Executive Summary

The fundamental problem of all post-communist states is corruption, or the misuse of public power of private gain. This is an inheritance of the lawless socialist state. The task is to establish a new state, replete with sound laws and norms. Kyrgyzstan has already accomplished much of this task, but many measures remain to be undertaken in the governance of the state.

A fundamental division must be made between business and government, and between regulation and taxation. The extensive financing of additional expenditures of state regulatory agencies through penalties and compulsory fees must be prohibited, as penalties are bad taxes. The government should cover all costs for the services it orders, and it must pay the salary of all government employees in regulatory and administrative agencies from the state budget. The government will have to sharply reduce its involvement and reduce its staff sharply, while raising salaries, especially for top staff. A comprehensive civil service reform should include full inventerization of the whole government. A clear division between political and civil service jobs should be made.

A fundamental choice which needs to be made is whether the President or the Prime Minister should lead the government. In any case, the President?s Administration and the Prime Minister?s Apparat need to be united. The central government structure looks good, but a few more ministries could be merged, and all revenue services should be united, notably the State Tax Inspection, the tax police and the State Customs Committee. It is good that the Ministry of Finance has become the dominant ministry, but it should deal only with finance and economic policy. All state plan targets for production and employment must be abolished.

The relationship between different administrative levels need to be clarified. Each level should be subject to democratic accountability at that level, preferably through democratic elections. At present, local organs are difficult to control from the center and locals have too little influence. Regional organs should either be subordinate to the central government or to the governor, but not to both, to clarify responsibility. Each administrative should have its own financing out of rational taxes determined from the center. The main over-staffing and disorder appears to exist at the raion level. One administrative level should be abolished, and the natural choice is the raion level.

The attitude to inspections and certification must change. Inspections should only be accepted when they concern human health and safety, notably of food, medicine, buildings and similar objects. Many regulations should be abolished, notably licensing. To check bureaucratic malpractices the government should eliminate the monopoly of licensing. Three different authorities should be entitled to issue any persisting license. It is vital that a free web-site displays all Kyrgyz legislation and regulations.

The fundamental problem with all post-communist states is corruption, defined as "the misuse of public power of private gain" (Rose-Ackerman 1999, p. 91). Corruption was part and parcel of communism, which was a system of kleptocracy, meaning that corruption was organized at the top of the government. After the collapse of communism, the Nomenklatura continued its enrichment with fewer constraints than under the old system, which had some rules, though it was never legally consistent or indeed reigned by a rule of law. The surviving Nomenklatura used the state and its regulatory system as a source of personal profits (Hellman 1998).

Corruption implies dysfunctional public institutions, poorly adapted to achieve social development goals, while state-building after communism aimed at the construction of a functional state, capable of achieving social goals, such as high economic growth and a reasonable degree of equity. The politics of post-communist transformation involved rendering such a transformation of the state politically possible. The problems of Kyrgyzstan differs little qualitatively from those of other post-Soviet countries, and this paper discusses them in a post-Soviet context. In many cases, Kyrgyzstan has done more than most post-Soviet countries, but qualitatively the lessons are the same.

The profound corruption has had multiple consequences for the economy. Taxes, regulations, subsidies, prices and privatizations have been used by kleptocrats to enrich themselves with severe consequences for the whole economy. The more corrupt and larger the state was the less growth and the lower total investment. Among public expenditures, subsidies and public investment crowded out investment in human capital through education and health care, as has been the case in the rest of the world (cf Tanzi and Davoodi 1997). The surprisingly high state revenues have naturally aggravated the harmful effects of a dysfunctional state, as that means that a larger share of GDP is being misallocated and used for the purpose of rent seeking.

The daunting task of the liberal reformers has been to transform this lawless monster into a democratic and law-abiding state, serving the interests of the people. A characteristic of the old Nomenklatura and its various services was: "Loyalty to other members of the organization is as important or more important than good administration" (Rose-Ackerman 1999, p. 107). Often, poorly-paid officials saw any act against corruption as a morally-objectionable attempt to take the food out of their mouths. Old Nomenklatura networks had to be broken down or taken out of state employment. A maximum disruption is desirable, though some direction of government and public order had to be maintained.

Corruption arises from direct actions by the state, notably state intervention and public redistribution. The most fundamental issue is for whom the state works ? a small privileged elite or the population at large. Conversely, is the state focused on the containment of rent seeking or its profusion? The rulers? interests have been reflected in their reforming or not reforming the state. Key aspects are the choice between parliamentary or presidential system, the reform of government, and civil service reform.

On almost every issue, there are traditionally two positions. One is that strife must be avoided, as it will be divisive and destabilizing to society. The opposing view is that openness and competition or pluralism are beneficial to the development of society, which is our view.

1. Corruption and Governance

Corruption means the malfunctioning of the state as politicians and civil servants sell public goods for private gain rather than pursue any public purpose. Good governance is the opposite, implying that state servants work for public purposes. While only hard-line communists claim that market reform has caused corruption, a common belief holds that transition has boosted corruption, which is widely seen as the greatest problem of the transition.

a. State Intervention, Size of Government and Corruption

The liberal instinct suggests that state intervention and corruption should be closely correlated, and that hypothesis holds true in general. Chart 1 shows the correlation between the share of firms that report state intervention and the share of annual revenues that enterprises state they pay in bribes (EBRD 1999). The greater state intervention, the more enterprises have to pay in bribes.

[Chart 1 approximately here]

State intervention and corruption are likely to reinforce one another. In traditionally corrupt states, the old elite presumably reassures itself of a great degree of state intervention to maintain their substantial incomes from bribery. Yet, a high degree of state intervention is likely to stimulate corruption, while one of the most remarkable developments is that Poland, which was traditionally perceived as quite corrupt, is now deemed surprisingly honest.

Another liberal instinct is that the larger the government, the greater corruption. To test this idea, we examine government influence as the share of GDP being redistributed through taxes and public expenditures, but we obtain a strong correlation in the opposite direction. Central Europe has the largest public expenditures as a share of GDP, but little corruption, while the Caucasus has minimal public expenditures and huge corruption.

Controlling the quality of government also, the causality between corruption and public expenditures is rather clear in the post-communist world, as most of these countries started with public expenditures of around 50 percent of GDP. On the whole, the worse a government has functioned, the smaller it has become.

Thus, while all the CIS countries are very corrupt, the size of the government seems to be the most plausible explanation for their contrasting economic performance. The conclusion is that "opportunities to engage in corruption need to be scaled down by reducing the government rule in the economy" (Tanzi and Schuhknecht 2000, p. 169). To obtain growth with these corrupt governments, the size of that cancer has to be reduced, so that free enterprises can flourish in spite of them. In parallel, corruption can be combat by other means, and it tends to abate with economic growth. While Kyrgyzstan is deemed a relatively corrupt CIS country, it has managed to achieve substantial growth thanks to limited public expenditures and few bureaucrats.

b. Who Corrupts Whom?

Two different views persist on demand and supply in corruption. One view is that corruption is caused by unscrupulous entrepreneurs who exploit the state to their advantage. The other view is that poor entrepreneurs are subject to extortion by corrupt politicians and bureaucrats. As corruption describes a party between the state and the private sector, either party can be the dominant actor (Rose-Ackerman 1999, p. 113).

Joel Hellman, Geraint Jones and Daniel Kaufmann (2000b) distinguish between three kinds of relationships between firms and the post-communist state, namely state capture, influence and administrative corruption. State capture, also called political corruption, means shaping the formation of the rules of the game, that is, laws, rules, decrees and regulations, through illicit private payments to public officials. Influence also refers to the formation of the rules of the game but without private payments to public officials. Administrative corruption implies private payments to public officials to distort the implementation of official rules, that is, ordinary bribery.

The patterns of bribery, state intervention and distribution of subsidies reveal evident discrimination between enterprises of different ownership. State-owned enterprises are subject to most state intervention, but they pay moderate bribes, while receiving the largest subsidies. The state intervenes almost twice as much in state-owned enterprises as in private firms. Admittedly, privatized enterprises face much less state intervention, pay slightly less bribes and still manage to extract significant indirect state subsidies. The real victims are new enterprises. State officials fail to control business decisions of new entrants, but they take their revenge by extracting the largest bribes from them and forcing them to spend more time with state officials than managers of either state-owned or privatized enterprises.

The picture is clear. The big state enterprises maintain a cozy relationship with the government, extracting state largess in exchange. As they are big and well-connected, government officials dare not extract much bribes from them. The situation of big privatized enterprises is similar, though they keep more distance form state officials. Small enterprises are easy prey for unscrupulous officials. The EBRD (1999, p. 127) established that "the more a firm pays in bribes the less likely it is to receive direct subsidies," and there is no trade off between time spent with officials and bribes paid. On the contrary, "comparing across enterprises within any given country, bribery, state intervention and time spent with officials tend to go hand-in-hand" (EBRD 1999, p. 125).

Our impression of bureaucrats as predators is being confirmed, and it appears to be the case in Kyrgyzstan as well. State officials are indulging in extortion on a massive scale. The weaker the victim, the worse the persecution. While large firms report paying 2.8 percent of their annual revenues in bribes, small firms are forced to pay almost twice as much ? 5.4 percent. Obviously, this lawless repression harms small private enterprises. The situation is far worse in the CIS than in East-Central Europe. The EBRD survey found that enterprises in the CIS countries pay almost twice as much of their revenues in bribes (5.7 percent) than enterprises in East-Central Europe (3.3 percent).

The EBRD survey confirms that privatization is beneficial to the combat of corruption, as Daniel Kaufmann and Paul Siegelbaum (1996) have argued. Privatization has really removed the state from many company decisions, and private enterprises obtain far less subsidies from the state than state-owned enterprises. The large bribes paid by small private enterprises does not underscore their corruption but their lack of power in the face of the post-communist bureaucratic Leviathan.

c. State Capture

In an enterprise environment with such great pressures for corruption, one would expect enterprises not only to suffer but also to exploit the opportunities and buy their piece of state policy. If all public goods are for sale, enterprises can benefit from buying parliamentary votes to extract laws, presidential decrees, central bank funds and court decisions, forming the rules of the state. In 1999, the EBRD made a large survey of enterprises in 18 post-communist countries, measuring state capture (Hellman, et al, 2000b).

[Table 1 approximately here]

Table 1 shows an astounding difference in degree of state capture. The countries with little state capture consist of two groups, the most advanced reformers (Poland, the Czech Republic, Hungary, Estonia, Lithuania, Armenia and suspiciously Kazakhstan) and the firmest dictatorships (Belarus and Uzbekistan), while the countries with the greatest state capture are largely intermediary reformers (in order of state capture: Azerbaijan, Moldova, Ukraine, Russia, Latvia, Kyrgyzstan, Bulgaria, Georgia, the Slovak Republic and Romania). This is only one measurement of sensitive variables, so individual countries may be mismeasured, but the overall picture makes sense. Private enterprises either cannot or do not find it worth privatizing state policy in liberal states, while it is the way to success in very corrupt states.

Naturally, state capture influences both the economic success of nations and of individual enterprises. The average growth of sales was almost twice as high in the countries with little state capture as in the high state capture countries, reflecting the great cost of state capture to society. The sales of captor firms grew nearly four times faster than those of either firms in high capture environments, but less in countries with little state capture, indicating the existence of one vicious and one virtuous circle.

The businessmen who took the initiative to buy politicians, senior officials and judges were not typically from the old Nomenklatura but new ruthless entrepreneurs without scruples, prepared to do what it takes to make a fortune, reflecting the popular image of the so-called oligarchs. Old big state enterprises, however, influenced the same kinds of officials by other means than private payments through their close formal and informal ties with the state. However similar their mode of operation, these two groups of enterprises are distinct, representing different cultures. The evolution of state capture further underscores the dangers of gradual and partial reforms. In Kyrgyzstan, the old state managers appear comparatively weak.

d. Strategy against Corruption

The fundamental cause of corruption is that "[c]orrupt incentives exist because state officials have the power to allocate scarce benefits and impose onerous costs" (Rose-Ackerman 1999, p. 39). Any strategy to combat corruption must, thus, diminish the supply of goods and services that officials can be use to extort bribes, while also disciplining officials.

Liberalization, stabilization and privatization all serve to combat corruption, and Kyrgyzstan has performed impressively in these three regards. The foundation, however, must be the construction of a consistent legal system. While communism had denigrated law and favored discretionary decisions by the authorities, a non-communist state needed to establish a clear hierarchy of legal rules and an effective system of the implementation of law. Institutions that protect property rights are crucial both to economic growth itself and investment, as they diminish corruption.

Deregulation would most obviously reduce corruption, as it diminished the power of officials to extract bribes for services or arbitrage opportunities, by legalizing previously prohibited activities, such as private enterprise, by abolishing licenses and permissions, by freeing prices and trade, and by unifying the exchange rate. State monopolies were notorious dens of corruption, as they maintained as many distortional regulations as possible.

Fiscal changes are possibly equally important to reduce the scope of corruption, but they are much less understood. Most important, subsidies and exceedingly ambitious public programs that could not be fully financed should be cut. Program budgeting was needed so that the state budget really covered all costs necessary to carry out government programs, and the budget should be implemented without arrears or diversion of resources to favored lobbies.

The revenue side of government has also contributed to corruption. To begin with, a state monopoly over the state extraction of taxes must be established, but many CIS states have so far failed to accomplish that, as numerous powerful authorities insist on their semi-private extrabudgetary funds beyond audits and public purvey. Taxation in some countries has degenerated into tax farming, where tax rates are at most nominal. In Kyrgyzstan, it would appear natural to merge all revenue services, including the State Tax Service, the tax police and the State Customs Committee.

Taxpayers in the CIS have often found that taxation is a matter of negotiation rather than law. Tax legislation must not exempt the big and powerful, but to make that politically possible, tax rates must be reasonably low. Taxes must be paid only in real money, as any monetary surrogate involves a change in prices and thus facilitates discounts, while taxation should be standardized and equal for all.

Privatization is more controversial but it should be obvious both in theory and from the current practice that privatization has reduced corruption. "Privatization can reduce corruption by removing certain assets from state control and converting discretionary official actions into private, market-driven choices." Even if the process of privatization inevitably is fraught with corrupt opportunities, they are not continuous processes. The alternative to full privatization is some kind of leasing, which seems highly corrupt all over. In Kyrgyzstan, it would be preferable that the local authorities sell off land reserves rather than leasing it to peasants at arbitrary prices. Apart from taking state enterprises out of the corrupt hand of government, privatization promotes the intensification of competition.

The measures so far discussed have primarily aimed at taking resources out of the hand of officials (deregulation, reduced taxation and privatization), but to some extent aimed at regularizing government procedures and constraining officials (improved fiscal procedures). However, a government needs to provide many collective services, such as law and order and a regulatory framework, that only the state can offer efficiently. Therefore, it is vital to clean up the government, which is a highly political task.

2. Reform of the State

The possibly most difficult task of the post-communist transition has been to reform the state to alleviate the chronic state failure of communism. An important first choice has been the nature of constitution ? parliamentary or presidential rule. The next task has been to rebuild the state apparatus, which has turned out to be particularly cumbersome. A third task has been civil service reform. Finally, the very mode of operation of the government should preferably change to facilitate a new service mindedness, but the question is how that can be done. Although much was actually attempted, this was possibly the sphere of the worst flaws in the average transition countries.

a. Parliamentary System or Presidential Rule

The fundamental problem of the communist states was that they were not full-fledged states in their own right. The state apparatus had existed and it was formally a self-contained mechanism as any Western state, but in reality it was only a subordinate appendix to the real state, the Communist Party, which was not legally included in the state until the late 1970s, when most communist countries adopted constitutions which just mentioned the leading role of the Communist Party. The Communist Party stood above the law, being allowed to intervene however it found convenient, and it was never accountable.

The former communist countries were left with a contradictory constitutional inheritance, with both their communist practice and their written constitutions never meant to be applied. Now these bogus constitutions assumed a life of their own, while most countries also tried to draw on pre-communist national history. To a surprising extent, constitutions and politics were seen as national prerogatives, for which international experience was not very relevant. Therefore, the impact of Western models was much more limited than in the economic sphere, albeit Western advice played a greater role in the western part of the region.

The main conflict concerned the division of power between the President, the Council of Ministers and Parliament. While the struggle between the President and Parliament have been the most dramatic, the government often played an important role in policy making. These strifes were further aggravated because the principle of the division of power, which had prevailed in the rest of the world since the late 18th century thanks to Montesquieu [1748], had never been accepted by the communists, since it circumscribed the complete power of the Communist Party, and the public understanding of the benefit of such a principle was strangely absent. Nor did any independent judiciary exist. In the old Soviet-type legal system, the prosecutor was superior to the judge, and defense counsels were rarely welcome. These conflicts were the worst in the CIS, with some democracy ? Belarus, Ukraine, Moldova, Russia, Kazakhstan, Kyrgyzstan, Georgia and Armenia, while the EU accession countries tended to adopt European standards gradually.

Communist institutions did not just go away. Under communism, the Politburo and the Central Committee of the Communist Party had been supreme. Now their place was now taken over by the President and his Administration, and at the regional level by the governor and his administration. By communist tradition, the presidential and gubernatorial administrations could interfere anywhere at will without accountability. They also took over most of the valuable real estate of the Central Committee of the Communist Party, and these assets were not subject to any financial control. The Presidential administrations were quite large ? at one stage 6,000 people in Russia and 1,000 people in Ukraine. These large central bureaucracies became rampant centers of corruption because of their large assets, great rights of intervention and absence of accountability. The same problem persists in Kyrgyzstan. A single line of government responsibility is needed.

The Soviet Parliament was a rubberstamp institution that convened twice a year and adopted one or two laws each time. Post-Soviet parliamentarians demanded substantial executive powers, notably in fiscal and monetary matters as well as privatization. The problems of the post-Soviet parliaments were aggravated by the lack of party structure and the not-fully democratic parliamentary elections in early 1990.

As each deputy was on his own and completely unregulated, they could charge for their services without fear of legal prosecution, leading to great corruption of parliaments. The very corrupt parliaments in the FSU are a serious concern, but the gradual formation of real political parties is one important means of reducing their corruption of parliamentarians. A political party is far more concerned about its reputation than are individual deputies, and this desire for strong political parties is a strong argument for proportional elections.

Initially, the presidency was relatively strong in most countries to offer firm leadership, but in East-Central Europe and the Baltics Presidents have increasingly developed into elderly statesmen rather than leading executives, being focused on constitutional and international issues. In the FSU, presidential powers have persistently been much stronger, but parliaments have challenged them, leading to virulent conflicts. Over time, some clarity has been established. In general, the greater the continuity and the less democratic a country has been, the stronger the presidential powers. But a continuous improvement in certain procedures is notable. Previously, ministerial officials wrote decrees on the basis of oral orders passed down from the Party. Now they are getting used to the idea of a rule of law. Increasingly, they draft laws that are to be discussed, amended and promulgated by Parliament. As the practice of issuing many decrees continued, this change occurred only gradually.

The Russian Parliament no longer tries to intervene in executive matters, and since 1996 the President and the government have reduced their number of decrees and instead tried to promote laws adopted by Parliament, as presidential decrees have not very effective, credible or well drafted. They can easily be issued, withdrawn and contradicted by other decrees or overturned by courts, while the time-consuming adoption of a law requires the commitment from a substantial number of people (Remington, et al, 1998). In Kyrgyzstan, the duplication of the Presidential Administration and the government apparatus persists, diluting decision making and responsibility, although the apparatuses are quite small with only 100 officials each. In Kazakhstan, which is mildly authoritarian, the President has greater power, issuing many principal laws are presidential decrees with the power of law, but these seemingly good laws are surprisingly ineffective. An attempt in early 1999 to shift many of the ordinary duties of government to the Presidential Administration ? even the state budget ? ended with the President transferring these tasks, and his most trusted collaborators, to the government. The broader implication is that a successful reform requires the support of an elected executive, because a couple of hundreds of laws have to be promulgated, and decent laws can only be adopted by a Parliament with a reformist majority.

A number of key principles need to govern the constitutional distribution of powers. First, there must be a clear division of executive and legislative powers. By and large, the democracies in the region have accomplished this, but at a rather high costs, since they did so through trial and error rather than through principled consideration. A second principle is that there must be some transparency and accountability, which is a strong argument for parliamentarianism, because a Parliament can supervise a government relatively closely, while presidents and their administrations are patently non-transparent and unaccountable. A third principle is that law should rule society, which means that Parliament must be given substantial legislative powers, while those of the government and the President should be minimized. Considering the moral weakness of government, discretionary government decrees are more often than not intent on favoring a specific lobby. Under the existing conditions, parliamentary rule is much preferable to presidential rule in the whole region, and the purported need for a strong president is only a variety of the myth of the need for a dictator, because a strong state is an accountable state.

b. Government Reform

The communist state did not only do too much, it also did the wrong things in the wrong way, while vital state functions were ignored. Everything had to change.

The most fundamental change was to get the bureaucrats out of enterprises and divide government from business. In a market economy, the state apparatus deals with legal regulation, not the management of enterprises. Therefore, a large number of state bodies designed for the management of industries and enterprises had to be abolished, ranging from the State Planning Committee, its subordinate State Material Supply Committee and the State Price Committee to scores of industrial branch ministries. Even when abolished, branch ministries tended to re-emerge, as their functions had not been eliminated. Kyrgyzstan has undertaken most of this task, but a few bodies could be merged.

Preferably, all state bodies should be prohibited from actually managing enterprises, but many state officials benefit from their mingling in enterprises. They protest that their duty is to "help" enterprises, refuting the market economic view of the regulatory state as a defeatist idea. The EBRD (1999, p. 123) state intervention index shows that even in 1999 substantial state intervention occurred in enterprise decisions throughout the region. In Kyrgyzstan, "indicative planning" pursued by the Ministry of Finance and the Ministry of Industry and Foreign Trade has resurfaced and must be abandoned, as it implies state intimidation against enterprises.

In other cases, state power is both too centralized and too diffuse. It is not uncommon that a post-Soviet decision requires 20-30 signatures, and then of course nobody is responsible. Functional ministries should wrangle power from the Council of Ministers apparatus and the Presidential Administration and become policy-making bodies. Unfortunately, responsibility has been diluted between these bodies. Although things have improved gradually from the west to the east, these habits of collectivism have lingered. These tasks have largely been resolved in Kyrgyzstan.

For communism, secrecy was as sacrosanct as openness is for a demo