The Transition Story in a Nutshell

The conclusions that early and speedy reforms delivered much better results, while delayed and hesitant reforms created conditions for poor performance and barriers to completion of reforms, such as the evolution of oligarchs, is central to the story of Ukraine. It is useful to tie together the various aspects of transition and how they give this result. Two polar cases can be described in a mechanism of a virtuous circle or a vicious circle. Ukraine is an example of the latter. Reforms may be delayed or be gradual for different reasons, but in most cases, delays or gradualism happened due to the fact that the preceding communist ruling class remained in power and sought to become the new capitalistic class. To achieve that aim, the former communists needed time. With private ownership allowed, but market liberalization delayed or partial, arbitrage and rent-seeking opportunities were created, and were most favourable to insiders. As new capitalists developed and gradually became rich enough to acquire oligarchic power, they continued to prefer a partially reformed economy, non-transparency, a privileged insider position, a monopolylike status and protection against new entrants based on onerous regulations for small- and medium-sized business. This process was also abetted by the retention of government subsidies, poor rule of law and other institutional deficiencies.

Many economists recognized the trap of this rent-seeking model, and some argued on the basis of the Coase theorem that more privatization would eventually lead the new capitalists to ‘demand’ protection of property rights and rule of law. That was an important part of the rationale for rapid privatization in Russia in the mid-nineties.[1] In retrospect, it is not clear that this process evolved quite as predicted. The oligarchs discovered that their informal power provided all the protection that they needed and that liberalization and rule of law for all not only was not needed but, in fact, threatened their position.[2] Hence they continued to influence government policy to remain within the vicious circle and to freeze transition at a state of partial reforms, which was optimal for them.

In contrast, countries which pursued early and rapid reforms established an open and competitive environment with considerable transparency. This minimized the opportunities for rent seeking and insider-privileged formation of oligarchs. The result was a virtuous circle of early growth recovery, favourable conditions for small business and new entrepreneurship.

  • [1] Boycko et al. (1995) are representative of this position. The simplest non-technical statement ofthe Coase theorem is as follows: if a demand for something develops, the market will provide it.
  • [2] For example, Havrylyshyn (2006), Buiter (2000) and Polischuk and Savaateev (2004).
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