Private Order Under Dysfunctional Public Order

Businesspeople need contractual assurance. Most transactions are less straightforward than a cash sale of an easily identifiable item. Buyers need assurance of the quality of what they are purchasing, and sellers need assurance that bills will be paid. The legal system may not always be available to provide contractual assurance – and when the law is dysfunctional, private order might arise in its place. Many developing and transition economies have dysfunctional legal systems, either because the laws do not exist or because the machinery for enforcing them is inadequate. In such countries, bilateral relationships, communal norms, trade associations, or market intermediaries may work in place of the legal system. In this Article, we use data obtained from surveys of firms in five transition economies in Eastern Europe and the former Soviet Union as well as Vietnam to show that, at least in these economies, social networks and informal gossip substitute for the formal legal system, while business networks and trade associations work in conjunction with it. These transition countries provide an informative place to examine the interaction between the formal legal system and private-order mechanisms because both are in a state of flux. Although market-oriented laws have begun to replace the bureaucratic controls of the old planned economy, private firms’ access to the courts varies, from almost no access in Vietnam to considerable access in Poland and Romania. Even within these countries, the transitional state of the legal system means that managers vary in their perceptions of the courts’ usefulness, and ultimately it is their willingness or unwillingness to utilize the formal legal system that shapes the development of private order. Because the data from these economies contain more variation than would be found in a steady-state economy, we can run meaningful regressions relating firms’ behavior to their perceptions of the courts’ workability.