In the first part of this paper we present an unconventional theoretical analysis of the failure of shock therapy in reforming the Russian economy. The inefficiency of the self-generated transitional process is explained in terms of multiple institutional and structural hysteresis effects such as agency failure, government and market failures, and de facto free banking. These failures are not mitigated by the passage of time, but instead become more and more integrated into the emerging market economy. Based on this analysis, in the second part we present some key elements of a coherent and comprehensive policy-led transformation design and implementation needed to put the transitional process on the right track. J. Comp. Econom., August 1994, 19(1), pp. 88-116. Center of Economic and Political Research, Moscow, Russia; and Yokohama City University, 22-2, Seto, Kanazawa-ku, Yokohama 236, Japan.