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By TIMOTHY FRYE AND ANDREI SHLEIFER*
In the 1990's, several East European economies went through radical liberalization. Among them, Russia and Poland adopted similar packages of reforms, including almost complete price and trade liberalization, macroeconomic stabilization (which Poland accomplished five years before Russia), largescale privatization (which Russia did four years before Poland), and small-scale privatization. While Poland started two years earlier, both reform packages were radical.
Despite the similarity of reform packages, the Polish economy responded much better to the treatment. By the mid-1990's, it was growing rapidly, while the Russian economy at best stopped shrinking. The formation and growth of small businesses was also more dramatic in Poland. According to the European Bank for Reconstruction and Development (EBRD, 1996), in 1995 Poland had about 2 million small private businesses, whereas Russia had only 1 million with a population almost four times larger. Even if we allow, as the EBRD does, that Russia had another 2 million unregistered private businesses, small-business formation is still more lethargic in Russia.
Why, despite similar reform packages, has the Russian entrepreneurial response been weaker? Using a pilot survey of shop managers conducted in Moscow and in Warsaw in the spring of 1996, we argue that a key reason for this outcome is there are very different relationships between government and business in the two countries. In the survey, we ask questions about the legal and regulatory environment in both cities. We find that the regulatory, and to some extent the legal, environment is a good deal friendlier to business in Warsaw than in Moscow.
I. Government in Transition
There are three basic views of how bureaucrats and entrepreneurs interact during transition, as well as more generally. Under the invisible-hand model, the government is wellorganized, generally uncorrupt, and relatively benevolent. It restricts itself to providing basic public goods, such as contract enforcement, law and order, and some regulations, and it leaves most allocative decisions to the private sector. Many countries in eastern Europe, particularly those hoping to join the European Community (Jeffrey Sachs, 1994), have looked to this model in their reforms.
In the two alternative models, government plays a larger role. Under the helping-hand model, commonly invoked in discussions of China (Andrew Walder, 1995), bureaucrats are intimately involved...