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Creating Capitalism

Transitions and Growth in Post-Soviet Europe

Patricia Dillon and Frank C. Wykoff

Employing historical analysis and building on growth theory and modern political economy, Dillon and Wykoff explain Soviet disintegration and analyze efforts to create capitalism in newly independent states. They show how five fundamental economic reforms generate growth, and use an original model to test the connections between reforms, elections and economic performance. The authors examine the progress of six countries (Bulgaria, Czech Republic, Estonia, Hungary, Russia and Slovakia) in terms of each country’s history and its successful application of the five reforms. Anyone interested in how capitalism works and why pro-market reforms encounter resistance in spite of their potential for generating higher living standards will find this book essential reading.
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Chapter 3: Why Private Markets Work

Transitions and Growth in Post-Soviet Europe

Patricia Dillon and Frank C. Wykoff


In order for reforms to be sustained, citizens must appreciate their benefits. Economic analysis demonstrates the value of five economic reforms. (1) Price liberalization is essential for the creation of a market system in which prices reflect social costs and in which these costs are paid by those who receive the benefits. (2) Private property is essential for capitalism. If property rights are well defined, the private owner is the residual claimant and therefore acts as the consumer best able to satisfy his own wants and as the producer inclined to satisfy consumer demands while husbanding resources and minimizing production costs. (3) Well-designed fiscal and monetary institutions and policies ameliorate business cycles, reduce crowding out and promote price-level stability. This last facilitates private decision-making by not allowing inflation to vitiate price signals. (4) Industry restructuring and deregulation reduces bureaucratic rent-seeking and empowers producers to maximize profits, which minimizes costs while satisfying consumer demand. (5) International trade liberalization exploits countries’ comparative advantages, maximizes the benefits of specialization and fosters technology transfer. Free trade also eliminates the rents that local monopolies would otherwise enjoy and thus reduces the concentration of power in the hands of former apparatchiks and state managers. Even though the political system may resist these reforms, each will improve economic efficiency. Inefficiencies are “failures” in both private markets and in government. Central and Eastern Europe continue to be troubled by the evident failure of planners to deal with environmental degradation...

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