In any single instance of state capture, there are winners and losers. Typically, winners are politically important or simply large firms or whole industries and bureaucrats that receive favors from those firms. On the losing side, there are small, politically unimportant businesses, and, ultimately, the public interest and consumer welfare. For transition economies, the overall growth rate of the enterprise sector is estimated to be ten percent lower in a capture state, than in a state where the effect is less pronounced (Hellman, Jones, and Kaufman, 2003).
The principal characteristics of transition economies, as related to the issue of state capture, are an excessively concentrated industrial structure inherited from the planned economy, a high level of discretion of public officials with respect to economic policy, weak institutions of political control such as party system or independent media, sub-optimal allocation of authority between government layers, and low labor mobility, both horizontal and vertical. In short, all of these factors might be traced to the command economy legacy, one-party political system, and legal system subordinated to political authorities, which were characteristic for most now-in-transition countries two decades ago.
In transition economies, political channels that transmit information and, if necessary, money from firms and other special-interests to politicians are not only less efficient, but also less institutionalized. Furthermore, conceptualization of a specific exchange, both by parties to the transaction or by a student of transition, might vary widely. For example, what is considered as a fully legal lobbying activity or campaign contribution in an OECD country might be thought of as a bribe or even outright extortion in some other economy.
Typically, special interests seek, through the channels of state capture, protection from competition such as barriers for entry to the local market. At the international level, protection usually takes the form either of import quotas or tariff protection. At the local level, it is licensing, small-scale regulation, and preferential treatment such as tax exemptions granted to individual firms. State capture, as a stable, long-time relationship between existing businesses and incumbent politicians, has adverse effects on business and politics. In business, state capture prevents innovation by new or potential entrants, and, as a result, by the incumbent firms as well and thus constrains market development. In politics, it decreases the chances of challengers to mount an aggressive campaign against an incumbent, which in turn reduces electoral accountability for incumbents.
It is possible to further refine the concept of state capture. Hellman, Jones, and Kaufman (2003) based on their econometric analysis of a large sample of firms in transition economies argue that is helpful to distinguish state capture from influence by special interests and administrative corruption, with each of the three forms of business involvement in politics having distinct causes and consequences. In this refined definition, state capture is the process by which firms shape rules of the game through semi-institutionalized bribes paid to public officials and politicians; influence is the same process without direct transfers (this category corresponds to costly “informational lobbying” a la Grossman and Helpman, 2001); and administrative corruption encompasses all “petty” forms of bribery related to law enforcement and regulation.
A specific feature of many transition economies, as compared to a developing country with a similar level of GDP per capita, is that they have been left with the remnants of the command economy with its highly centralized industry. The effect was more pronounced in industrially developed countries such as Russia or Slovakia, and less in countries such as Vietnam or Albania.
Proponents of Big Bang reforms argued that establishing the rule of law, including institutions of property rights protection, requires the creation of a “grass-roots” demand for the rule of law. In practice, it meant that the former state property should first go into the hands of private owners, and only then would those owners become natural proponents of a system of property rights protection. With the high degree of concentration present in transition economies, and with undeveloped factor markets, this forecast (from private ownership to demand for the rule of law to property rights) has not been borne out. The rich – e.g., the beneficiaries of early privatisation – have obvious advantages in protecting their property privately, e.g. via state capture. Consequently, they do not have incentives to lobby the establishment of well-working state institution such as independent courts or efficient bureaucrats. Instead, they seek to increase their political influence and modify the existing state institutions so that resources and wealth continue to be redistributed in their favour (Polishchuk and Savvateev, 2004, Sonin, 2003).(This is an example of how the Coase Theorem is not valid when there are wealth effects.)
In Russia, the country that entered transition after the longest period of communist rule, and was the most industrialized of the transition economies, a decade after economic reforms were launched, most of the productive assets were concentrated in the hands of a few individuals, the so-called oligarchs (see Guriev, Oligarchs, this volume). In part, it is the efficiency requirement that when property rights are poorly protected, control rights over assets become concentrated: the larger a single owner's share is, the greater her incentives are to pursue improvements, such as improving corporate governance. (Recent cross-country studies show that the worse the general protection and enforcement of property rights are, the greater the concentration of control rights.) On the other hand, wealth inequality very often induces heavy costs on the economy, primarily because it produces wide disproportions in the opportunities available to the people. Still, the main problem is that the oligarchs who rely on state capture for protection of their property rights and enforcement of the contracts, do not become a natural constituency for the rule of law. This effect is especially strong when economic inequality is accompanied by underdeveloped democratic institutions, which is the typical case for formerly communist countries.
The effect of decentralization on state capture is two-fold. First, more authority allocated at the local level makes the agency problem at this level less prevalent, thus increasing accountability and reducing corruption. On the other hand, special interests might have much more influence over local government bodies; therefore, shifting authority downward might make state capture both more desirable and easier to achieve. In Bardhan and Mookherjee (2006) a re-allocation of authority toward local government brings the following consequences: first, the amount of bribes collected by the central government decreases; second, local governments become captured by local special interests. Since local capture might be supported by a social network more easily, the total amount of bribes in the economy decline. However, since corruption at the central level is more money-based, the special-interest are less entrenched than at the local level, and thus local capture brings more economic inefficiency. Ultimately, decentralization, while reducing bribe-based corruption measures, reduces economic efficiency.
Following a decade and a half of transition, the fear of the leviathan state has been swiftly replaced by the fear of the capture state, where powerful large businesses shape the playing field through bribery, media ownership, huge campaign contributions, and direct participation in politics. Horrible stories told about some extreme forms of capture, i.e. use of corrupt secret service and police officers against business competitors, have crowded out images of millions perishing in forced labor camps or dying in numerous famines caused by communist economic management. There is a false sense of symmetry between the state manipulating its subjects, and subjects manipulating the state: while the former has proved to be dangerous at a large scale, the second is a mere obstacle to economic development. There are several ways to deal with this obstacle: one, the backward-looking, is through restoration of the repressive capacity of the state. The second is through the development of political and civic institutions that may put a check on elected officials and bureaucrats, and through institutionalization of business influence on politics in an efficient way.
Rose-Ackerman, S. (1999), Corruption and Government: Causes, Consequences, and Reform. Cambridge, UK: Cambridge Univ. Press.