The Review of Austrian Economics, 16:4, 347–361, 2003.
2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Understanding the Transaction Costs of Transition:
It’s the Culture, Stupid
SVETOZAR (STEVE) PEJOVICH email@example.com
Department of Economics, Texas A&M University
Abstract. The process of transition in Central and Eastern Europe from socialism to capitalism is a cultural
issue rather than a mere technical one. To support this proposition, economic analysis must explain why and how
informal rules affect the results of transition.
KeyWords: transition economies, Central and Eastern Europe, culture, transaction costs
JEL classiﬁcation: B52, O1, O2, P2.
Introduction: The Interaction Thesis
Scholarly research and empirical evidence showing the strong positive relationship be-
tween the free-market, private-property economy and economic growth is quite convincing.
Forexample, Haan and Sturm ﬁnd that greater economic freedom correlates with higher
economic growth (Haan and Sturm 2000). Torstensson demonstrates that unstable private
property rights retard economic growth (Torstensson 1994). North and Weingast argue that
the development of credible private property rights, the adoption of common law, and non-
enforcement of wage and price controls explain economic growth in Seventeenth-Century
England (North and Weingast 1989). Economic studies covering eight countries on four
continents show the power of property rights to explain and predict economic behavior
overarange of cultures (Pejovich 2001). The Heritage Foundation’ Index of Economic
Freedom and Fraser Institute’s Economic Freedom of the World illuminate a strong positive
relationship between economic freedom and growth.
In the early 1990s, the end of socialism in Central and Eastern Europe (hereafter C&EE)
created incentives to seek growth oriented institutional reforms. Responding to those in-
centives, the former socialist states in Central and Eastern Europe (hereafter C&EE) began
transition into free-market, private property economies.
Thirteen years later, the 2003 In-
dex of Economic Freedom classiﬁed only Estonia as a free-market country.
countries from the region were classiﬁed as mostly free, nine as mostly unfree, and two as
The same initial objectives of transition have clearly produced different results
in different C&EE countries. I conjecture that differences in the results of transition are not
The process of transition from socialism to free-market, private-property economies calls
for the development of new institutions. The transaction costs of institutional restructuring
must then affect the results of transition. To understand differences in the observed results of