The Rise of the Private Sector

1. The Rise ofthe Private Sector

2. Why It Happens • Doesn’t 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 Cuba’s 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 China’s 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 Yugoslavia’s 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 China’s 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 China’s 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 Cuba’s 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. Bureaucracy’s 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 it’s 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 person’s 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 China’s 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 don’t 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 don’t 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 don’t 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/asce/cuba10/trumbull.pdf