The Rise of the Private Sector

1
The Rise ofthe Private Sector
2
Why It Happens

• Doesnt take much for a private sector to
  develop
  
• whenever possible, individuals will meet for
  mutually beneficial exchange
  
• they are attracted by material incentives
• alternative path to prosperity

3

• some are attracted by the desire for autonomy
• to be their own boss
• The private sector under classical socialism is
  tiny because of artificial prohibitions placed on
  it
  
• all that is needed for the private sector to
  expand is to lift the barriers
  
• although if that is all that happens the private
  sector that develops might not be want you want

4

• The bureaucracy is motivated to permit the
  private sector to expand but they hate doing it
  
• they need to relieve shortages and the state
  sector is unable to do it
  
• consumers are getting restless
• they need to recharge the economy, which is dead
  in the water or even shrinking
  
• Cubas was sinking like a rock

5

• in some cases, the state sector is unable to
  prevent the appearance of unemployment
  
• China
• Cuba
• they need to ease the social tension
• if the most active and enterprising persons are
  busy with business, they will be less likely to
  be political agitators

6
Types ofPrivate-Sector Production

• Small-scale family agricultural holdings
• this is what launched Chinas remarkable
  transition
  
• communes disbanded and small holdings distributed
  to households
  
• the household responsibility system

7

• initially not a true transfer of property to the
  private sector but has become essentially that
  
• not planned
• a bottom-up reform
• Yugoslavias classical period did not last long
  enough for there to be a full collectivization
  
• after the reform period started (or transition to
  market socialism) much of agriculture based on
  small peasant holdings

8

• Poland never did collectivize and agriculture
  also based primarily on small-scale family
  holdings
  
• Hungary did collectivize but allowed small-scale
  family holdings in the hills
  
• security of these holdings formalized during
  reform period
  
• cooperative members given household responsibility

9

• great resistance to privatization of land at all
  levels in Russia and Ukraine in the Soviet Union
  
• never had been well-defined rights
• individuals too traumatized by the past
  experience of collectivization
  
• did not trust the government
• no one wanted to be the next kulaks
• privatization much more rapid in the Baltic
  states, on the other hand
  
• did not experience the same trauma

10

• Household farming on cooperatives
• during the reform period, cooperatives provide
  far more resources and support to a form of
  private farming that had always existed in the
  classical period

11

• Nonagricultural family undertakings
• household labor
• no hired workers
• Cuban self-employment
• repair shops
• taxis
• restaurants
• retail trade

12

• Nonagricultural moonlighting
• exists during classical period on a very limited
  basis but becomes very common during the reform
  period
  
• Private firm with hired labor
• mostly small where allowed at all
• not allowed in Cuba

13
Other Property Forms on the Border Between Public
and Private

• Leasing state property or management contracts
• private entity enters into contract with the
  state to run enterprise using state property
  
• Spanish hotel chain Sol Meliá has a contract to
  manage the Hotel Havana Libre

14

• Joint enterprises
• ownership shared between state and private
  entity
  
• a major form of foreign investment in Cuba today
• on foreign investment in Cuba, see
  http//lanic.utexas.edu/project/asce/pdfs/volume12
  /travieso.pdf

15

• an interesting kind of state-private ownership is
  Chinas township and village enterprises
  
• for the most part private firms that have special
  (preferential) status because they formally have
  village ownership
  
• a major factor in Chinas transition

16
Other PrivateSector Incomes

• Income from property
• interest on state bank accounts
• more possibilities become available
• interest on bonds issued by the state or SOEs
• money lending
• profits from money invested in a private
  enterprise
  
• leasing land

17
Mechanisms of Expansion

• Two mechanisms
• spontaneous privatization
• new business activities started up in the private
  sector
  
• conversion of state property and state production
  activity to private sector
  
• sale, auction, or giving away of SOEs
• conversion of Chinese communes to households
  responsibility

18

• For the most part, the private sector expands
  through spontaneous privatization during the
  reform period
  
• Chinese agricultural reform being the major
  exception
  
• Conversion of state property becomes much more
  important during the post-socialist period

19
Private Ownershipand Socialist Ideology

• Essentially incompatible
• basic tenant of Marx that private ownership is to
  be eliminated
  
• socialists have a great antipathy toward private
  ownership
  
• source of exploitation
• source of unequal incomes and the unjust
  privileges of the wealthy
  
• income from ownership is unearned

20

• To a socialist, elimination of private ownership
  is a moral victory worth the sacrifice of
  efficiency
  
• This is a huge dilemma during the reform period
• results in some very schizophrenic behavior by
  the bureaucracy
  
• Cubas Special Period

21

• Rationalizations made to reconcile expansion of
  private sector with ideological antipathy toward
  it
  
• small-scale production proclaimed essentially
  socialist in nature
  
• but where is the line drawn between small and
  large?
  
• inevitably, the most successful grow and become
  large scale
  
• they grow up to become capitalists, just as Lenin
  warned

22

• the successful then find themselves vulnerable to
  being taken over by the state
  
• as happens in Cuba constantly unless the owner is
  rich enough to bribe his way out of it
  
• hardly a healthy climate for a successful private
  sector

23
Market Coordination

• With the expansion of the private sector comes an
  expansion of market coordination
  
• But market coordination still dominated by
  bureaucratic coordination that can interfere at
  any time

24

• Also, the institutions of market coordination are
  underdeveloped and purposely stunted
  
• financial system wholly directed to needs of
  bureaucratic coordination
  
• lack of credit and other financial services
• no commodity and stock exchanges
• little or no wholesaling, transportation,
  warehousing

25

• no real estate agents
• no insurance
• little or no advertising
• poor communications technologies
• communications tend to be relatively primitive
  and scarce in socialist countries
  
• few telephones
• service poor and unreliable
• mail delivery slow and unreliable

26

• Most important of all, though, is the lack of
  well defined and enforced private property
  rights
  
• no real commercial code
• developed over centuries in modern capitalist
  economies
  
• no legal enforcement of contracts
• primitive property law
• usually nothing more than pronouncements
• primitive tort law

27

• most private business activity operates by
  necessity in gray area, often in contradiction to
  some law
  
• private property always vulnerable to
  confiscation on any number of trumped up
  justifications
  
• as happens in Cuba
• The importance of poorly developed or lacking
  market institutions was not well understood when
  transition began
  
• even by Kornai

28
Relationship withthe Bureaucracy

• The bureaucracy needs the private sector
• it promotes it to a limited degree
• But it despises the public sector
• private ownership is incompatible with socialist
  ideology
  
• the loss of control is hard to tolerate

29

• Bureaucracys attitude toward private sector
  highly ambivalent and restrictive
  
• low security of property rights
• can be confiscated at any time
• to be legal, private sector activity needs a
  license
  
• as opposed to capitalist countries where licenses
  are the exception

30

• however, many unlicensed activities are
  overlooked
  
• as was true during the classical period, but the
  extent of the gray market becomes much greater
  
• allows the bureaucracy to pretend that its not
  happening but still benefit from the private
  sector activity
  
• allows the bureaucracy to reconcile ideological
  contradiction
  
• prostitution has flourished in Cuba during the
  Special Period

31

• The bureaucracy explicitly works to curb the
  growth of the private sector
  
• whenever it gets too large, taxes and regulations
  are used to knock it back down
  
• Cuba in 1996

32

• Regulations imposed to limit the size of private
  businesses
  
• Cuban paladares limited to twelve patrons
• private businesses in Cuba not allowed to hire
  workers outside the family

33

• Lack of enforcement of private contracts
• business persons tend to be those willing and
  able to enforce contracts themselves
  
• major reason for the criminality of the former
  Soviet republics

34

• Lack of protection from the authorities
• bureaucracy above the law
• if some authority behaves in a way that is
  damaging to a business there is no recourse but
  to lodge a complaint with the persons superior
  
• no private person or organization can sue a state
  agency or authority

35

• Taxes are repressive, arbitrary, and subject to
  constant change
  
• along with willingness to overlook gray-market
  activities makes for considerable tax evasion
  
• used as tool to limit size of private sector

36

• Credit, foreign exchange, and state orders
  limited
  
• discriminated against in favor of public sector
• state bank exists to provide credit to SOEs
• no alternative financial sector for the private
  sector
  
• materials in short supply allocated to SOEs, not
  the private sector

37

• SOEs generally will not deal fairly with private
  sector
  
• either because prohibited or because there is a
  dislike of the private sector
  
• There is no political representation
• no political party to champion the rights of the
  private sector
  
• not even members of parliament to represent them
• recent admission of capitalists in Chinas
  parliament a first
  
• has China advanced beyond the reform stage?

38

• Lack of basic property protections and
  repressive, arbitrary treatment by the
  bureaucracy creates a very short time horizon for
  business
• tend not to invest for the future
• quick profits
• earnings used to buy wealth-preserving assets
  rather than plowed back into business
  
• big houses, jewelry, gold

39

• Creates culture of criminality
• always operating in the shadowy areas of the law
• need to be willing and able to enforce contracts
  themselves
  
• always looking for the opportunity to take
  short-cuts and cheat
  
• creates a bad reputation for entrepreneurship in
  general
  
• attracts those who dont mind being envied and
  despised

40
Role of the Family

• The family undertaking takes on a role that had
  all been wiped out during the classical period
  
• creates sudden leap in labor intensity as family
  now working for itself
  
• household responsibility system created a huge
  jump in productivity
  
• inability to enforce contracts makes family trust
  central

41

• Change in reform period in favor of
  owner-occupied housing as state no longer able to
  provide as much socialized housing
  
• further increases family autonomy
• Demand for private cars increases as another
  mechanism of autonomy
  
• The state cuts back on care for children, the
  sick, and the elderly
  
• becomes responsibility of family

42

• Surge or services that substitute for domestic
  work
  
• restaurants
• laundries
• Surge of demand for household appliances to make
  household work easier
  
• Thus, former trend toward socialization of
  consumption reversed

43

• This is great for those who enter the private
  sector and succeed
  
• they get greater autonomy and independence and an
  easier life
  
• Those who dont get left behind
• housing becomes expensive and state wages do not
  compensate the increase
  
• loss of social services like day care, care for
  the elderly makes life hard
  
• La vida no es fácil

44

• The social contradictions of the reform period
  become more and more severe
  
• creation of new classes
• those who make it and those who dont in the
  private sector
  
• socialism is supposed to be all about the
  classless society
  
• For more on the social contradictions of reform
  in Cuba, see http//lanic.utexas.edu/la/cb/cuba/as
  ce/cuba10/trumbull.pdf