Current Legal Issues Affecting Central Banks, Volume III.


Robert Effros
Published Date:
August 1995
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In the course of the International Monetary Fund’s technical assistance work in Central and Eastern Europe, two issues have repeatedly been confronted: namely, the phasing and pace of legal reform, in general, and the privatization of state enterprises, in particular.

Pace of Legal Reform

The first of these issues could be put in the following terms: should legal reform be restricted to transitional legislation, or should such reform produce legislation that is designed to meet the needs of a fully developed market economic system even before that system is in place? It is clear that the transition from a communist command economy to a market economy must be accompanied by legal reform. In many respects, the rules and institutions of the communist legal systems of Central and Eastern Europe simply do not permit, and are not suited to support, the transition from a command economy to a market economy. There is therefore no disagreement that legal reform is needed and that an important task of such reform must be to authorize and support the transition to a market-oriented society. What is at issue is whether legal reform should extend beyond this transitional task, or whether the completion of the new legal system that is required for a market-oriented society should be postponed until the economic and political reforms have been completed, until this revolution has run its course and there is a better view of where these countries came from and where they have arrived. This is a fascinating, nearly philosophical, question.

On the one hand, there is much to be said for a reactive approach to legal reform. Normally, in a developed legal system, legal reform does not lead, but follows, the changes in conditions that it purports to reflect. Law at its best reflects the law consciousness of the nation. How can such a consciousness be formed and how can it be examined before the development of the societal conditions on which it depends has been completed? How can a postcommunist society that is still battling the cross-currents of a tumultuous socioeconomic revolution select in advance the rules of law that should govern its as yet uncertain economic and political future?

On the other hand, it must be admitted that for many of the countries in transition the postponement of legal reform would be tantamount to condemning economic reform to what at best would be a legal vacuum and what at worst would be the ruins of a communist legal system that contradicts the preeminence of the rule of law and the individual freedoms without which a market-oriented society cannot begin to function. This is indeed a powerful consideration: a market-oriented system cannot begin to function without support from market-oriented law and legal institutions.

There is another important point to be made. The idea that, during the transition to a market economy, legal reform should be limited to transitional law appears to be based on the premise that permanent legal structures will not be needed until the transition is completed. It has been discovered that this premise cannot be reconciled with the experience of countries in transition. Their experience shows that the transition of a national economy to a market-oriented system is not a gradual process that is uniformly phased and that makes each sector of the economy move in lockstep with the others to complete the process of transition simultaneously. In fact, some sectors of the economy produce market activities long before others. The need for market-based law is felt long before the economic transition as a whole is completed.

Ideally, market-oriented law and legal institutions should be available at the moment that the first market activities take place, regardless of when they occur during the transition process. This argues for the immediate introduction of market-oriented law and legal institutions at the beginning of the transition process. If the introduction of market-oriented law and legal institutions is postponed until some or all of the economy has made the transition, the economic reform program could well fail in its entirety, because the sectors of the economy that make the transition first—and thus would be most vulnerable to setbacks—would lack the legal support required to survive. Therefore, uncharacteristically perhaps, in the transition from a command economy to a market economy, legal reform should lead economic reform, in order to provide the support without which market-oriented activities cannot be sustained.

Privatization of State Enterprises

The second issue to be addressed concerns the privatization of state enterprises. In most countries in transition, a great deal of effort—often too much effort—has been spent on privatization. Before much time and money is invested in privatization, one should ask: how important is private ownership of enterprises (as compared with state ownership) to the efficient functioning of a national economy? In industrialized societies, ownership has become increasingly anonymous and passive, especially in public corporations. As a rule, shareholders of public corporations exert little influence on the operations and financial conditions of their corporations. It is true that the law grants certain powers to shareholders of a corporation, but, especially with respect to large public corporations, these powers are rarely exercised. Why then would a private individual own shares in a public corporation? It is neither because he or she wants to be an entrepreneur nor because he or she wants to exercise the rights of an owner of a corporation. Usually, a private individual owns corporate shares because he or she hopes to earn income or capital gains. Frequently, the interests of owners in their corporations do not extend beyond the achievement of these investment objectives. There are persons, however, whose interests in the corporation are much more profound than those of its shareholders. They are the people who work at the corporation, its managers and employees. Often, they behave more like owners of the corporation than its passive and anonymous shareholders. This is so because the authority of the owners to manage the corporation has been delegated to its managers. From an economic perspective, who works at the public corporation is more important than who owns it.

In conclusion, how a corporation is managed is more important than who owns it. For instance, a state-owned corporation that is well managed along sound commercial principles is better for the national economy than a mismanaged corporation that is privately owned. Private enterprise ownership and sound management practices are not always interdependent. There are examples of state-owned corporations that are operated as well as private commercial enterprises under the supervision of state officials who have the power and the incentive to enforce sound management practices and to deny any form of state subsidy.

The foregoing supports the following proposition: more important than privatization of corporate ownership is privatization of corporate management practices.

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