Volume 11/12 Number 4/1

Winter 2002/Spring 2003

Special Reports

Foreign Direct Investment in Transitional Economies: Does the Rule of Law Matter?
John Hewko

The conventional wisdom within the international development community is that foreign direct investment (FDI) is an important component of economic growth and prosperity in transitional and developing countries, and that a crucial, if not decisive, factor in enticing such investment is a stable, consistent, fair, and transparent legal and judicial system. As a recent World Bank publication concluded:

The massive move by developing and transition countries toward market economies necessitated the adoption of strategies for the encouragement of private investment, domestic and foreign. Naturally, there was a general realization that such an objective could not be achieved without modifying and, sometimes, completely overhauling the legal and institutional framework and firmly establishing the rule of law, thereby creating the necessary climate of stability and predictability.

Implicit in this “general realization” is the premise that the foreign investor is a passive spectator of the reform process, hesitant to enter the fray until a modification
or overhaul of the legal system has occurred. Based on this assumption, governments, multilateral institutions, development agencies, and various nongovernmental organizations (NGOs) have expended considerable resources in initiating, encouraging, and funding a myriad of legal and judicial reform programs throughout the transitional and developing world.These actions have been taken in the belief that legal reform and the establishment of the rule of law could be accomplished in relatively short order and in the hope that, once the reform process was complete, FDI would begin to flow.

This article argues that the philosophical framework traditionally used by the international development community to carry out its legislative and institutional reform efforts in the postcommunist countries of Eastern Europe and the former Soviet Union is incomplete and has failed to take into account several critical concepts and factors.The principal conclusions may be summarized as follows.

First, the experience of most postcommunist societies demonstrates that legislative and institutional reform is an organic process not conducive to easy or quick solutions. Regardless of whether one holds the view that such reforms can be accomplished from the “top down,” through aid to state institutions, from the “bottom up,” through assistance to NGOs and other elements of civil society, or through some combination of both, and regardless of the amount of resources allocated to the problem, the fact remains that the process of legislative and institutional reform is long and tortuous. Genuine reform requires that a new legal culture be developed and ingrained in a society; this takes considerable time, effort, and several generations. As a result, the framework within which legal reform efforts are structured and implemented must be designed with the understanding that, in the absence of external factors (such as harmonization of legislation as a precondition to EU membership or national reunification), most transitional and developing countries will require several decades to develop the legal culture needed for the effective implantation of judicial reform and the rule of law.

Second, an extensive overhaul of a country’s legislative and institutional framework is generally not a necessary precondition to attract direct investment from large multinational investors (although certain changes are generally required to retain such investment) or from smaller, entrepreneurial investors. Other factors, significantly more important for investors, are the existence of genuine business opportunities and the overall visceral perceptions foreign investors have of a host
country (foreign investors for purposes of this article are investors making direct investments and does not include portfolio investors).

Third, foreign investors, at least in the context of most postcommunist economies, are not passive bystanders in the legislative and institutional reform process, as is widely assumed. Rather, foreign investment is a dynamic force in the forefront of the push for change and an agent for such reform. This phenomenon has been largely misunderstood by the international development community and ignored in the prevailing literature.

Fourth, the international development community has traditionally discussed legislative and institutional reform in grand, sweeping terms and general concepts, issuing calls to modernize bankruptcy legislation, eliminate corruption, and establish an efficient and rule-based judiciary. It has encouraged countries to carry out large-scale and radical legislative reform and to adopt legislation that emulates that of highly developed countries. This approach, although easy to articulate at conferences and television interviews and in eye-catching headlines, is misdirected.

Most foreign investors, when faced with an attractive business opportunity, are prepared to accept the fact that, in general terms, the legislation and legal systems in
postcommunist countries are inadequate, and that the laws pertinent to their concerns are, no doubt, far from ideal. However, once their investment is made, a short laundry list of specific complaints usually arises, which, if rectified, would greatly facilitate the success and continued viability of their investment. As a result, the emphasis of legislative reform efforts should be on details (not general concepts) and on determining the specific and often mundane changes that need to occur for existing legislation to function within the cultural, political, and economic realities of the host countries while still answering the needs of the foreign investors.

Finally, if a goal of legislative and institutional reform is to attract FDI, considerably more attention needs to be paid by the international development community to the precise concerns of foreign investors and their advisers. Foreign investors place their own resources at risk and spend considerable funds on lawyers and accountants to identify the specific dangers and problems relating to their investments. As a result, foreign investors and their advisers,much more so than a development guru flying in for a weekend of diagnostic analysis, are best suited for identifying exactly the changes needed in the legislative framework to address foreign investors’ concerns and thus to facilitate FDI.

Nevertheless, a healthy dose of caution is required when addressing any issue as complex as the process of legislative and institutional reform in transitional
countries. Although the role of foreign investment in the process has been neglected and misunderstood, FDI is by no means a panacea. Foreign investors are generally not altruistic organizations, and their interests may not always coincide with those of society as a whole or with those of domestic investors. As a result, the legislative and institutional reform process should not (and cannot) be left exclusively to foreign investors; domestic institutions, bilateral donors, international development agencies, and local and international NGOs must continue to provide the basic impetus and tools in aide of reform, albeit with a revised philosophical approach.

In addition, any analysis of FDI and the legislative and institutional reform process must recognize that not all foreign investors are created equal. Investors from
different countries have varying degrees of tolerance for imperfections in the host state’s legal system, and they bring to the table a variety of values, perspectives, and practices. A foreign investor from a country with a tradition of corruption and weak enforcement may have a different view of, and contribution to make to,
legislative and institutional reform than an investor from a country at the opposite end of the enforcement and corruption spectrum. To the extent that foreign
investors encourage or support the prevailing legislative or institutional situation or engage in bribery and other forms of corruption, they become, of course, part of the problem and not part of the solution. Similarly, not all postcommunist countries are created equal; for example, the historical, political, and economic context within which Hungary or the Czech Republic have attempted to institute legislative and institutional reform is different from that of many of the former Soviet republics.As a result, although this paper attempts to provide conclusions that may be applied generally to postcommunist countries, the development community and foreign investors must consider those differences when designing specific programs or issuing prescriptions for any one country.

Foreign investment: The initial phase
The conventional wisdom argues correctly that FDI is a vital aspect of economic development. Rather than a pernicious force (as maintained by the antiglobalization protesters at multilateral institution meetings throughout the world), foreign investment is generally beneficial to a host country. The conventional view is also correct in recommending that developing and transitional countries undertake measures to encourage and promote FDI.

However, the view that luring FDI can occur only by “modifying and, sometimes, completely overhauling the legal and institutional framework and firmly establishing the rule of law,” at least as it relates to postcommunist countries, is not correct.A legal and judicial system that includes consistent and modern legislation, effective and efficient courts, and regulatory institutions that interpret and enforce the laws in a fair and transparent manner is a desirable and laudable
goal and, all things being equal, a country with such an ideal system will attract more FDI than one that does not. Additionally, a foreign investor will generally prefer a country whose legal system is developed, fair, open, and transparent to one in which the rule of law is absent. Nevertheless, the existence of such a pristine system—or the degree to which it is absent—is often not the decisive factor in attracting foreign investment.

What attracts foreign investment?
The most important factor in attracting FDI remains the existence of actual business opportunities. Even if a country, under the careful guidance of the development
community, were to implement a modern, fair, efficient, and transparent legal system, it would not attract foreign investment in the absence of genuine economic opportunities.

However, the opposite of the above statement is also true: if such economic opportunities do exist and are made available, the simple fact that a country’s legal
system is imperfect will not dissuade FDI.This could be seen in the postcommunist countries when the advent of perestroika resulted in an explosion of interest by
foreign investors. Clearly, the deciding factor for foreign investors could not have been the legal systems in these countries: in the early 1990s, their laws and legal institutions were generally primitive, undeveloped, and incapable of addressing the many issues that arise in a market-based economic system. Rather, early investors were drawn to these countries by large untapped markets, a highly educated yet inexpensive labor pool, and tremendous natural resources. In many cases, the deficiencies in a country’s legal and institutional structures were simply factored into the risk-reward analysis: the higher the potential rate of return on a given investment, the more investors were willing to look past deficiencies in a country’s legal system. In others, the foreign investors were attempting to implement a longterm strategy to penetrate a given market (or were mimicking or anticipating moves on the part of their competitors) and were not influenced nor dissuaded by the state of the legal system.

As a result, if a country offers significant business opportunities (through privatization or other means) and does not present any formal barriers to investment (for example, war, significant social unrest, severe economic crisis, or legislation that prohibits foreign investment), it will attract a certain level of foreign investment despite the lack of an “ideal” legal system. In the case of the postcommunist countries, even if the countries in the region had immediately reformed their laws and legal institutions following the fall of the Berlin Wall and the advent of perestroika, it is doubtful that during the initial period of euphoria they would have obtained significant additional foreign investment beyond the amount actually received. Although the potential global investment pool was considerably larger than the amount that initially made its way into the region, foreign investors who chose not to invest during the early period were generally investors with a corporate culture averse to risk, with little foreign investment experience, or with a competitive cost structure that could not absorb the costs of higher risk in an uncertain
environment. For these less courageous foreign investors, the fact that laws and institutions had been reformed on paper would not have been terribly relevant to their decision-making process.They were more concerned with onerous tax regimes and inadequate accounting standards and practices, the risk of expropriation,
the ability to repatriate profits, the manner in which the host countries would operate in practice, and the fate of their more adventurous colleagues.

A second factor in attracting foreign direct investment in postcommunist countries was the investors’ general perception of the stability and investment climate in the host country.This perception was rarely based on a thorough understanding of the political, social, legal, and cultural situation in the country, but, rather, on information obtained from newspaper headlines and television news reports back home, anecdotes from previous trailblazers, perceptions as to what their competitors were thinking and doing, or an article read in the International Herald Tribune during the flight over. Although the issue of the “legal system” formed a part of the overall perception of the foreign investment community, very rarely was the legal system and its failings (difficulties in enforcing contract rights, unclear
foreign investment laws, or a poorly drafted or nonexisting bankruptcy act) the pivotal factor in determining whether an investment was made.

In short, most foreign investors were willing to accept or ignore actual problems in legislation and the legal system if they had a visceral “feel good” perception of the target country. Conversely, if the general perception of a country were negative or were to decline, foreign investors would be more hesitant even if, on paper, the state of the legal system were actually improving.

Finally, foreign investors tended to place a high premium on clear lines of authority and decision making. A common complaint among investors in those countries that were least successful in attracting FDI was that there was no one in a position of authority to take a decision. Nothing exasperates an investor more than the need to shuffle from ministry to ministry or to negotiate a seemingly endless bureaucratic maze where everyone and no one is in a position to resolve issues or grant approvals.As a result, an exemplary legal system is not nearly as important as the existence of a clear, consistent, and unambiguous decision-making process.

With respect to the postcommunist countries, while a certain amount of FDI (largely represented by midsized companies) was lost due to legal uncertainties and the absence of the rule of law, a significant portion of potential FDI was not affected by such imperfect conditions. Although objective factors often adversely affected investment decisions, factors such as corruption, a weak court system, and uncertain laws were generally not basic deterrents. If they were, one would
not have had any foreign investment at all since these conditions existed in all of the transitional countries.

Thus, to the extent that the international development community is structuring its legal reform activities within a framework that assumes foreign investment is largely passive and will only enter a transitional country when the legal system has been modified or overhauled, such assumptions are not—at least in the context of the postcommunist countries— correct. Foreign investors, in making their investment decisions, were influenced first and foremost by the nature of the business opportunity, the potential for high returns, the risk of expropriation, the ability to repatriate profits, the existing tax regimes, and an often superficial “feel” about a country. Although the state of legal system was a component of foreign investors’ perception, it was generally not the decisive factor in making an investment decision.

The cycle of foreign investment and legislative reform
The interplay between foreign investment and legislative reform may be seen most clearly in the process of revising laws and regulations affecting commercial
activities. This dynamic, still present in postcommunist countries, is largely cyclical, with many starts and stops, and can be summarized as follows:

• As part of the process of perestroika, the postcommunist countries made the political decision to open their borders to foreign investment.

• Legislatures or governmental organizations with little or no experience in market concepts or principles adopted legislation, issued decrees, or announced regulations permitting varying degrees of foreign investment.These legislative measures were generally very primitive and failed to address the myriad of issues that arise in a normal marketbased economy.

• Many multinationals and small entrepreneurs invested in these countries in spite of the inadequate legal system. (Midsized companies faced the greatest difficulties in investing.They were generally too large to use the informal methods of individual entrepreneurs, yet, in contrast to the multinational investors, too small to muster the resources needed to deal with the bureaucratic and other hurdles of the various systems.)

• In carrying out their investments, foreign investors attempted to undertake actions that were a necessary part of their business activities, that were standard procedure in the West, but that were either prohibited by or not addressed in existing legislation. Thus, when problems arose with joint-venture partners or the bureaucratic burdens of operating in a particular country became difficult to accept, investment would begin to falter.

• As a result of the increasing legal problems, foreign investors and local elites with a vested interest in foreign investment would begin to complain and demand changes in legislation and procedures; embassies would lobby the host country; and negative press stories in both the domestic and foreign media would put indirect pressure on the host government to address the failure of the initial wave of laws and regulations.

• The host states then adopted amendments to the commercial legislation.These amendments tended to be poorly drafted and only partially resolved the problems. It was at this point that investors, frustrated with the process, began to hesitate and withdraw their investments.The negative publicity of these withdrawals, in turn,
deterred potential new foreign investors.

• This entire cycle was repeated several times until gradually the domestic legislation began to conform to the standards required for a sophisticated market economy and the overall perception of the country would improve. Foreign investors who were able to stay the course began to spread the word that the investment climate had improved, and foreign investors who had been sitting on the sidelines began to renew their interest.

• With respect to countries such as the Czech Republic,Hungary, and Poland, a further external factor—the need to harmonize domestic legislation with that of the EU as a precondition to EU membership—significantly influenced the pace and scope of legislative reform.

Lessons learned
What are the lessons to be learned from this process?

Legislative reform through cyclical and incremental change. Reform of commercial legislation is a tedious process characterized by a continuous and seemingly unending series of small, incremental changes resulting from the cycle described above. Even in those cases where a country adopts the “big bang” approach and significantly rewrites its commercial legislation, the effort is almost always incomplete and, indeed, it gives rise to the cycle described above, as the significantly
amended legislation becomes subject to a further series of smaller changes and corrections.A significant driving force in identifying the needed changes is the foreign investment community (and its advisers), which almost immediately identifies the problems and inadequacies in new legislation as it attempts to apply the fresh, untested provisions to existing and contemplated transactions and commercial activities.

The role of inexperienced legislators.Very few legislators and drafters of commercial legislation have acquired the necessary understanding of how business transactions are carried out in well-established market economies. Parliamentary drafting committees or governmental agencies have often been staffed with civil servants or academics with only a theoretical understanding of how a market economy functions, but with little practical business experience as to how private actors will respond to poorly drafted or enforced legislation.

Laws lag behind actual transactions. The legal system is generally several steps behind what is occurring in real-world business transactions. This is not surprising;
it is a rare legislator or government that is capable of foreseeing future trends in the marketplace. As a result, legislation dealing with cutting-edge legal issues in a
commercial context almost always follows actual transactions taking place in the market.

Inadequate consultation with foreign investors and other affected parties. Although many changes in legislation were either induced by pressure from the investment
community or were intended to reflect innovations occurring in the host country’s marketplace, only rarely did the drafters of the legislation consult with foreign
investors or the lawyers and accountants representing such investors. A common complaint among the accounting and law firms in the region concerns the
considerable disconnect between politicians and policy advisers, on the one hand, and those in the business world, on the other, attempting to carry out the very
transactions the proposed reforms were meant to encourage. As a result of this failure to communicate, changes in legislation designed to address a given
problem were often not “quite right,” although they could have been if someone experienced with such transactions (under the existing, inadequate legislation)
had been consulted in advance.

In fact, generally, the legislative reform process in postcommunist countries fails to canvas the views of those elements of society most affected by proposed
reforms. Often legislative reform is hijacked by an elite that will determine the content of the new law, obtain limited comments from a narrow circle of cronies, and
then push the new legislation through a parliament that tends to rubber-stamp executive initiatives. It would be preferable, of course, to obtain the views of those who need the reforms to pursue their activities more effectively (namely, the business community) and to include broader public debate among the interest groups
affected by the proposed changes.

The failure to include a broad range of stakeholders in the reform process prior to adoption of legislation has at least three negative consequences. First,
it can perpetuate the anticompetitive interests of cartels, monopolies, and elites who represent only one set of the many interests involved. Second, it creates
“enemies” of the specific reform who can hamper its implementation out of self-interest or even revenge for not having been included in the process. Third, it
encourages a lack of respect for the legislative process and the rule of law generally.

Clearly, the quality and appropriateness of reform legislation would increase substantially if parliaments were to institute a process in which draft commercial legislation was made available for public scrutiny and comment before being brought before the legislators for formal adoption. Such a procedure should be the centerpiece of any development agency’s proposal for the reform of a country’s legislative procedures.

Foreign investors—the ideal source for identifying legislative deficiencies. The foreign business community and its professional advisers represent the most efficient
and accurate mechanism for identifying the exact problems in commercial legislation and regulations. If one purpose of the legal reform efforts is to create conditions that attract foreign investment, then no actor is better placed to understand and explain the precise changes necessary in a country than those entities
investing in that country.

A popular pursuit of the international development community has been to determine the changes in legislation needed to improve the efficiency, transparency,
and functioning of a country’s capital markets. A particular goal has been to specify the legislative changes needed to facilitate access by local companies to foreign capital markets through the issuance of global depository receipts (GDRs) or other financial instruments. The traditional approach of the development community has been to issue a detailed request for proposals from several consortia of consulting, law, and accounting firms. (On too many occasions, the effort would be repeated with several development agencies funding a study of the same problem with little or no coordination between them.) Often foreign firms with very little or no experience in the country would bid as a means of establishing a foothold for future business in that country. At times, the winning consortia would be chosen not so much for its skill or experience, but on the basis of political considerations (for example, not enough Portuguese consulting firms have had a chance to dip their hand into the EBRD technical assistance trough).

Once chosen, the winning consortia would then carry out detailed diagnostic reviews of the host country’s capital markets. Since the fees to the consortia were in most cases subject to a cap, junior staff would generally carry out the review so a profit on the work could be realized (or at least the loss minimized). Occasionally a senior Western securities guru would fly in to explain how such legislation is structured and implemented in the West.The result of this effort would
be a thick and extensive report, presented to the relevant governmental agency, recommending radical and sweeping changes to the host country’s securities legislation based on the system in the United States or Western Europe. Such recommendations would be made with little regard to whether there was a demand
in the local market for legislative changes of this sort or how to such legislation would operate within the existing legal culture and system.

Unfortunately, this approach is astonishingly costly, inefficient, and ineffective, and it often results in advice being provided by experts who have considerable
knowledge in their fields, but very little understanding of the host country and its legislation, or by junior staff, with perhaps an understanding of the country and its legislation but limited knowledge in the field.There is, however, another more useful and costeffective approach worth considering.

Rather than conducting a tender among various consortia, the development institution that is funding the diagnostic analysis and the relevant governmental agency would only need to approach those major law and accounting firms in the country that have already represented an underwriter or an issuer in a previous
international securities transaction. Since these firms have been paid considerable sums to analyze all the legal and accounting issues related to these types of
transactions and are subject to significant liability risk if they get it wrong, one can be quite confident they have an extensive understanding of the legal problems and can immediately identify the exact provisions in already existing legislation that need to be modified or clarified. This approach would obviate the need for
extensive and expensive diagnostic studies funded by external agencies since they already exist in the form of the memoranda these firms have supplied to their
clients and that summarize in excruciating detail the issues involved in attempting to carry out an international offering under the host country’s prevailing
legislation.These memoranda would, of course, be sanitized to remove sensitive information, repackaged, and, for a fraction of the cost of the traditional approach,
provide legislators with a detailed explanation of the needed legislative changes.

The guiding principle in addressing inadequate commercial legislation should not be to suggest wholesale amendments in an effort to ensure that the resulting system complies with an abstract, uniform,and probably utopian standard.We should be guided, rather, by the determination to isolate the specific provisions (or lack thereof) in existing legislation that prevent honest foreign investors from executing business activities in the country and to recommend changes that make sense in light of the country’s social, economic, and cultural conditions. No one is better positioned to provide that information than existing foreign investors and their legal and accounting advisers.

The big-bang approach to legislative reform. There is a tendency in the international development community to view reform in large grandiose terms. Emphasis is
often placed on “macro” issues articulated in a quasidetached and general fashion: the need to eliminate corruption, to implement legal and judicial reform, and to develop transparent capital markets—these desiderata are repeated mantralike at legal-reform and development conferences. However, the serious mplementation
of reforms that have a practical impact on a country’s investment climate requires a focus on details and not on general concepts, if only because it is usually the details that give rise to actual day-to-day problems. Unfortunately, the international development community often fails to give sufficient attention to the “micro” problems and issues that most immediately affect the private sector.

This is especially true with respect to legislative reform and foreign investment. Once a foreign investor takes the leap of faith and makes an investment, he is
generally not concerned with corruption in general or with the need for legal reform in the abstract. Rather, he is focused on how specific aspects of the law and
system affect his particular business: that the ambiguity of one word in an existing piece of legislation could put at risk the legality of his proposed transaction, or that official X at window Y at Ministry Z requires a bribe to issue a routine permit.

Most foreign investors who have committed resources to a country have probably already accepted the fact that, in general terms, the legislative and legal systems are inadequate.They are also prepared to accept that any given piece of legislation is unlikely to conform to an ideal standard.The immediate focus of committed
investors tends to center around a succinct list of specific complaints about the one piece of legislation or regulation
that, if rectified, would greatly facilitate the success
and continued viability of their investment.

Unfortunately, many investor surveys carried out by the development community tend to focus on very broad areas of concern: Is the current bankruptcy law effective? Are contract rights enforced effectively by the courts? Is the pledge law incomplete? Is it a concern that laws are not being enforced consistently, expeditiously, and impartially? When faced with these sorts of general questions, most foreign investors tend to respond that, yes, the situation needs improvement. Of course, a foreign investor will prefer to see a better bankruptcy law or commercial code or be in favor of improved enforcement mechanisms—who would not?
However, understanding in general terms what concerns a foreign investor is not terribly relevant. What is important is to isolate the specific provisions in
legislation that need amendment. And this can only be carried out by submitting to the legal and accounting advisers of the foreign investors already active in the
country extremely detailed survey questionnaires that delve into the nitty-gritty of problematic clauses in the laws governing particular situations.

Critical mass for reform and the need to retain foreign investment. There is little doubt that in the postcommunist countries a certain amount of FDI was (and will
continue to be) lost in the absence of fully viable legal systems.However, with respect to the goal of developing appropriate commercial legislation to attract foreign
investment, the important issue is not that potential investment may have been lost as a result of an imperfect system, but that enough investment has been
attracted initially to create a critical mass of large multinational investors capable of instigating and participating in the process of legislative reform as described above. It is this critical mass of successful investors that will set an example for new foreign investors, attracting considerably more FDI than any long-awaited, and, in truth, never-to be-achieved ideal legal system.

Nevertheless, it is not sufficient simply to attract foreign investment; it must also be retained. This is necessary for two reasons. First, foreign investors play an
important role in the legislative reform process and in the process of institutional reform. Significant losses of FDI necessarily weaken the overall process of such
reforms. Second, and perhaps most important, a failure to retain the initial pioneering foreign investors severely affects a country’s attempt to encourage new FDI.
There is nothing more frightening to a potential foreign investor than to hear about or to read in the papers about existing investors losing their shirts or
liquidating their investments as a result of corruption, inadequate legislation, and the lack of the rule of law.

Whereas an inadequate legal system is often not a decisive factor in attracting (or repelling) FDI, the lack of legislative and institutional reform is a significant
barrier to retaining such investment. Even the most entrepreneurial foreign investors have a limit as to the type and level of systemic difficulties they are willing to
endure. In Russia, for example, a significant number of foreign investors lost considerable sums in the 1998 financial crisis.These events had a significant impact on
foreign investors’ perception—not only were the losses significant but they occurred in a manner that made painfully evident the unique inadequacies of Russian
laws and the general lack of the rule of law and a legal culture.When Russian banks start rescinding currency swaps and forward contracts on the grounds that they
constitute “illegal gambling,” when foreign creditors see assets being blatantly stripped from their debtors, and when the courts begin to rule that force majeure events have occurred (the force majeure event being that one party to the transaction has no money)—all of these actions raise, once again, among foreign investors the concerns about a “Wild East” that had been pushed aside when things were going well.

As a result, reform efforts must recognize that it is extremely important for the host state to retain a critical mass of foreign investment, and that legislative and
institutional reform be a key component of such efforts. However, in carrying out such reforms it is important to bear in mind, and to work within, the
lessons and principles outlined above—in particular, to consult adequately with foreign investors and to identify the specific deficiencies in the legislation of
concern to such investors.

The need for a new paradigm
In light of the lessons learned from past efforts, a fundamental shift is required in the manner in which the international development community views certain
aspects of legal reform in postcommunist countries, particularly in the area of commercial legislation and regulations.The community should move away from a
process almost exclusively driven and created by multilateral organizations and NGOs to a process that recognizes and expands the role of the private sector.
This new paradigm also calls for a change in focus, away from working feverishly to develop perfect legislation that will attract all possible investment and/or funding grandiose diagnostic studies and toward an emphasis on working with host countries in order to attract and retain a persuasive threshold level of investment. This new effort would establish (together with the host country) a more direct and meaningful dialogue with existing foreign investors (perhaps through the various chambers of commerce located in each country), would focus on specific investor concerns within the framework of existing legislation, and would recognize, finally, that the process of legislative reform is long, tedious, and subject to an almost continuous cycle of incremental change and trial and error.

John Hewko is a partner with the law firm of Baker & McKenzie. From 1990 to 2001 he practiced law in Moscow,Kyiv, and Prague. This article is a shortened version of the original Carnegie Endowment for International Peace Working Paper No. 26 (Washington, D.C., 2002).

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