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The Economic and Political Liberalization of Socialism: The Fundamental Problem of Property Rights*

  • William H. Riker (a1) and David L. Weimer (a2)

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All our previous political experience, and especially, of course, the experience of Eastern Europe and Central Asia, offers little hope that democracy can coexist with the centralized allocation of economic resources. Indeed, simple observation suggests that a market economy with private property rights is a necessary, although not sufficient, condition for the existence of a democratic political regime. And this accords fully with the political theory of liberalism, which emphasizes that private rights, both civil and economic, be protected and secure. At the same time, our previous experience also indicates that market economies are more successful than centrally planned economies not only in producing, but also in distributing, both private and collective goods. This economic experienee is supported by neoclassical economic theory, which treats clearly defined and secure rights to private property as essential to a market economy.

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1 Lindblom, Charles E., Politics and Markets (New York: Basic Books, 1977), ch. 12. The most extreme cases of centralized planning in democracies seem to be the wartime experiences of the United States and Great Britain. In the context of our discussion, it is worth noting that these episodes did not radically alter the existing system of property rights.

2 We take voting as the central method and ideal of democracy. By “voting” we mean, of course, all of the institutional environment of elections, e.g., political parties, free speech, etc. The degree to which a political system is democratic depends on the practical effectiveness and political relevance of voting in terms of participation (the promotion of popular choice), liberty (the freedom to pursue one's goals), and equality (the facilitation of self-respect and self-realization). Liberalism emphasizes the role of voting in controlling officials (by expulsion, or threat of expulsion, from office) and the value of individual rights in protecting liberty against tyranny by the majority. In contrast to populism, it does not interpret majority opinion as necessarily right and therefore vests in it no special moral character. See Riker, William H., Liberalism against Populism (San Francisco: W. H. Freeman and Company, 1982).

3 For example, in his score card comparing advanced capitalist and advanced socialist polities, Peter Rutland considers thirty-eight social values, finding the following: capitalism strongly superior (thirteen); capitalism weakly superior (six); no major difference (fifteen); socialism weakly superior (three—freedom from crime, wealth and income equality, housing for the poor); and socialism strongly superior (one—unemployment). Rutland, Peter, “Capitalism and Socialism: How Can They Be Compared?Social Philosophy & Policy, vol. 6, no. 1 (Autumn 1988), pp. 197227. One might question the claimed superiority of socialist systems in terms of wealth and income equality in view of the common finding that higher levels of wealth seem to be positively correlated with greater equality. For an overview, see Ward, Michael Don, The Political Economy of Distribution (New York: Elsevier, 1978). For an assessment of recent Soviet experience, see Ericson, Richard E., “Classical Soviet-Type Economy: Nature of the System and Implications for Reform,” Journal of Economic Perspectives, vol. 5, no. 1 (Fall 1991), pp. 1127; and Bergson, Abram, “The USSR Before the Fall: How Poor and Why,” Journal of Economic Perspectives, vol. 5, no. 1 (Fall 1991), pp. 2944. For the argument that Communism should be viewed as “vulgar capitalism” that is more subject to Marx's criticisms than the modern capitalism of the West, see Clark, John and Wildavsky, Aaron, “Why Communism Collapses: The Moral and Material Failures of Command Economies Are Intertwined,” Journal of Public Policy, vol. 10, no. 4 (10 1990), pp. 361–90.

4 North, Douglass C., Institutions, Institutional Change, and Economic Performance (New York: Cambridge University Press, 1990), pp. 92104.

5 We use “disequilibrium” here in sense of the failure of a collective-decision rule to yield stable social choices even for a stable distribution of individual preferences. See Riker, William H., “Implications from the Disequilibrium of Majority Rule for the Study of Institutions,” American Politicai Science Review, vol. 74, no. 2 (06 1980), pp. 432–46.

6 For an overview of the institutional assumptions of neoclassical economics, see Bromley, Daniel W., Economic Interests and Institutions: The Conceptual Foundations of Public Policy (New York: Basil Blackwell, 1989).

7 For a review of the development of this “general equilibrium theory,” see Wein-traub, E. Roy, “On the Existence of a Competitive Equilibrium: 1930–1954,” Journal of Economic Literature, vol. 21, no. 1 (03 1983), pp. 139.

8 For an overview, see Weimer, David L. and Vining, Aidan R., Policy Analysis: Concepts and Practice (Englewood Cliffs, NJ: Prentice Hall, 1989), ch. 3.

9 Economists often use “open access” and “common property” interchangeably. We consider common property to be a special case of open access in which the good is open only to members of a clearly identified group. On the definition of property regimes, see Bromley, Daniel W., Environment and Economy: Property Rights and Public Policy (Cambridge, MA: Basil Blackwell, 1991), ch. 2. For an extensive treatment of institutions for governing the use of common property, see Ostrom, Elinor, Governing the Commons: The Evolution of Institutions for Collective Action (New York: Cambridge University Press, 1990).

10 Coase, Ronald H., “The Problem of Social Cost,” Journal of Law and Economics, vol. 3, no. 1 (10 1960), pp. 144. Note that Coase's examples all involve externalities between producers. When considering externalities involving consumers, wealth effects may negate the economic neutrality of alternative allocations of rights.

11 The extension of the competitive model involves distinguishing consumption by time period and contingency. See Arrow, Kenneth J. and Debreu, Gerard, “Existence of an Equilibrium for a Competitive Economy,” Econometrica, vol. 22, no. 3 (07 1954), pp. 265–90.

12 Adverse selection arises when individuals have more information about the risks they face than do insurers; if insurance is priced for the average risk of the group, then those with greater risks will find the insurance relatively most attractive, and they will be over-represented among policy holders. The equilibrium result will be a higher price that drives the best risks from the group. Adverse selection explains why individual health-insurance policies often cost several times as much as similar policies sold to inclusive groups such as the employees of a firm. Moral hazard refers to the reduced incentive that insurees have to prevent compensable losses. Policies often require co-payments by insurees to give them a stronger incentive to avoid losses.

13 See, for example, Jensen, Michael C. and Meckling, William H., “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” Journal of Financial Economics, vol. 3, no. 4 (10 1976), pp. 305–60.

14 For an overview, see Eggertsson, Thrainn, Economic Behavior and Institutions (New York: Cambridge University Press, 1990).

15 For reviews of the property rights literature, see Furubotn, Erik G. and Pejovich, Svetozar, “Property Rights and Economic Theory: A Survey of Recent Literature,” Journal of Economic Literature, vol. 10, no. 4 (12 1972), pp. 1137–62; De Alessi, Louis, “The Economics of Property Rights: A Review of the Evidence,” Research in Law and Economics, vol. 2 (1980), pp. 147; and Barzel, Yoram, Economic Analysis of Property Rights (New York: Cambridge University Press, 1989).

16 In the case of Russia today, and previously in Poland and Hungary, a considerable amount of reallocation by de facto users to new owners or new de facto users seems to be underway. See Johnson, Simon and Kroll, Heidi, “Managerial Strategies for Spontaneous Privatization,” Soviet Economy, vol. 7, no. 4 (1012 1991), pp. 281316.

17 As we write, Poland is restricting foreign ownership generally, perhaps as a way of precluding German investment in the formerly German territories. Russia and Czechoslovakia are restricting foreign participation in aspects of their privatization plans. Only Hungary seems to have fully embraced investment by foreigners. In any case, no Eastern European country yet has an active stock market on which capital can be freely exchanged.

18 See Baumol, William J., “Entrepreneurship: Productive, Unproductive, and Destructive,” Journal of Political Economy, vol. 98, no. 5, pt. 1 (10 1990), pp. 893921. For a very explicit exposition of the consequences of ineffective property rights in Peru, see De Soto, Hernando, The Other Path: The Invisible Revolution in the Third World (New York: Harper and Row, 1989).

19 Some observers see the problem of establishing “economic legality” as fundamental to liberalization. See, for example, Litwack, John M., “Legality and Market Reform in Soviet-Type Economies,” Journal of Economic Perspectives, vol. 5, no. 4 (Fall 1991), pp. 7789.

20 In the theory of rights offered by Wesley Hohfeld, the claims of right-holders and the respect of those claims by duty-bearers constitute the first-order relations defining rights. Second-order relations include the power to change, and immunity from changes in, the first-order relation between claims and duties, and thus encompass the notion of credibility. See Hohfeld, Wesley Newcomb, Fundamental Legal Conceptions (New Haven, CT: Yale University Press, 1919). Most modern legal writers concentrate on the first-order relations, taking for granted immunity, perhaps because of the stability and continuity of our legal institutions—just as neoclassical economists assume an effective system of property rights.

21 Obviously, the most urgent kind of innovation for the countries of Eastern Europe and the former Soviet Union is in the area of organization. Whereas more efficient physical processes for converting inputs to outputs can be relatively easily imported from abroad, organizational innovations, such as various forms of corporate ownership and credit systems, cannot as easily be replicated, because the prerequisite systems of property rights and economic law are not yet in place. See, for example, Cooler, Robert D., “Organization as Property: Economic Analysis of Property Law as Applied to Privatization,” in Clague, Christopher and Rausser, Gordon C., eds., The Emergence of Market Economics in Eastern Europe (Cambridge, MA: Basil Blackwell, 1992), pp. 7797.

22 Elster, Jon, “Constitutionalism in Eastern Europe: An Introduction,” University of Chicago Law Review, vol. 58, no. 2 (Spring 1991), p. 480.

23 David Ost develops this point in the context of Poland. He argues that the absence of organized interests renders theories of democratic transition, which were motivated largely by the experiences of South America and Southern Europe, inapplicable to Eastern Europe. See Ost, David, “Shaping a New Politics in Poland: Interests and Politics in Post-Communist East Europe,” Program on Central and Eastern Europe Working Paper Series No. 8, Minda de Gunzburg Center for European Studies, Harvard University, 03 1991.

24 Bialer, Seweryn, “Is Socialism Dead?Bulletin, The American Academy of Arts and Sciences, vol. 44, no. 2 (11 1990), p. 25. A1990 study based on random samples of New Yorkers and Muscovites, however, failed to find many significant differences in attitudes toward the fairness of allocation by price and income inequalities, and in their understanding of market processes. Shiller, Robert J., Boycko, Maxim, and Korobov, Vladimir, “Popular Attitudes Toward Free Markets: The Soviet Union and the United States Compared,” American Economic Review, vol. 81, no. 3 (06 1991), pp. 385400. One may not necessarily be reassured by the finding of little difference in attitudes between a U.S. city that embraces residential rent control and a Russian city that has been at the forefront of liberalization! Nevertheless, in the U.S. case the popular attitudes are only occasionally an impediment to market freedom, while in Russia such attitudes pose a risk to free institutions at the threshold.

25 The notion that wealth as a general social resource contributes to stability by making society more resilient against shocks is developed by Wildavsky, Aaron in Searching for Safely (New Brunswick, NJ: Transaction Publishers, 1988).

26 Spatial voting theory represents the considerations for a political choice as dimensions in (usually) Euclidean space. Voters are assumed to have ideal points (most desired policy outcomes) that can be represented as points in the Euclidean space. For each voter, assume that, as between two alternatives, the voter prefers the alternative closer to her ideal point. And, of course, she is indifferent between any points of equal distance from her ideal point. Then an indifference curve, a set of points that give equal utility, can be drawn for each voter. By constructing indifference curves that include, for each voter, the status quo, it is possible to identify any alternatives that would win a majority of voters as points that lie inside the indifference curves of a majority of voters. Assuming a single dimension with an odd number of voters, the equilibrium—that is, the alternative that cannot be beaten in a head-to-head vote by any other alternative—is the median of the ideal points (the Median Voter Theorem). With two or more dimensions and three or more voters, with the exception of a few special cases, it is always possible to find an alternative preferred by a majority to the status quo. Thus, in the absence of restrictions on the introduction of alternatives, there is no equilibrium. For an excellent introduction to spatial voting theory, see Kreh-beil, Keith, “Spatial Models of Legislative Choice,” Legislative Studies Quarterly, vol. 13, no. 3 (08 1988), pp. 259319.

27 On the fundamental problem of instability, see Arrow, Kenneth, Social Choice and Individual Values, 2d ed. (New Haven, CT: Yale University Press, 1963); and Sen, Amartya K., Collective choice and Social Welfare (San Francisco: Holden-Day, 1970). On instability under majority-rule voting, see McKelvey, Richard D., “Intransitivities in Multi-dimensional Voting Models and Some Implications for Agenda Control,” Journal of Economic Theory, vol. 12, no. 3 (06 1976), pp. 472–82. On the notion of structure-induced equilibria, see Shepsle, Kenneth A., “Institutional Arrangements and Equilibrium in Multidimensional Voting Models,” American Journal of Political Science, vol. 23, no. 1 (02 1979), pp. 2759.

28 Riker, William H. and Sened, Itai, “A Political Theory of the Origin of Property Rights: Airport Slots,” American Journal of Political Sdcnce, vol. 35, no. 4 (11 1991), pp. 951–69.

29 Demsetz, Harold, “Toward a Theory of Property Rights,” American Economic Review, vol. 57, no. 2 (05 1967), pp. 347–59; and Libecap, Gary D., Contracting for Property Rights (New York: Cambridge University Press, 1989).

30 Specifically, we accept the four necessary conditions for the emergence of a right identified by Riker and Sened: (1) scarcity—the content of a right is scarce, driving its value above enforcement costs; (2) right-holders desire the right—if they do not, then they will not seek the right; (3) rule makers (government) desire to recognize the right; and (4) duty-bearers must respect the right at the levels of enforcement made by the rule makers. See Riker, and Sened, , “A Political Theory of the Origin of Property Rights,” p. 955.

31 See Umbeck, John R., A Theory of Property Rights with Application to the California Cold Rush (Ames: Iowa State University Press, 1981).

32 See Libecap, , Contracting for Property Rights.

33 Our account is based primarily on Marrese, Michael, “Hungary Emphasizes Foreign Partners,” RFE/RL Research Report, vol. 1, no. 17 (04 24, 1992), pp. 2533.

34 Our discussion is based largely on Havel, Jiri and Kukla, Eugen, “Privatization and Investment Funds in Czechoslovakia,” RFE/RL Research Report, vol. 1, no. 17 (04 24, 1992), pp. 3741.

35 We rely on Brada, Josef C., “The Mechanics of the Voucher Plan in Czechoslovakia,” RFE/RL Research Report, vol. 1, no. 17 (04 24, 1992), pp. 4245, for our sketch of the voucher plan.

36 See Deis, Michael and Chin, Jill, “Czech and Slovak Views on Economic Reform,” RFE/RL Research Report, vol. 1, no. 23 (06 5, 1992), pp. 6465.

37 For an overview of privatization in Poland, see Slay, Ben, “Poland: An Overview,” RFE/RL Research Report, vol. 1, no. 17 (04 24, 1992), pp. 1521.

38 Bienkowski, Wojciech, “Poland's Bermuda Triangle,” RFE/RL Research Report, vol. 1, no. 17 (04 24, 1992), pp. 2224.

39 Under pressure of threatened strikes by the Federation of Independent Trade Unions, representing sixty million workers, the government agreed to guarantee work collectives access to 51 percent of shares, though at a price to be established by the State Committee on Property. See “Quality Versus Speed in Privatization Discussed,” Moscow interfax, 05 7, 1992, in Daily Report, Central Eurasia, Foreign Broadcasting Information Service, 05 12, 1992, pp. 4043.

40 Olson, Mancur, “The Hidden Path to a Successful Economy,” in Clague, Christopher and Rausser, Gordon C., eds., The Emergence of Market Economies in Eastern Europe (Cambridge, MA: Basil Blackwell, 1992), pp. 5575.

41 Encompassing interests are to be contrasted with distributional coalitions (special-interest groups) that can gain at the expense of social output. Olson, Mancur, The Rise and Decline of Nations (New Haven, CT: Yale University Press, 1982), pp. 3674.

42 In September 1992, we assembled political scientists with specializations in China, Czechoslovakia, Hungary, Poland, and the former Soviet Union for a nine-month seminar at the University of Rochester devoted to theories of property rights and to the design of a common research protocol for studying the evolution of property rights in these countries. After spending three to five months executing the protocol in their countries of specialization, the seminar participants will contribute to a comparative volume on the evolution of property rights in the transition from socialism to market economies.

* The authors thank Roger James, Brendan Kiernan, Nikolai Mikhailov, Ellen Frankel Paul, and the other contributors to this volume for helpful comments.

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The Economic and Political Liberalization of Socialism: The Fundamental Problem of Property Rights*

  • William H. Riker (a1) and David L. Weimer (a2)

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