The stakes raised by the Putin government's actions are high for Western governments, multilateral banks and foreign investors that have bet Russia is headed toward democratic capitalism. By leading Yukos to accept standards of corporate governance, Khodorkovsky had become exhibit A for the case that Russia should be included in western institutions as a market economy. In response to the prosecution, U.S. Senators John McCain and Joe Lieberman have introduced a bill to exclude Russia from the G-8 group of market democracies.

On Dec. 7, the President's party, United Russia, along with nationalist parties that promise to re-claim Russia's wealth from billionaires such as Khodorkovsky, won effective control of the parliament. Now that Putin has consolidated his power and Khodorkovsky sits in jail awaiting trial, how will the president use his mandate to promote "law and order" and social justice? How should the west respond?

In order to attack corruption, the president must demonstrate that no one is above the law. Notwithstanding their recent commitment to corporate governance, Khodorkovsky and other Russian business leaders continue to use patrons in the government to secure favorable decrees, licenses, tenders and tax treatment. This practice has become so pervasive that Russia suffers from "state capture," a condition where it cannot operate as a law-based state, regulate markets fairly and allocate resources efficiently.

Putin, however, cannot ensure equality before the law if government officials have the discretion to engage in selective prosecution. Following Khodorkovsky's arrest, the Russian prosecutor's office froze public trading in certain shares of Yukos, which have now fallen in price by over 30 percent. Yukos has been unable to merge with the Russian oil company Sibneft on terms that would have created one of the largest oil companies in the world. The result of the investigation is that Yukos' property is being re-distributed by prosecutorial fiat.

Putin has sought to assure western parties that Khodorkovsky will receive a fair and open trial. Many are inclined to give the president the benefit of the doubt. After a recent meeting with the president, the chair of the International Monetary Fund stated that the prosecution of Khodorkovsky does not signify a reversal of economic and legal reform.

Such "happy talk" misconstrues the dilemma the West faces in Russia today. Though the Putin government has adopted new commercial laws and criminal procedures, it has not shaped institutions capable of executing, adjudicating, or enforcing them. Absent such institutions, neither property nor contract rights are enforceable.

In the 1990s, despite concerns that Russia was privatizing state enterprises too quickly, the IMF, World Bank and foreign governments agreed to financially support the process. This "Washington consensus" was based on the belief that an independent judiciary and other institutions would sprout naturally to protect the private wealth of a middle class spawned by privatization.

Instead of a middle class, Russia's rapid privatization empowered a class of "rent-seekers" - those who profit by using access to power to control state assets. Instead of a rule of law, rent-seekers created the "law of rules." Under this system, state institutions, including the public prosecutor, the courts and the bailiffs, can be manipulated to re-examine or reverse the privatization of Yukos or any Russian company.

Under the law of rules, there are no free rides for foreign investors. Any business, even one with clean hands, may have its property taken, its profits squeezed, its people prosecuted as criminals. For example, in the name of vaguely defined "state interests," officials in Russia's regions have engaged in "discretionary expropriation" of foreign businesses sanctioned by local courts.

The evidence is mounting that Russia seeks to engineer the construction of a market economy without a rule of law based on a strict separation of powers. In order to hold Russia accountable to protect private property, western stakeholders must find common language with President Putin over the precise role of institutions in building a law-based state.

Recently, Prime Minister Kasyanov declared that the Putin government will eventually seek to bring the public prosecutor under the control of the Ministry of Justice. In the meantime, to restore confidence in the investment climate, the Putin government must strictly define and curb the public prosecutor's discretion. Putin officials should clarify how a Russian court can exercise independent judgment where the public prosecutor, or any other government agency, is representing state interests.

As a threat to Russia's national security, corruption should be a priority matter of mutual concern to president Putin and his supporters in the West. Western stakeholders should closely monitor the results of the president's efforts to re-capture the Russian state from special interests. For example, on Nov. 24, he created the "Anti-Corruption Council" to uncover conflicts of interest among government officials. In order to attack the institutional roots of corruption, however, Putin must also be convinced to empower independent courts and allow a free press.

As a sovereign nation, Russia has the right to establish its own rules of the game. Western stakeholders, however, have the right both to know the rules and to expect that they cannot be changed at will. Currently, rent-seekers can control both process and outcome. Western parties are entitled to know whether Russia intends to build a market governed not by men, but by institutions and laws.

Matthew H. Murray is president of Sovereign Ventures, Inc., a management consultancy firm specializing in Russia and the Independent States.