Formerly planned economies making the transition to the market follow one of three trajectories, according to a recent CEPR Discussion Paper by Gérard Roland and Thierry Verdier. The first is the one followed by Poland, the Czech Republic and the other countries of Central and Eastern Europe, all of which began the transition process in 1990. In most of these countries, there was a strong political will to introduce reforms as quickly as possible and the strategies were typically ‘big bang’. The main objective was to combine early price liberalization and stabilization with mass privatization of state-owned enterprises. After a significant initial fall in output, these countries have, with varying degrees of success, found the route to economic recovery and growth. They are now expecting accession to the European Union (EU).

The second trajectory is that of Russia. Here too, a big bang strategy of rapid reform was pursued in the early days, similar in most respects to the strategies of the Central and East European countries. Nevertheless, Russia has experienced a persistent and much greater economic decline since the beginning of transition, culminating in the devaluation and debt default of August 1998.

The third trajectory is that of China, which has followed a very different strategy from the European countries. Its ‘gradualist’ approach to reforms meant that they were ‘sequenced’ over a longer period of time. Furthermore, a ‘dualist’ approach led to the coexistence of an unreformed state sector, where the government keeps direct control over economic resources, and a liberalized non-state sector, which follows market rules.

Roland and Verdier explain these three trajectories by emphasizing the key role of law enforcement in transition. They argue that the vision of many transition experts, in which markets evolve spontaneously following liberalization, neglects another spontaneous evolution, namely criminal activity preying on private producers. The emergence of predatory behaviour naturally calls for law enforcement, but there are important coordination problems.

First of all, for a given level of spending on law enforcement, a strongly law abiding citizenry will ensure that enforcement is effective. If people are less law abiding, this will reduce potential criminals’ expectation of getting caught and hence the disincentive to break the law. Coordination is also necessary to provide the public good of enforcement technology. This coordination problem is usually solved through tax collection though tax collection itself is likely to be weak in countries where law enforcement is weak.

These coordination problems in law enforcement typically lead to a range of possible outcomes – what economists call ‘multiple equilibria’. Such multiplicity may help to explain why countries with similar reform strategies may have such different outcomes in law enforcement. But what explains why some equilibria are selected and not others? The answer lies in assessing whether there are institutional mechanisms for eliminating the ‘bad’ equilibrium.

In the context of transition, Roland and Verdier identify two such mechanisms. The first is the dualism of the Chinese transition. Keeping direct state control over sufficient economic resources to deter predatory activity is a way to eliminate the bad equilibrium of low tax collection and weak law enforcement: the state has the resources to enforce the law and there are fewer targets for predators. This points to an important trade-off between the potentially high efficiency costs of maintaining state control over resources and the benefits of coordination.

The second mechanism is EU accession, provided the accession country is small enough relative to the club it is joining. The channel through which this works relates to the coordination problem arising from the degree of law abidance. If EU accession is expected, citizens anticipate law enforcement in the future and conclude that they will be better off if they choose to be producers rather than predators. This incentive can be sufficient to achieve law enforcement today even without a sufficiently effective apparatus of enforcement. From this point of view, accession without conditions of entry is the ideal mechanism since expectations of accession will be naturally higher. Attaching conditions to accession creates a coordination problem of its own, which can reduce the positive impact of expected accession.

The researchers conclude that while the first mechanism explains China’s success in law enforcement, the second mechanism may explain why Central European countries are faring much better than Russia in terms of law enforcement, and also in terms of the effects of enforcement on growth and economic performance.

This article summarizes research reported in ‘Law Enforcement and Transition’, CEPR Discussion Paper No. 2501 (July 2000), by Gérard Roland and Thierry Verdier. Roland is at ECARES, Université Libre de Bruxelles, and Co-Director of CEPR’s Transition Economics programme; Verdier is at DELTA, Paris and a CEPR Research Fellow.