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States and Markets in Transition
Lecture 8




  1. Deregulation – reduce state’s power

    1. Marx and Lenin – guided by a set of official beliefs

      1. "The party line"

      2. Communal ownership – gov. owned means of production—factories, land, property

      3. Marx – private property is a means by which one person can exploit another

        1. An owner of a factory exploiting a worker

        2. Communism – state exploits a worker

    2. Free markets requires that economic and political power are separated

      1. Ideology

        1. Marx and Lenin ideology loses appeal

        2. Free markets

        3. Mercantilism and economic nationalism

      2. Gov. loses its ability to set prices or plan the economy

      3. Requires

        1. Private ownership

        2. Free markets

        3. Flexible wages and prices

      4. Deregulation does not mean power is dispersed

        1. New sources of power emerge outside the state

        2. Power could become re-concentrated in the hands of a few elite

        3. Old communist party bosses became the new capitalist bosses

    3. Does not exist under socialism

      1. Individual profit

      2. Unemployment - everyone who was able to work was required to do so

      3. Competition between firms

      4. Bankruptcy

    4. Transition requires new constitutions, political parties, electoral rules, administrative and judicial structures

      1. Educate citizens on "the rules of the game."

  2. Problems of large state bureaucracies

    1. Decided production level, prices, and who consumes them

    2. Soviet planners – used production quotas

      1. Quality was a secondary issue

        1. Soviet industries produced low quality goods

        2. Markets – consumers may flock to producers for better quality goods

    3. Material balancing – output and inputs have to match in manufacturing

      1. Requires perfect information

      2. Led to shortages and surpluses

      3. Example – mines do not meet their quotas for iron

        1. Steel factories do not meet their quotas

        2. A steel shortage trickles through causing shortages in other industries

        3. Military industry gets its steel first

        4. Consumer products for steel are last

          1. Shortage of cars

    4. Innovation – Soviet Union had a high-level of education

      1. Difficult to change production technologies because of the quotas

      2. Imposes costs

      3. No incentives to design new products

      4. Product designs were rarely updated

  3. Methods to convert public assets into private ones

    1. Voucher privatization – gov. gives or sells people vouchers

      1. People have no money

      2. Vouchers become assets

        1. Buy shares in privatized companies

        2. Purchase apartments and real estate

        3. In some cases, gov. gave vouchers to families that had their property seized by gov. when country went socialistic

    2. Auctions – gov. sells firms to the highest bidder

      1. Generates revenue for gov.

      2. Usually people within country have no money

        1. Foreigners buy assets

        2. Attracts foreign investment

        3. Country is “being sold to foreigners”

    3. Convert public companies into corporations

      1. Joint ventures

      2. Gov. retains control by being a majority shareholder

      3. Allows foreigners to invest

      4. Attracts foreign technology

    4. Examples

      1. Hungary allowed foreigners to freely invest

        1. Capture a 1/3 of all investment to Eastern Europe and CIS

      2. Czechoslovakia and Poland had more restrictions

    5. Fairness issues – many, because who gets what

  4. Prices are signals

    1. Prices tell individual consumers and producers about the cost and benefits of different actions

      1. Prices reflect a product’s scarcity

      2. More scarcity a product is, the higher the market price

    2. Socialist countries – prices for goods were relatively low relative to their wages

      1. Bureaucracy sets prices

      2. Consumer goods and services were often limited and of poor quality

      3. Consumers found themselves with more money than they could spend.

        1. Black markets emerged for imported goods, hard currency, or products and services in short supply.

        2. Pay bribes

          1. Ex: Pay doctors for better health care

    3. Painful when gov. removed price controls

      1. Removing price controls leads to rapid price increases (rapid inflation)

      2. Shortages disappear, but goods are sold at high prices

        1. Hurts the poor, elderly, and pensioners

        2. Workers demand higher wages from their places of work

        3. Employers are still owned by the state

      3. Some governments printed money to cover budget deficits

        1. Causes inflation or even hyperinflation

        2. Hyperinflation devastates a economy


Russia's Transition to Capitalism


  1. Communist party – power is rooted in one party

    1. Written into the nation's constitution

    2. "Leader" is General Secretary of the Communist party

    3. Membership in the Communist party was limited to about 5 to 10 percent of the population

      1. Nomenklatura – controlled all machinery of government

      2. Lived better than rest of population

      3. Preferential treatment

        1. Better housing

        2. Travel abroad

        3. Special stores stocked with Western goods or products in short supply

  2. Russia jumped from an agrarian society directly to Soviet industrialization in 1917

    1. Little experience with democracy and free markets

    2. Growth of heavy industry, infrastructure, educational and health facilities, and urbanization.

    3. Soviet Union grew rapidly during 1960s

    4. Stagnation and resignation reigned during 1970s and 1980s

    5. In some countries even life expectancy began to decline

  3. Mikhail Gorbachev came to power in 1985

    1. Inherited a stagnant economy

    2. Gorbachev represented a new, younger generation of Soviet leaders

    3. Set of economic and political reforms

      1. Glasnost (openness) – greater personal freedom

      2. Perestroika (reconstruction) - reorganization of the economy

        1. Factory managers were given greater authority to make production decisions

        2. State planning bureaucracy was still in place and maintained its power

        3. Private ownership and private enterprise were encouraged, but prices remained regulated.

  4. System was doomed to collapse

    1. Political power and gov. are intertwined

    2. Difficult to separate the two

  5. Soviet Union dissolved in 1991

    1. Cut subsidies to firms and agriculture

    2. Eliminated fixed prices on most goods

    3. Sold millions of apartments

      1. Over 100,000 small firms

      2. Over 15,000 large ones

    4. Used voucher privatization – allowed workers and managers to buy shares in their firms

      1. Auctioned firms to the highest bidder

        1. Gov. needed revenues

        2. Discouraged foreign investment

        3. Private Russian banks bought the largest and most valuable firms

          1. Marx’s fear – Country is now owned by a few rich bankers

  6. Russian is not integrated into the world or European economy

    1. Relies on its own large internal market

    2. Abundance of natural resources

    3. Sells petroleum and minerals to international market

      1. Petroleum and mineral prices are volatile

      2. The petroleum price oscillates between $50 and $150 per barrel

      3. Causes large swings in government revenue

  7. Russia achieved high GDP growth rates before 2008

    1. Businesses may not be following all the rules and regulations

    2. The Russian gov. passed the flat tax of 13% in 2001

    3. Banks own industry

      1. Similar to a Japanese Keiretsu

      2. Bank can grant low-interest loans to businesses within its group

      3. Provide financial management

    4. In 2007, 16% of the population now live in poverty

  8. Problems

    1. Russia inherited the debt of the Soviet Union

    2. The Soviet industries were spread out among the different republics

      1. During the breakup of the Soviet Union, industries shutdown because their suppliers were located in other republics

    3. Enforcement of basic laws are weak

      1. Organized crime – quickly expanded throughout country

      2. "Offer protection" to businesses or monopolizing markets

      3. Between 1991 and 1996 more than 100 bankers were assassinated

    4. The collapse of the Russian ruble in 1998

    5. Fears that private property could be renationalized by the state

      1. PresidentsVladimir Putin and Dmitry Medvedev are moving towards a more authoritarian government

      2. Kills foreign investment

    6. 2008 Financial Crisis

      1. Investors had fear that Russian banks could collapse

      2. Russia experienced a large outflow of capital


China – Successful


  1. Chinese leader Mao Zedong (1893-1976)

    1. Used Stalinist model – state owns the means of production, creates collective farms, and uses central planning

  2. China was even less agriculturally developed than the Soviet Union

    1. Peasants were hostile to bureaucracies and centralization

    2. Tried communal farms in favor of traditional family units

    3. System failed

  3. Gov. gradually introduced market forces to stimulate the economy but retained party power

    1. The Chinese economy experienced rapid growth

      1. Real GDP was growing 9% per year before the 2008 Financial Crisis.

      2. After the financial crisis, China is still growing

    2. Strong economic growth is fueled by mercantilism

      1. China devalues its currency

        1. Exports expand

          1. manufactured products, such as computers, textiles, heavy machinery, and industrial equipment

        2. Imports contract

      2. The trade surplus allowed China to garner approximately $2.2trillion of foreign currencies and gold in 2009

    3. Allowed peasants to sell agricultural products in markets

      1. Ag. production increased dramatically

      2. Food producers were more efficient

      3. Consumers benefited from increased production

      4. Alleviate rural poverty

    4. Lowered barriers to international trade and finance

      1. Attracted foreign investment

        1. World Bank’s estimates - China attracts $80 billion per year in foreign investment

      2. Introduced new products and resources

      3. Access to new technology

      4. "to be rich is glorious" (Marx would disapprove)

    5. Gov. legalized private businesses

      1. Started with small-scale firms

      2. Mid-1980s, state allows large private firms with thousands of workers

    6. State tries to control private enterprise and markets

      1. "the bird in the cage"

      2. State-run companies comprise approx. 60%

        1. tend to be inefficient, outdated, and kept afloat by government financial support

      3. State goes through cycles of relaxation and control of private markets and enterprises

    7. Some predict China will become the new leader and hegemon in the 21st century.

      1. China has two problems that could slow down its growth and prevent it from becoming a world leader.

        1. China does not have enough resources to fuel this strong growth for the next generation.

          1. Eventually, China will have to import minerals and resources on a large scale.

          2. Japan and the Asian tigers also have this problem

        2. The China’s policy of one child per family will come back to haunt them.

          1. Eventually, China’s population will largely comprised of the elderly and retired people.


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