In Economics for an Imperfect World, Essays in Honor of Joseph Stiglitz, eds.

Economists have long recognized the importance of law for behavior, but we are just beginning to recognize that the law is endogenous. One of the most important instances of social change in recent years is the transition in Russia and Eastern Europe from public to private ownership of the means of production. These countries share a stated objective of establishing market economies: not only privatization of state enterprises but also systemic change—the creation of an institutional environment, based on the “rule of law, ” where competitive market transactions can take place.1 In the early 1990s, the dominant paradigm in the West regarding the transition was that granting individuals the control of property would create a political constituency for the rule of law, where there is protection for private property rights.2 All over the 1 By the rule of law I mean a legal regime where property rights are secure, since there are rules on which even the ruler cannot infringe; access to legal rights is broad; and rules for solving legal disputes are predictable. The rule of law is the institution that makes possible a competitive market economy as formulated in the neoclassical model. Empirical work confirms that the rule of law is critical to the success of actual market economies. Three strands of this literature are: macro-studies on the security of property rights (e.g. Barro 1997 and La Porta et al. 1998), firm-level studies(e.g. Johnson et al.), and case studies on the breadth of access to property rights (e.g. Kahn and Sokolof