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The Rise of the Private Sector 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 some are attracted by the desire for autonomy

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why it happens
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
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

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

in some cases, the state sector is unable to prevent the appearance of unemployment



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

types of private sector production
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”
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

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

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

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

Nonagricultural family undertakings

household labor

no hired workers

Cuban “self-employment”

repair shops



retail trade

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

other property forms on the border between public and private
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
Joint enterprises

ownership shared between state and private entity

a major form of foreign investment in Cuba today

on foreign investment in Cuba, see

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

other private sector incomes
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
mechanisms of expansion
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
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

private ownership and socialist ideology
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”
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

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

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

market coordination
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
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

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

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

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

relationship with the bureaucracy
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
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

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

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

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

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

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

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

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

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?

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

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

role of the family
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
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

Surge or services that substitute for domestic work



Surge of demand for household appliances to make household work easier

Thus, former trend toward socialization of consumption reversed

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”

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