Center for the Study of Democracy

Theorizing market transition, the orthodox economic perspective stipulates that markets will emerge spontaneously once the control of the party-state is abolished and the incentive structure is put in place for self-interested actors to exchange and maximize utility. The institutional perspective emphasizes the role of states, politics and path dependency on creation and operation of markets. The study uses originally collected data on foreign direct investment (FDI) in eleven Central and East European countries since 1989 to examine the proliferation of market-exchange. Pooled cross-sectional time series analysis shows that economic incentives and stabilization in host countries contribute little to explaining the inflow of FDI into Central and Eastern Europe. Similarly, instituting democratic order in post-socialism is not significantly related to the speed of marketization. However, the direct involvement of post-socialist states in the economic transformation is crucial. The extent of privatization, a pro-market reform government in place, and host states acting as market players by selling large state monopolies to foreigners all significantly induce FDI. Overall, the results show that, at least in the first decade of post-socialism, it is the involvement of the state rather than its withdrawal from the economy that facilitates marketization. Providing details of the substantive variety of state-market embeddedness in the post-socialist context, the study also advances a perspective on market creation, in contrast to market emergence.