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Economic Reforms and Constitutional Transition Jeffrey Sachs Wing Thye Woo and Xiaokai Yang
We are grateful to Yingyi Qian, Ralph Thaxton, Yijiang Wang, James Wen, Jieh-Min Wu, Chenggang Xu, Yongsheng Zhang, Francis Lei, Leond Chen, David Li, Wen Hai, Tim Zhu, and participants of seminars at Australian National University, Peking University, and Hong Kong University of Science and Technology for helpful discussion. The remaining errors are solely of ours.
This paper investigates the relationship between economic reforms and constitutional transition, which has been neglected by many transition economists. It is argued that assessment of reform performance might be very misleading if it is not recognized that economic reforms are just a small part of large scale of constitutional transition. Rivalry and competition between states and between political forces within each country are the driving forces for constitutional transition. We use Russia as an example of economic reforms associated with constitutional transition and China as an example of economic reforms in the absence of constitutional transition to examine features and problems in the two patterns of transition. It is concluded that under political monopoly of the ruling party, economic transition will be hijacked by state opportunism. Dual track approach to economic transition may generate very high long-term cost of constitutional transition that might outweigh its short-term benefit of buying out the vested interests.
There are two major approaches to studying
economic transition. One of them, surveyed by Dewatripont and Roland
(1996), McMillan (1996), Blanchard (1997), Qian (1999), Maskin and
Xu (1999), and Roland (2000), uses formal models of endogenous transaction
costs to analyze economic transition. This approach explicitly spells
out the assumptions and predictions and has all the advantages of
the formal models. Its shortcoming is that most of the formal models
are partial equilibrium models that cannot figure out the complex
interplay between endogenous transaction costs and the network size
of division of labor. Also, the formal models are too simple to
capture the complexity of institutional changes. The core of transition
is a large-scale shift of constitutional rules (Sachs and Pistor 1997).
Economic transition (i.e., price liberalization and privatization)
is only part of the transition. In a recent debate about relative merit of
gradual versus shock therapy approaches to the transition, the gradualist
view was overwhelmingly dominant (see Roland, 2000 and Sachs and Woo,
1999). This is partly due to the lack of constitutional thinking among
economists. Some economists who are in favor of gradualism easily
jump to the conclusions by looking only at the short-term economic
effects of different approaches to the transition. To understand why
this is not appropriate, we may raise the question: If the transition
of constitutional rules in France in the 19th century had been gradual,
would the transition have been more successful and welfare improving?
There are three difficulties in answering
the question. First, the long-term effects of the changes in the constitutional
rules on economic performance are not always consistent with their
short-term effects. It is not easy to distinguish one from another
of the two. For instance, the formation of the constitutional order
in France started in the French Revolution and lasted for about one
century. The short-term effect of the French Revolution on the economy
was disastrous (Beik, 1970). However, the Napoleonic Code and many
other institutions and policies that emerged from the long transition
process from the Old Regime to the new constitutional order might
have had positive long-term effects on economic development in France.
This transition, together with the rivalry between the UK, France,
other European continental countries, and the US, generated the leap-frog
of the Western Continental Europe's economic development over the
UK in the second half of the 19th century (Crafts, 1997). Also, the
short-term economic effect of the American Independence War and American
Civil War was very negative. But most historians would not deny the
significantly positive long-term economic effects of the two transitions
of constitutional rules. The transition from the old regime to the
new constitutional order may have significant short-term negative
effects on economic development for at least two reasons. First, the
transition must face the well-known dilemma of powerful and legitimate
state violence being essential for protecting all individuals' rights
(Barzel, 1997). According to Buchanan (1989), property rights emerge
from the police's powerful (hence credible) and legitimate violence
that can effectively enforce the penalty for theft. But such powerful
state violence usually tends to violate rather than protect individuals'
rights. Because of this dilemma, the short-term economic effects of
the changes of constitutional rules on economic development are more
likely to be negative. Second, it takes a long time to build up players'
confidence in game rules. When changes in game rules occur during
the transition, the lack of credibility of the new rules could create
social disorder and have adverse effects on economic development. The second difficulty in answering the above
question relates to the trade off between the smooth buyout provided
by gradualism and state opportunism institutionalized by the dual
track approach that is associated with gradualism (Roland, 2000, p.43,
and Cheung, 1996). It is not easy to identify the efficient balance
of the trade off, which might be different for different countries.
The transition to fair, transparent, stable and certain constitutional
rules is incompatible with the dual track approach, which features
arbitrary and discretionary government power and unfair, unstable,
uncertain, and nontransparent game rules. The former requires the
credible commitment of the government to the game rules, while the
latter is characterized by non-credibility of the government's commitment
to the fair rules. Also, the dual track approach institutionalizes
the arrangements wherein the government officials are the rule maker,
the rule enforcer, the referee, and the player at the same time. This
is incompatible with the constitutional principle that they must be
separated (see sections 4 and 5). If economic development is a process in which
many countries conduct social experiments with various institutions
in a long period of time in order to find the institutions that promote
economic development, then some countries happen to be associated
with an evolutionary process toward the efficient institutions and
others happen to experiment with the inefficient ones. For the former,
economic transition would be associated with gradual evolution of
institutions. But for the latter, the inefficient institutions, old
game rules, and related tradition must be discontinued and new game
rules and new tradition must be created and consolidated. This transition
needs big bang to establish credible commitment by major players to
giving up old game rules. The third difficulty in answering the question
raised above involves the comparison of total discounted welfare between
different generations of individuals. The French Revolution intensifies
the rivalry between French continental culture and British common
law tradition. This might increase the generic diversity of institutional
experiments and create more opportunities for welfare improvement
in human society. Certainly, if such benefit exists, it goes to the
younger generations in many countries at the cost of the older generations
in France. Similarly, the US's Independence War increased the genetic
diversity of institutions and culture within the Anglo-Saxon tradition,
thereby increasing the welfare of young generations at the expense
of the old ones. But we economists have no consensus about how to
efficiently trade off one generation's welfare against the other generation's.
Finally, the transition of constitutional
rules usually involves many stages. It is very difficult, if not impossible,
to analyze the complete effects of a single stage of transition. For
instance, the French Revolution had very negative immediate impact
on France's economic development. It did, however, clear the way for
Napoleon's big-bang transition to the new constitutional rules based
on the Napoleonic Codes and equality of all men before the law, which
had positive effects on France's economic development. Mao's experiments
with administrative decentralization in the absence of markets and
private property rights in the 1960s and early 1970s were disastrous
for China's economic development. But they generated a big shock to
the central planning in China and cleared the way for Deng's regional
decentralization and other market-oriented reforms. According to Mokyr (1990), the rivalry between
Britain and France was an important driving force of the big bang
transition of French institutions during and after the French Revolution.
According to Yang (1994), the rivalry between Chinese and Russian
communists was an important driving force of Mao's big shock to the
central planning system in 1960 and 1970 China. Hence, it is more
important to investigate the driving mechanism than to investigate
the short-term economic effects of one of the many stages of transition
of constitutional rules. Recently, many models of the commitment game
have been used to show why, in the short-run, the dual track approach
can work in China in the absence of the credible commitment mechanism
to constitutional order (Qian 1999). But it is much more important
to use the commitment game models to formalize North and Weingast's
(1989) ideas about why the credible commitment mechanism to constitutional
order is essential for long-term economic development. This may need evolutionary game models with
information problems to explain the endogenous evolution of game rules
associated with institutional changes and constitutional transition.
But so far, no such models are available. The existing evolutionary
game models can only explain the evolution of strategies, but not
that of game rules. We cannot even predict the emergence of the simple
game rule that penalizes theft via criminal laws, the judiciary system,
and the police. Perhaps, evolutionary game models that formalize economics
of state, developed by Barzel (1997), and economics of constitution,
developed by Buchanan (1989), can finally provide some tools of the
trade for the economics of transition. But before that, formal models
of economic transition might play a quite limited role in policy making.
They are too simple and too specific to be close to real complex large
scale of institutional changes. Hence, another approach to the economics of
transition that involves no formal models has so far been very influential
in policy making. This line of research includes the meticulous documentation
of changes of institutions and policies and their economic consequences,
represented by Lardy (1998), and the descriptive analysis of policy
and history, represented by North (1997), North and Weingast (1989),
Qian and Weingast (1997), Sachs (1993), and Sachs and Woo (1999).
In this paper, we shall combine the two approaches
to study transition economics. We will use the inframarginal analysis
of the network of division of labor to investigate economic transition.
When formal models are too simple to capture the complexity of institutional
evolution, we will combine this inframarginal analysis with insights
from constitutional economics, new economic history school, and the
economics of state to address problems in economic transition. Sections 2 and 3 discuss how to use the Smithian models covered in Sachs and Yang (2000) to investigate the features of the Soviet style socialist system and the driving mechanism for economic transition. Sections 4 and 5 examine the relationship between market-oriented reforms and the transition of constitutional rules. Section 6 uses some formal models to analyze some transition phenomena, such as large scale output fall and financial crisis. Inframarginal Economics Society www.inframarginal.com |