Volume 8 Number 4

Fall 1999

Feature

Demand for Law
    Supply and Demand for Law in Russia
     Katharina Pistor

Kathryn Hendley's essay is a timely comment on legal reforms in Russia. After years of intensive lawmaking in the hope that—by creating a well-designed legal system and improving legal institutions—economic growth would resume, an assessment is in order. The sheer volume of legal rules that have been issued in Russia over the past eight years is truly stupendous. In the beginning, economic reforms were driven by regulations and decrees issued by the executive, most notably the president. Since the mid-1990s, however, many key laws were adopted by the legislature, and earlier laws that had been rushed through parliament were substantially revised. As Hendley points out, these legal statutes were backed by newly established institutions. Thus, law reform was not limited to introducing new formal rules but was reinforced by institution building. Why has this proved inadequate for establishing a law-bound economy in Russia?

Hendley argues that what went wrong is that most reform measures were implemented top-down. They were motivated by lacunae in the formal legal system but their sponsors ignored the legacy of the socialist system and how it had shaped the perception by citizens and entrepreneurs of formal law. Both law and law-enforcement agencies are greeted with a skepticism that has been bred for decades—if not for centuries—by the experience that extralegal motives often influence decision making and that law is chiefly an instrument of those in power. Few will see it as the neutral transaction-cost–reducing and transparency-enhancing mechanism it is idealistically said to be by foreign-policy advisers. Because of this distrust of formal law, Russians rely much more on informal mechanisms, at best on networks of trust and relationships, at worst on private security services and organized crime.

One should add that the claim that informal rules, relational contracts, and networking are important features of business transactions is in line with both the law-and-society literature and a new trend in the economic analysis of law that has enriched this approach—regarding informal rules and networking—with elements of legal pluralism. (In recent years there have been several legal symposia that discussed the relation between norms and formal law. See "Law and Society & Law and Economics: Common Ground, Irreconcilable Differences, New Directions," Wisconsin Law Review 375, no. 3 [1997]; "Law, Economics, & Norms," University of Pennsylvania Law Review 144, no. 5 [1996]; and "The Nature and Sources, Formal and Informal, of Law," Cornell Law Review 82, no. 5 [1997].)

According to this literature, the role of formal law is usually overstated. Even in the most efficient legal systems, most contractual disputes are solved outside the formal court system; indeed, entire trades or communities opt out of the legal system and informal norms may well govern long-term business relations. Assuming that this is an adequate account of how legal systems operate in the West, is Russia truly different?

Hendley argues yes, and I agree. The difference lies not so much in the fact that most transactions are concluded and carried out, and disputes are resolved, outside the realm of the formal law, but in the relationship between formal law and informal rules. In a legal system where formal law is an accepted and widely used mechanism for structuring transactions and settling disputes, informal and formal rules complement each other. Formal legal institutions, such as courts, can induce out-of-court settlements because the credible threat of litigation is sufficient to bring about negotiated settlements. There is some evidence that some communities completely ignore formal law, though the overwhelming evidence is that informal and formal rules complement, rather than contradict, each other. In a more figurative sense, one could speak of a continuum that ranges from informal norms to formal rules. Where a particular transaction lies on that continuum would depend on a number of factors, including previous relations between the parties, the cost of litigation, the predictability of the outcome of litigation (which may be enhanced by well-established precedents), and the degree of trust in state institutions.

In Russia, however, the relation between the formal law on the books and the norms that govern daily transactions is different. Formal and informal normative systems run parallel to each other, without regular crossovers from one to the other. Formal law is not completely irrelevant, but its relevance is confined to certain segments of the market—particularly those involving foreign investors—and to selective strategic behaviors that signal that recourse to formal law may be an option. But in contrast to the informal-formal continuum, formal law itself is not considered a general fallback option by most economic agents.

There is a growing consensus that the enactment of more or better laws alone will not change the current situation. In order to think about possible ways to enhance the role of the formal legal system, which most observers seem to agree is desirable, the causes of the current situation require analysis. I agree with Hendley that some of the causes may lie in the reform process of the past eight years. But we seem to disagree on what went wrong.

Some observers have suggested that legal reforms should have paid greater tribute to Russian legal history rather than transplanting laws from foreign legal systems. But this is not very convincing. True, Russia is a civil-law system by tradition, but this does not mean that Russia cannot borrow from other legal systems if they offer better rules. After all, most civil-law systems borrow heavily from Anglo-American systems when it comes to corporate law, capital-market law, and the like where these systems seem more advanced. Such borrowing does not always go unchallenged by protagonists of the domestic legal systems. But warnings that the consistency of the legal system may be in danger are raised more often in the interests of the legal profession than on behalf of economic agents as users of the legal system.

Hendley's claim that law should fit into the existing legal culture is not confined just to the legal tradition of the formal law but includes society's past experience with law and how this has affected the perception and the demand for formal law. Ultimately, she argues for a socialization of the lawmaking process, greater participation of users of the legal system, and greater adherence by the state and its agents to legal constraints. This claim refutes the idea that law can be regarded as part of the infrastructure, which might be improved by way of technical-assistance programs. The goal in the postsocialist world should be to overcome the crudely instrumental use of law by the state and to rid the legal system of direct political influence. But this can be done only if the relationship between the state and the law is redefined. The credibility of the legal system stands or falls with the respect paid to it by those in power. This is a political rather than a technical issue.

Viewed in this light, the history of postsocialist legal reforms in Russia is much less satisfying than a list of newly enacted laws and newly established legal institutions might suggest. During the first years of economic reform, the reformers used law in the same fashion as their predecessors: as an instrument for realizing their policy agenda. The goals might have been different, but, again, the ends justified the means. Presidential and governmental decrees were used to implement privatization and other reform measures. Protests from parliament were ignored. The conflict culminated in the events of October 1993, when, after President Yeltsin dissolved the parliament, its leaders called for open insurrection, and the president answered by calling in the troops. The crisis left behind a discredited Constitutional Court, a weakened parliament, a strong presidency that controls the government, and a deeply cynical populace—hardly fertile ground for the growth of a credible legal system.

The irony is that many economic reformers and their foreign-policy advisers would claim that what they were doing was creating the conditions for a demand-led evolution of law and legal institutions. They used economic-reform measures to signal change and expected that the process of change would create a demand for law. Privatization, for example, was implemented on the basis of a governmental decree stipulating only the most basic rights of shareholders. Mass privatization was completed before a corporate law had been enacted. The hope was that by redistributing property rights, new constituencies would emerge that would demand the protection of their rights. Over time and with some occasional robber-baron lapses, a demand-led legal system would evolve. In fact, the legal lacunae, which existed at the time rights were put up for grabs, enabled those who had earlier secured de facto control rights to influence the privatization process and ultimately to legalize these rights. In the process, minority shareholders were systematically frozen out. The enactment of the new law governing corporations, in 1996, must be assessed against this background. It was not built "so that they would come"—to paraphrase Hendley's introductory remarks. Rather, shareholders were there already, but the paper document or computer entry they held did not confer effective rights and was, therefore, of little economic value.

The history of privatization in Russia exemplifies the dilemma of rewriting the rules of the game in the context of a far-reaching economic, political, and legal regime change. The collapse of the Soviet Union called for an extensive rewriting of the rules of the game on all fronts. This entailed an extensive reallocation of political and economic control rights. In this context, the concept of demand for and supply of legal rules must be reassessed. The dynamics of such a change are fundamentally different from an evolutionary process. Where control rights are up for grabs, they will be heavily contested. Law simply may not be in great demand because it imposes unwanted constraints during the "great snatch." The weakest are least able to voice their demand for law in such a situation. It seems quite idealistic, therefore, to suppose that the state would reach out to its citizens to become their state, or for the law to become their law, in a situation where the state itself was up for grabs.

Over the past few years, various interest groups could and indeed have claimed that the state was "theirs." The gas giant Gazprom has been a silent coowner of the Russian state all along. During the early years, it was joined by the managerial-industrial lobby. Subsequently, the "big six" banks emerged, which came to control large industrial empires, including natural resources (oil, gas, and nickel) and the media. Their hold over the country was broken, at least temporarily, by the financial crisis of August 1998. But the reshuffle of the government in the summer of 1999 suggests that some have bounced back to claim their property rights.

What are the implications of this sketchy analysis for legal reforms in Russia? I share Hendley's view that, as of now, the enactment of new formal law has not brought about the desired results. Optimists may point out that it is far too early to expect significant changes because institutional change is necessarily slow. Nevertheless, compared with other reforming transition economies, Russia's certainly lags behind. I also agree that the key for building a rule-of-law state lies not in technical matters but in political processes and the commitment of those in power to legal constraints.

But I am more skeptical about the idea that a demand–led legal system can grow in the context of a fundamental regime change. The latter is a dynamic process in which not only the rules of the game are rewritten but, concurrently, the political and economic control rights are reallocated. A demand for law will not easily coalesce, or is at least difficult to identify, in such a situation. Waiting for the demand to arise may undermine the prospects of reform, and I would argue that this is what has happened in Russia. The agenda of radical economic reformers was to let loose, wait for the dust to settle, and then respond to new demands for institution building. But when the dust settled, the outcome differed substantially from expectations. As a result, the regime change lacked a supply of rules that could have served as signposts for the reallocation of assets and the rights they conferred. Most of these rules probably would not have been observed. Still, even a few cases of effective law enforcement would have sent an important signal. A far different message was delivered when cases were dismissed by the courts for lack of legal grounds to support them.

I do not disagree with the proposition that, to be effective, law requires a constituency or an active demand. I would argue, however, that the supply of key rules up-front may help elicit a critical mass of demand for law, and that providing such a supply at the outset is highly warranted, especially in the context of a root-and-branch change of regime.

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Katharina Pistor is a research associate at the Max Planck Institute for Foreign and Comparative Private Law, Hamburg.

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