UC Berkeley

The importance of property rights to economic and political development is widely recognized. Yet it remains unclear why institutions for protecting property rights often fail to emerge. Many scholars focus on leaders’ incentives and assume that if institutions are “supplied,” then firms will automatically use them. By contrast, this study emphasizes that firms often circumvent or subvert newly created institutions. Consequently, theories of property rights formation should not focus exclusively on whether or not leaders create institutions. They must also explain the conditions under which firms actually use formal institutions for protection.

This study analyzes firms’ strategies for protecting property rights in Russia and identifies conditions under which firms rely on state institutions. Observers of Russia frequently focus narrowly on high-profile property rights disputes and mistakenly conclude that the lawlessness of the 1990s persists. However, my original survey of Russian enterprises and in-depth interviews with firms, lawyers, and private security agencies reveal a remarkable shift in firms’ strategies over time: Whereas Russian firms in the 1990s used illegal coercion — such as mafia rackets — to protect property, today they increasingly utilize law and formal institutions.

To examine this shift in firms’ strategies, I develop an analytical framework based on evolutionary game theory. The framework draws attention to several key characteristics of institutional development: (1) The expected payoffs to firms’ strategies for protecting property depend on the interplay of direct effects (i.e., exogenous factors that determine the benefits and costs of a given strategy) and interactive effects (i.e., the extent to which other firms in an economy use a given strategy). (2) Over time, more effective strategies become predominant, due to mechanisms such as natural selection or adaptive learning. (3) A tipping point exists, at which society begins to break from a vicious cycle to a virtuous cycle. Relatively small changes can therefore initiate self-reinforcing cycles with large effects.

Based on this analytical framework, the study investigates the sources of change in firms’ strategies. Over the past decade, an incentive transformation has occurred. Firms now recognize that law is a more effective tool for protecting property than alternatives, such as private security agencies or informal connections with government officials. Three types of factors have shifted the benefits and constraints of illegal versus legal strategies in favor of law: (1) organizational changes within firms, such as the evolution of firm ownership structures; (2) changes in other institutional spheres, including the development of the tax administration and banking sector; and (3) changes from outside the domestic political and economic system, including the inflow of foreign investment.

Incentive structures also explain variation across firms’ strategies for protecting property. The nature of threats and available resources shape the relative benefits and constraints of using illegal versus legal strategies. Analysis of these two factors predicts the types of firms most likely to use legal strategies: (1) medium-sized firms rather than small or large firms; (2) firms that produce physical products rather than services; (3) firms that operate in large-scale rather than exclusively local markets; and (4) firms that lack informal connections to government officials.

This study’s conclusion explores pathways to the rule of law in transition and developing countries, with specific reference to Russia. Whether the rule of law will take root in Russia depends on the outcome of two conflicting tendencies: (1) increasing demand for law by firms; and (2) decreasing supply of law by predatory state officials.