcement of contracts, and the rule of law is not provided effectively by the state in Russia, what provision of these public goods there is has often been privatized. Criminal protection rackets—using threats, intimidation, extortion, and blackmail, backed with the threat of violence against property or persons—are thriving. A cynic might consider this an efficient adaptation to an unfortunate environment. Apart from the obvious moral shortcomings of these arrangements, the huge transactions costs and abiding uncertainty associated with these extralegal methods of contract enforcement cause any society that is forced to rely on them to function very inefficiently.

The absence of the rule of law and chronic and widespread insecurity of title has two unsurprising consequences. The first is that effort is diverted from productive activities to predation, including rent-seeking and "dupe" activities (lobbying, corruption, and other illegal forms of influence-seeking, theft; the involuntary and unrequited transfer of property rights through the use of inside information and intimidation; extortion; and threats of and use of violence against property or persons). The talents that make a good productive entrepreneur are not that different from the talents that make an efficient predator. When the returns to productive activity are low and the returns to predation high, talented individuals will tend to choose predation over productive activity. The result is an inefficient use of existing resources, or static inefficiency.

The second consequence is dynamic inefficiency: the accumulation of capital is discouraged and distorted. The national saving rate will become suboptimally low, and within this diminished national saving rate, the allocation of saving across instruments will be heavily influenced by the perceived security of the owners’ title to these instruments. When the tax collection system is both inefficient and arbitrary, taxation tends to become source based rather than residence based: the jurisdiction of the tax authorities tends to be restricted to tax bases located within national boundaries. In addition, title to offshore assets is less easily contested than title to onshore assets. Financial assets abroad are superior, from this point of view, to financial assets at home. Hard currency under the bed is superior to ruble accounts in the bank; deposits in Sberbank, the state-owned savings bank, are superior to deposits in private banks. Real, tangible enterprise assets at home become an especially unattractive proposition, because the owners often have insecure title and the asset is highly visible and accessible to the tax authorities and private predators.

We therefore expect to see in post-perestroika Russia a declining saving rate, an even greater decline in fixed domestic capital formation, and capital flight. We see all three, dramatically.

Russia today stands at a critical juncture. After almost 15 years of economic, social, and political disorganization and disjunction, there is now a unique opportunity to turn away from predation and negative-sum redistribution games to a future of growth and widely shared prosperity, made attainable through increased efficiency and higher rates of accumulation of all types of capital. To make this a reality, comprehensive reform of the institutional framework must take place that permits an efficient market economy to function.

The first, and most difficult, institutional reform needed to put Russia on a path of efficient accumulation is a strong and capable but limited state. Since the collapse of communism, Russia has had an incapable, but overreaching and overstretched, state. The state should only do only those things the private sector truly cannot do. The list is familiar: providing internal and external security and the macroeconomic public goods of price stability and stability of the financial system, enforcing the rule of law, defending legitimate property rights, securing a level economic playing field for incumbents and newcomers, encouraging competition and regulating natural monopolies, financing (but not necessarily providing) public goods, financing public health and education, ensuring that a proper social safety net is in place, and raising the revenues necessary to fund these essential state activities in a nondistortionary, administratively efficient, and equitable manner.

The problem with the prescription of a strong and capable but limited state is that it is almost an oxymoron. A strong state will be an irresistible target for capture by sectional interests who aim to turn it into the ultimate predator.

To a certain extent, the design of the institutions of the state—the constitutional arrangements—can keep Leviathan in check. The horizontal separation of powers—an independent judiciary and an independent legislature—can check the might of the executive. So can a vertical separation of powers, through a federal constitutional design that grants each tier of government distinct, nonoverlapping jurisdictions and competencies. Russia has been wrestling with the design of constitutional arrangements of this kind that suit its unique historical and cultural traditions and its ethnic diversity.

Ultimately, however, the state cannot keep itself in check; only a confident citizenry, backed by the institutions of a varied and dynamic civil society, can do so. A strong civil society and a confident citizenry can even help sustain an equilibrium in which the political players and the state bureaucracy internalize norms and notions of acceptable behavior that dilute the prevailing miasma of suspicion and mistrust between the governed and those who govern. The international finance institutions cannot make a significant contribution to the emergence and flourishing of civil society in Russia; only the Russian people can create and sustain a healthy civil society.

Other than the meta issue of the creation of a strong and capable but limited state, there remain a large number of policies, programs, and reforms to be implemented throughout the country, its regions, sectors, industries, and markets. The program outlined by Prime Minister Kasyanov June 29, 2000, contains a comprehensive outline of what needs to be done. Of course, many of the details still need to be fleshed out, and the devil is always in the details. The experience with a long list of past comprehensive reform programs—many of which also said exactly the right things but all of which sank effectively without leaving a trace—should make one cautious, but not cynical.

The international financial institutions can make an important but limited contribution to the government’s reform program, once the reform of the state has gained momentum. They can provide financial support and technical assistance. The EBRD—which operates exclusively in the transition economies and whose main instrument is the financing of projects, predominantly in the private sector—is well positioned to advance the rising tide of market-oriented reform.

The policy recommendations made by the EBRD as part of an ongoing process of policy dialogue are perfectly congruent with the Gref plan and the program announced by the Russian government. They include the following:

Russia’s tomorrows can be so much better than her yesterdays. Only the Russian people can make the necessary choices to make this come true.

Willem H. Buiter is the Chief Economist of the European Bank for Reconstruction and Development. This paper is forthcoming in The Economics of Transition.