Stiglitz on the Rule of Law

Stiglitz is going at it again.  This is a very nice paper where the authors tackle not only Shleifer & Co. but also Coase and many Coasean wannabes…

The Creation of the Rule of Law and the Legitimacy of Property: The Political and Economic Consequences of a Corrupt Privatization
Joseph E. Stiglitz and Karla Hoff
NBER Working Paper No. 11772
November 2005

How does the lack of legitimacy of property rights affect the dynamics of the creation of the rule of law? We investigate the demand for the rule of law in post-Communist economies after privatization under the assumption that theft is possible, that those who have “stolen” assets cannot be fully protected under a change in the legal regime towards rule of law, and that the number of agents with control rights over assets is large. We show that a demand for broadly beneficial legal reform may not emerge because the expectation of weak legal institutions increases the expected relative return to stripping assets, and strippers may gain from a weak and corrupt state. The outcome can be inefficient even from the narrow perspective of the asset-strippers.

From the paper conclusions:

“At the end of communism in the former Soviet bloc, the states owned assets of immense value that had been created in some cases by collective efforts over a period of 70 years. The privatization of state enterprises increased private opportunities for wealth creation, but also—given the absence of effective corporate governance systems—for theft. We showed that even when all agents are better off building value in the rule of law state than stripping assets in a lawless environment, once agents have engaged in asset stripping, at least some of them will have in an interest in prolonging a weak, corrupt state that does not interfere with their theft. Thus, the path of institutional change can be inefficient even from the narrow point of view of the asset strippers, who do not internalize the effect of their economic choices on how the political environment evolves.”


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