Devolution of Government in Russia

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Transition and Development:

China, East Europe and North Korea


2009 Seoul National University WCU


Hong Kong University Conference

October 30
-

October 31, 2009


A
Tale of Two Decentralizations:
Devolution of Government in Russia
and China



Leonid
Polishchuk




Reflection on:



Chenggang

Xu

The Institutional Foundations of China’s Reform and
Development

To appear in the Journal of Economic Literature


Leonid
Polishchuk

Legal Initiatives in Russian Regions: Determinants and
Effects

In: P. Murrell (ed.) Assessing the Value of Law in
Transition Economies, University of Michigan Press,
2001




Difference in differences
a
pproach in
institutional
s
tudies


A
good way to assess potential and limitations of institutions
is through comparative analysis when similar institutional
setups produce strikingly different outcomes.


Such comparisons reveal complementarities and
contingencies that could decide the fate of a policy reform.





Case
in point: decentralization in Russia and
China



In
both countries decentralization was implemented almost
simultaneously to advance modernization and reform of a
formerly command economy in a large and diverse country.


Outcomes



China


Decentralization
is
sustained and
institutionalized as a
signature feature of the
Chinese economic
development model
and powerful engine of
economic
growth.



Russia


Decentralization
was a
fiasco economically and
politically and was
curtailed and reversed
in
the early 2000s.


Russia and China on decentralization map


Explaining the difference




Such multiplicity
of outcomes begs explanations and
should be related to differences in conditions,
endowments, and path dependencies, as well as to
choices of different decentralization modes.


Rationales and precedents



China


Decentralization
was a
deliberate choice of the
central government, an
innovative “made in
China” approach to
reform and itself a source
of numerous institutional
innovations.


It
had precedents in the
country’s old and recent
history, from the imperial
times to the “Great Leap
Forward
”.



Russia


Decentralization
was a
spontaneous reaction to
earlier failures of hyper
-
centralization, an ad hoc
elite pact based on
power
-
loyalty swaps, a
pragmatic choice of the
central government
offloading risks and
responsibilities of reforms
to regions, and an
attempt to grow market
institutions “organically”,
from bottom
up.



Legal
and political accommodations







China


Decentralization
was implemented
by an authoritarian regime (the
RDA

model) without
a de jure federal
basis that includes inter alia
elections of regional governments.
“Federalism, Chinese style”

(
Montinola
,
Quian
,
Weingast
, 1995)
combines far
-
reaching economic
decentralization with unwavering
political centralization. Instead of
standard “best practice institutions”,
including private ownership and the
rule of law, “transitional”
institutions” were put in place,
which are gradually evolving to a
more conventional institutional
setup.












Russia


Decentralization
was attempted
in the format of a rule
-
of
-
law
-
based federal state with political
checks and balances and
constitutionally stipulated
divisions of power.
Decentralization was concurrent
with an economic reform which
emphasized private property and
free market.



Quality
of institutions: ex ante and ex
post





The
Russian foundations appeared more solid and credible than
China’s, and scored higher on conventional institutional
measurement scales. Performance outcomes were exactly
opposite.



Do
Institutions Cause Growth
?
(
Glaeser

et al., 2004
)


Checks
and balances on
executives could be less important than
good
policies
pursued under authoritarian
regimes.



Imprecision
of the Russian federal law and lax enforcement
practices narrowed the gap between the two systems. What
mattered were self
-
enforcing incentive
-
compatible equilibrium
institutions (
Weingast

1997; Aoki 2001
) emerging in China and
Russia.


Economic benefits of decentralization





Earlier
view:
decentralized
system of government
customizes
economic
policies and provision of public goods
to
local
needs
and
regulates inter
-
jurisdictional
spillovers

.





Modern
view: decentralization
strengthens
performance
incentives for
subnational

politicians and public servants, and
opens up a competitive market for regional and local
policies.




Incentive multipliers of
decentralization:



competition
for mobile factors of production


availability
of comparative benchmarks (yardstick, or



tournament
, competition)




Solutions of
subnational

government
agency problem





China




Top
-
down
(accountability
to the central
government through
appointments and
subordination)





Russia




1990s


bottom
-
up
(accountability to voters
through direct elections)


2000s


top
-
down
(accountability to the
central government
through appointments
and subordination)



Factors
affecting performance and
outcomes of decentralization





Economic
structure


Economic trends


Objectives and capacity of the central government


Civic culture


Impact of economic structure



Concentration of production and high degree of
specialization of local economies
require
unimpeded
interregional exchanges which could be obstructed by local
trade barriers.


Concentration of production and interregional division of
labour raises importance of centrally supplied institutions,
policies and
infrastructure.


Concentration
of production reduces short
-
run significance
of competitive markets and private sector
development.


Concentration of production increases the danger of
capture of
subnational

governments by dominant economic
and political interests
(
Bardhan
,
Mookherjee
, 2000).


Dissimilarity of regional economic profiles and socio
-
economic conditions complicates interregional
comparisons of government performance and devalues
tournament
competition.


Economic structure comparisons



China



Relatively
even allocation
of
industries
across the
country and “completeness”
of regional economic
profiles.


Similarity
and comparability
of economic conditions in
various regions facilitates
tournament
competition.



Russia


High concentration of
production and profound
disparities in income and
welfare.

Importance of national
markets and
infrastructure.

Susceptibility to capture of
subnational

governments
by narrow
interests.

Difficulties in assessment of
regional and local
governments’
performance.




Impact
of economic trends:

strategic
complementarity

between
decentralization and growth





Economic
growth and massive inflow of investments
nation
-
wide strengthen performance incentives of regional
and local governments: efforts to improve investment
climate and supply market
-
enhancing institutions bring
high rewards. Economic growth makes
government
reputation a
valuable long
-
term capital asset and thus
substitutes for the rule of law as a commitment device.




Recession
and a lack of investments devalue local pro
-
market efforts and reduce economic costs of reneging on
policy announcements and expropriating private
investments.


Costs and benefits of expropriation of
external investments

Political economy of scale and
endogenous rule of law


High inflow of investments maintains “supply” of good
institutions and lends credibility to government’s
commitment to honour investors’ rights. In a rational
expectations equilibrium good institutions and policies
and private investments feed upon each other.

When investments trickle in, violation of investors’ rights
is a distinct possibility, making investors’ scepticism
rational and self
-
fulfilled (
Rodrik
, 1991;
Polishchuk
, 2003)



Economic trends comparison



China


Fierce
regional competition
for massive inflow of foreign
investments has been a
powerful force for pro
-
market policies, which
contributed to the nation’s
reputation of an investor
-
friendly economic
powerhouse.



Russia


Throughout
the recession of
1990, capped by the 1998
financial crisis, foreign and
domestic investments
remained suppressed. Local
efforts to attract
investments were devalued
by the overall negative
investment
profile of
the
country at large, which in its
turn was sustained by
predatory policies of
regional
governments.



Somewhere in Russia: a 1999 dialog
between regional governor and
investor






Investor:
“What are you doing?! No one will ever
invest here again
!”


Governor
: “Big deal! No one is investing here
anyways.”



Objectives
and capacity of the central
government



China


The
central government was
consolidated and committed to
economic growth and
modernization. National interests
were properly protected against
regional attempts to e.g. raise
local trade barriers. Proper
enforcement incentives for
regional officials were set and
consistently
applied and
enforced
.



Russia


Throughout
1990s the
government remained weak,
divided and unstable. It did not
have, let alone being able to
implement, a clear vision for the
country, and surrendered much
of its policy prerogatives to
regions. The ability of the
government to enact and enforce
laws required to maintain
“market
-
preserving federalism”
was low throughout 1990s, and
multiple regional transgressions
into the federal domain
(“sovereignties parade”) went
unopposed.


Role of civic culture


E
conomic
benefits of decentralization
hinge upon
accountability of
subnational

governments. If economic
decentralization is coupled with political one,
civic culture,
i.e.
political awareness, participation and capacity for
mobilization and collective action, is of paramount
importance “to make democracy work” (Putnam, 1993). Civic
culture keeps narrow interests in check.


Russian mode of decentralization was highly sensitive to the
capacity of the society to uphold democratic institutions


Social capital endowments



China


Economic
decentralization
was decoupled from
political one, and the
impact of civic culture was
insignificant.



Russia


Past
experience of political
participation and self
-
government is nearly
absent, and the stock of
social capital, eroded by
centuries of despotic rule, is
low. Regional politics was
easily manipulated and
controlled by vested
interests. Non
-
transparency
of government and wide
variations of local
conditions further
weakened accountability of
regional administrations to
voters.


Conclusions




(
i
) Chinese
economic structure was more conducive to
“localization” of economic policy
-
making than the Russian
one.


(ii) Central
government in China was able to clearly articulate its
policy priorities and align incentives of regional governments in
accordance with these priorities; it was also able to effectively
police its relatively few areas of direct economic responsibility, such
as unimpeded trade between regions and macroeconomic
stability.


(iii) Central
government in Russia was unable to properly implement
its role in the “market
-
preserving federalism”
compact,
and
tolerated massive regional transgressions into the federal policy
domain.


(iv) Democratic
processes in Russian regions failed to ensure
accountability of regional governments to
voters.


(v) Economic
structures of Russian regions and protracted recession
distorted incentives of regional policy
-
makers away from improving
market institutions and investment
climate.



Regional policy innovations




Economic decentralization allows


end encourages!


regional and local policy initiatives. Market
-
preserving
federalism generates such initiatives, puts them to test
through competitive selection, and facilitates dissemination
and emulation of successful ideas throughout the country.




Both countries counted on regional innovations. China relied
on regions in navigating through unchartered waters of
“transitional institutions”, where the main appeals were lower
risks and local creativity in search of indigenous reform
strategies. In Russia regional lead in reform was considered as
an opportunity to sidestep policy gridlocks in Moscow and to
demonstrate merits and potential of market reforms to other
regions and nation
-
wide.






Regional initiatives in Russia and China

Both countries had indeed produced a number of regional policy
innovations that were massively emulated by other regions. However
the impact of such initiatives was markedly different. In China the
innovations that survived reality checks and competitive selection
were usually conducive to economic growth. In Russia they were often
detrimental to economic efficiency.


China

Land reform

Privatization

Special economic zones

Township and village enterprises (TVEs)

Bankruptcy procedures


Russia

Trade, investment and migration barriers

Local price controls

Takeover of federal economic
prerogatives

Floating of “junk” regional bonds

Multiple local taxes and off
-
budgetary
funds

Issuance of monetary surrogates

Bilateral “treaties” with the central
government

Collusions with firms to avoid remittance
of federal taxes



Advantages of reform through local
experimentation: the case of bankruptcy

(M
-
form vs. U
-
form;
Quian
, Roland,
Xu
, 2006)




The institution of bankruptcy was introduced in China through
local trials and errors within loose centrally set guidelines.
Regional experimentation gradually relieved political tension
over bankruptcy and provided vital input into the final version
of the national law.



In Russia the trial and error process was nation
-
wide, leading
to a costly legal roller
-
coaster: the first version of the national
bankruptcy law set excessively high requirements to initiate a
bankruptcy procedure, which rendered the institution
defunct; the second version radically reduced those
requirements, opening a floodgate of “contracted
bankruptcies against sound businesses; the third version,
presently in effect, raised the barriers back again.


Subnational

governments’ direct involvement
in private sector





Both in Russia and China local public officials become entrepreneurs
not only metaphorically (when they introduce policy innovations), but
also directly. In China local governments are involved in the economy
e.g. through TVEs, whereas in Russia such involvement takes various
forms of “public
-
private partnership”.





In China the TVE model served as transitional institution that secured
property rights in lieu of their unavailable conventional legal
protection, and strengthened incentives to provide local public goods
(
Che
,
Qian
, 1998). The latter effect is of more general nature: it is
argued that if an otherwise unaccountable government official
acquires a stake in the private sector, his public policy decisions
become better aligned with social needs (McGuire, Olson, 1996).
However this is no longer the case if market interests of a politician
-
turned
-
entrepreneur value rent extraction over value creation
(
Polishchuk
, 2008). In such case, common in regional “public
-
private
partnerships” in Russia, the wedge between government priorities and
social welfare does not get narrower, but grows wider.




Lessons learned








Egregious failures of the Russian federal model prompted the
newly consolidated central government to re
-
establish
political control and directly subordinate regional governors
to Moscow by turning them from elected politicians into
presidentially appointed administrators.


Liberal critics considered such measures as overreaction,
especially since the resumption of economic growth and
increased sophistication of voters improved chances for
success of the Russian federalism. Still, “de
-
federalizaton

brought the Russian system of government closer to China’s,
and was expected to improve performance of regional
officials (Blanchard,
Shleifer
, 2001).







… a Tale of Two Centralizations


Such expectations however did not materialize,
which can be seen from continued deterioration
of economic institutions, neglect of
infrastructure, multiple complaints about public
service provision, widespread red tape,
corruption and government mismanagement and
predation.


Comparisons between the Russia and China still
remain relevant


this time to shed light on
uneven outcomes of
political centralization
.


“It’s economy, stupid!”




Sweeping re
-
centralization in Russia was not confined
to the political domain


it was extended into the
economy by re
-
allocating tax revenues away from the
regions to the federal government, and by radically
reducing regional policy
-
making autonomy.




The economic part of centralization was a clear
departure from the Chinese approach. However, the
centrally imposed constraints are not always
sufficiently rigid and binding, and regional executives
still exercise de facto considerable discretion over
economic and social policies.



Corporate social responsibility as an alternative
to taxes and regulation





The new policy
-
making environment generated another wave
of regional innovations, prominent among them


informal
taxation and regulation of the private sector under the guise
of “corporate social responsibility” (CSR).


The conventional role of CSR is to serve as a private
alternative to government regulation by allowing civil society
groups to settle directly their relations with companies. In
Russia CSR is largely dictated by regional governments or
accommodates informal bargains between regional
governments and firms (
Polishchuk
, 2009). This practice
illustrates the “see
-
saw” effect whereby unforeseen and often
informal reaction finds ways around an economic policy
reform and thus diminishes its effect (
Acemoglu
, Robinson,
2008).





How effective is political control?





Economic disparity between Russian regions did not get
narrower, which ceteris paribus makes the task of
performance assessment of government officials in Russia
more difficult than in China.



The main difference however is in policy priorities of the
central government


in China the priority is given to
economic growth
, in Russia


to
political stability
. The
second objective often contradicts with modernization and
reform (
Acemoglu
, Robinson, 2006) and does not allow
clearly identified and measurable performance targets.


The importance of staying focused





Assessment of performance of regional officials


a critically important element of
a politically centralized system of government


is based in China on economic
growth indicators. While the Chinese assessment system is somewhat complicated
and includes “hard”, “soft”, and “priority” targets, economic performance is the
key concern which sets in motion competition between regions and thus
performance incentives.





In Russia a presidential decree has established in 2007 43 “primary” performance
measures for regional officials, and a specially assembled government commission
added to the list another 39 “auxiliary” indicators. Such incomprehensible and
unwieldy system of tasks does not provide a clear focus for regional executives
which are now supposed to be officially guided in their actions by the central
government. Multitasking is also at odds with “yardstick competition” (
Holmstrom
,
Milgrom
, 1991). In reality practical indicators include social stability in the region,
balanced relations with local elites, and expected election results in support of the
ruling party. However controlled media and stifled political competition often
suppress early warning signals, and elections are widely believed to be rigged to
produce the “right outcome”.




Self
-
defeating purpose





Stability as the main objective of the central government
could be hard to maintain through credible sanctions
against non
-
performing regional officials. When rule of law
and formal institutions are weak, chief executives in
Russian regions maintain stability through mostly informal
and personalized networks built around them. Removing
the key linchpin from such system could jeopardize the
fragile socio
-
political equilibrium, which explains the
longevity of some of Russia’s regional political players.
While the task of sustaining economic growth is
implementable through compatible with effective political
centralization when the strong central government
monitors performance and rewards leaders and punishes
laggards, the task of maintaining stability is inherently at
odds with such model.



Limits of the two models


Institutional imperfections and flaws of the Russian and
Chinese models of
subnational

governance are likely to
become more pronounced and contentious than
before.



China



Profound structural distortions prior
to the reform and enormous growth
potential of the country allowed to
sustain rapid growth as a Pareto
-
improving process without major
re
-
distributional conflict. As reform
deepens and development
challenges become more complex,
tasks of regional governments
acquire multi
-
dimensional nature
which make the top
-
down agency
problem less adequate.



Russia


The crisis has exposed
weaknesses of the Russian
institutions and threatens the all
-
important stability, especially in
single
-
factory cities
(
monogoroda
). Suppressed
private sector cannot generate
adequate income and
employment, and reduced fiscal
resources of regional
governments are insufficient to
cushion off the recession.