Institutions and Firms in Transition Economies

Prepared for the Handbook Of New Institutional Economics, this chapter focuses on how the NIE has been used to understand transition and how the experience of transition can help inform the NIE. It first shows that the NIE, as an analytical tool, hardly played any role at all in early transition, but that strategies of transition might have been very different had they embodied the lessons of the NIE. Institutional lacunae are now presumed to underlie the deep recessions in the first post-communist years. Subsequently, however, institutional construction has been quick. This chapter presents evidence on the speed of construction and on variations across different types of institutions. It also examines the reactions of firms to the new institutions. Firm adjustment is slower than institutional construction. The contrast between law's use in transactions and problems in corporate governance suggests that complementarities between institutions are important and that new institutions cannot quickly negate the effects of past privatization policies. These conclusions reverberate with the process of Chinese reforms, which relied on transitional institutions and which had characteristics that would seem familiar to a practitioner of the NIE. The chapter concludes by emphasizing the lessons from transition for the NIE. The destruction of even very poor institutions can be costly. Institutional construction can proceed very quickly when there is consensus on change and the process of institutional development is supply driven. At the same time, increases in national income can lag institutional development, if firms are slow to react, which will especially be the case if the new institutions are far removed from existing ones, as is likely when changes are supply driven.At present, there is no generally accepted accounting of the institutional strengths and weaknesses of the transition economies. The first goal of the paper is to fill this gap by assessing current levels of institutional development. The second is to examine which types of institutional mechanisms make relatively strong contributions. Extensive empirical evidence shows that institutional quality in transition countries is roughly as expected given per capita incomes. Institutions are improving continuously. Given prevailing assumptions that the institutional situation is dismal, the developments giving rise to this surprising finding must be investigated more fully. This investigation begins by cataloging the mechanisms that could have improved institutional indexes. Then, evidence is examined on the relative strengths of each of these mechanisms. Formal institutions have contributed more than informal ones. The largest contributions have come from formal institutions separate from the state administrative structure. Political institutions, legal systems, and independent governmental agencies have been important.