Conventional models of the politics of economic reform tend to be based on an assumption about the costs and benefits of reform, known informally as the J-curve. Reforms are expected to make things worse before they get better. This presents a classic time inconsistency dilemma for reformist governments forced to demand severe sacrifices from the public in the short term for the mere promise of future gains. In response, political economy models of the reform process have tended to stress the importance of insulating governments from the pressures of the short-term losers until a sufficient constituency of winners has been created with a stake in supporting and enhancing the reforms.Based on evidence from the postcommunist transitions, this article suggests that the most serious political obstacles to the process of economic reform have come not from the short-term losers but from the shortterm winners. Groups that gain substantial rents from the early distortions of a partially reformed economy have a stake in maintaining a partial reform equilibrium that generates high private gains, but at a considerable social cost. In these countries, the main political challenge has been, not to marginalize the losers, but to restrain the winners. This explains the paradoxical outcome of the postcommunist transitions: that political systems which are more inclusive of the losers have been able to adopt and sustain more comprehensive economic reforms than states insulated from popular pressures.

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We study the nexus between enterprises and the state in transition countries, using new enterprise survey data. We examine the quality of governance, state intervention in enterprise decision-making, state benefits to firms, and corruption payments. The quality of governance varies both across countries and across different dimensions of governance within countries. Economic reform improves governance in countries with a low degree of 'state capture' by vested interests, but not in high-capture countries. Despite reform, state intervention in firm decisions continues, but it varies substantially across firms. At the micro level (within a country), there is clear substitution between the degree of state intervention, state benefits to firms, and corruption payments, which is consistent with a bargaining model of politicians and firms. But at the macro level (across countries) these elements are complementary, suggesting that politicians, perhaps under pressure from captor firms, have some control over the scope of regulation and intervention.