A popular proposal for market socialism is Oskar Lange, (1936) "On the Economic Theory of Socialism: Part One," The Review of Economic Studies, Vol. 4, No. 1 (October), pp. 53-71.
"With government provision, there may be only a few people who can contribute to cost-saving innovations."
People often lament the waste, corruption, and downright absurdities of government enterprises, wondering why they can't be "run like a business." Yet economic theory shows that this is no mere accident: Serious institutional differences make government officials much less efficient at managing scarce resources than their private-sector counterparts. We can see these theoretical lessons illustrated in numerous examples spanning a wide range of industries. This evidence should place a prima facie hurdle in the spread of government intervention into new sectors, such as health insurance.
Government versus Private Resource Management: The Theory
According to a common but naïve worldview, there are objective, well-known techniques for producing various goods and services, and the consumer preferences regarding these outputs are also common knowledge. In such a worldview—which even many professional economists, in discussing policy, seem to hold—it seems only natural to conclude that government officials could improve upon the decentralized market outcome. After all, the government has access to the same "production function" as private firms, and if it decides to be the monopoly producer of a good or service, it can avoid wasteful advertising expenses and other redundancies. Such arguments were behind the proposals for outright "market socialism" in the era between World Wars I and II, and, to this day, they guide recommendations for heavy government regulation of "natural monopolies" such as utilities.1
However, more-practical economists recognize the limits of their textbook diagrams with elegant marginal revenue and marginal cost curves. In reality, we operate in a world of uncertainty. The "least cost" method of producing a good or service is never obvious, nor is what consumers will be willing to pay for various items. In a famous lecture, "Competition as a Discovery Procedure," Friedrich Hayek explained how markets in the real world stumble upon this hidden knowledge.2 Various people with access to different information make piecemeal discoveries and constantly modify their operations accordingly; they receive feedback from market prices in the form of profit or loss. Firms mimic particularly profitable innovations, and if a firm does not adapt quickly enough, it will go out of business. Hayek thus viewed competition as a process rather than a condition or end-state. The state of "perfect competition" described in the textbooks—which includes the property that all firms in an industry use the identical "least-cost" method of production—is actually something that would emerge over time only because of the competitive rivalry between the firms, and only if the conditions in the real world remained static long enough for all firms to fully adapt.
From this Hayekian perspective, we have little reason to expect government provision of a good or service to reduce costs, if only because such an institutional arrangement limits the number of minds brainstorming on how to cut costs. Under competitive free entry into an industry, and even into a "natural monopoly," an outsider always has the freedom to supplant the established firms if he or she comes up with a new, cost-saving idea. Thus, in principle, the entire society contributes to solving the problem of minimizing costs in the particular industry.
In contrast, with government provision (or government anointment of one firm as a regulated monopolist), there may be only a few people who can contribute to cost-saving innovations. This insight provides a strong reason to expect government-managed enterprises to have higher costs of operation than a private-sector firm would have—out of sheer ignorance. In this view, government officials waste money and offer shoddy output relative to private managers, simply because they don't know any better.
Beyond these subtle problems of knowledge is the stark issue of incentives. If a government enterprise is funded through tax dollars, it does not face the same market test as a genuinely private business. The problem is all the more severe if the government grants an outright monopoly to the enterprise. The bureaucrats running it have little reason to cut costs or to please their "customers" if they receive a guaranteed level of funding regardless of their outcomes. In an extra twist of perversion, when a government agency botches its job, it often receives more funding. In this view, government officials waste money and offer shoddy output simply because they can.
The Rose Bowl anecdote is relayed in the The Concise Encyclopedia of Economics entry on Armen Alchian:
... In their textbook, for example, Alchian and Allen ask why the organizers of the Rose Bowl refuse to sell tickets to the highest bidders and instead give up wealth by underpricing the tickets. Their answer is that the people who make the decision on ticket prices do not have property rights in the tickets, so the wealth that is given up by underpricing would not have accrued to them anyway. But the decision makers can give underpriced tickets to their friends and associates.
In the next section, where we turn to real-world examples, a key theme is that political managers often set the price of a good or service below the market-clearing level. The insights of the Public Choice School explain this pattern. Government managers, especially in Western democracies, cannot personally keep the extra revenues from charging a higher price. Those who tried to do so would be thought of as thieves. However, the various government officials involved with the enterprise can curry favor with the customers of the good or service who receive it at a discount. Armen Alchian and William Allen memorably illustrated this phenomenon with the case of organizers of the Rose Bowl, who sold tickets at prices at well below what the market would bear because, unable to pocket the revenues personally, they could at least bestow valuable gifts on favored recipients.
A second, related theme running throughout our real-world examples is the arbitrary restrictions that officials place on the use of a government-provided good or service. Again, institutional differences explain this striking result. From the perspective of government managers, a higher demand for their product is generally cause for misery. In contrast, private owners jump for joy when customers line up for their product, and they take steps to cater to the increased demand. Murray Rothbard pointed out that by separating payment from service, government enterprises end up treating the consumer "like an unwelcome intruder, an interference in the quiet enjoyment by the bureaucrat of his steady income."3
Armed with these theoretical insights, we can see the drawbacks in government-run enterprises through many real-world examples.
Government versus Private Resource Management: The Examples
Even though most people view roads as a resource that "obviously" should be managed by government, this is an area where government control causes an enormous amount of waste and even death.
For the reasons described earlier, governments typically charge below-market prices to consumers. This rule holds for roads controlled by governments. Especially during morning and evening rush hours in major cities, it is obvious that the monetary price for using the roads in question (which is often zero) is below the level that would equate quantity supplied with quantity demanded. (Note that what is being sold is not "a road" but, rather, "use of the road.")
In other words, traffic jams are not a feature of road usage per se; they are largely the creation of government. We already see timid steps in the right direction, with government-set tolls varying according to the time of day. Yet if the roads, bridges, and tunnels were privately owned, and the owners were free to charge "what the market would bear," the peak prices—at least initially, when dealing with the same infrastructure—would likely be much higher. It is true that the owners of the infrastructure would reap large revenues in such a setting, but these very revenues would prompt them, or competitors, to build other roads or alternate methods of transportation.
The forfeited resources to society caused by government ownership of roads are staggering. According to the Texas A&M Transportation Institute, traffic congestion in the U.S. wasted $121 billion in fuel and time in 2011.4 For those concerned about greenhouse gas emissions, the daily traffic jams should be even more alarming.
Beyond underpricing of roads, government ownership also causes more traffic fatalities than would occur with privately owned competing roads. For example, a few years ago, State Farm Insurance declared an intersection in Pembrook Pines, Florida to be the most dangerous in the nation (during the period 1999-2000), with an accident occurring every other day. Yet rather than dealing with this enormous problem for their "customers," a Florida Transportation Department spokesman told USA Today that there "are 36 million cars on [the intersection] every year" and, consequently, "[s]ome accidents are inevitable."5
In 2012, there were almost 34,000 traffic fatalities in the United States.6 As Walter Block has pointed out, if this number of deaths were due to a privately produced good or service, there would be a national outcry for an immediate government investigation.7 Yet since these deaths occur at the hands of government, they are attributed to "driver error," drunk driving, and other "blame-the-victim" excuses.
Especially during the summer months, certain cities are hit with drought conditions. The problem is just another example of underpricing a critical resource—in this case, water. When the supply falls and the demand increases, the obvious response should be a substantial increase in the price per unit. This would "ration" the available quantities for the most urgent uses and give outsiders an incentive to ship in more water.
Alas, governments typically do not follow this path. Instead they maintain the "normal" price of water and urge the public to conserve. Here, the difference between government and private management is obvious: While the government browbeats the public for "inappropriate" uses of water from the tap, there is no problem obtaining bottled water at the grocery store. Nestle, Dasani, and Poland Spring are overjoyed when it's hot and their customers increase purchases. Their attitude, to adapt the Doritos slogan, is: Drink all you want; we'll bottle more.
When I was in grad school, I experienced the extremes of the central-planner mentality. During early 2002, historically low rainfall levels led New York City officials to issue a "Drought Management Plan," which specified the conditions under which "Drought Emergency Rules" would kick in. Citizens would not be allowed to wash their vehicles with a hose. They would be allowed to water their lawns from 7 to 9 a.m. and 7 to 9 p.m.—but only odd-numbered house numbers on odd-numbered days (and likewise for even numbers). Plant nurseries could continue to use water, but only at 95 percent of their previous levels. Restaurants would be required to stop serving water unless patrons specifically requested it. All showerheads would be required to have a maximum performance of three gallons per minute at 60 psi. Finally, a "SAVE WATER" sign—the dimensions and appearance of which were also specified in the plan—would have to be placed in all dwellings housing more than four families.8
Anyone who lives in a major urban area that experiences severe summers is probably familiar with such micromanagement. City officials may even go so far as to set up "hotlines" so that neighbors can tattle on each other when someone is using water in a non-approved manner. Beyond the economic waste involved—with bureaucrats making one-size-fits-all decisions about the proper use of units of water—its Orwellian aspect is chilling.
The analysis for electricity is quite similar to that of water. Especially during the summer months, when people in warm climates rely on air conditioning, officials, rather than raising electricity prices, instead urge the public to turn up their thermostats and even call for offices to allow their employees to wear t-shirts.
In extreme cases, officials impose "rolling blackouts" during peak loads, pre-emptively cutting off the power in certain areas in order to prevent the whole system from overloading. They are termed "rolling" because officials deny power to a particular group of customers temporarily and then move the blackout to another area. For example, in April 2006, certain areas of Texas were intentionally denied power for five hours. In California, power customers are divided into different groups and are given advance warning of when they will lose power during a "Stage 3 power emergency."9
Although the notorious Enron is associated with power outages in California electricity markets, here, too, the fundamental issue is poor institutional design. In a genuinely open market with free entry and free pricing at all levels, we would not see intentional disruptions of service to customers, for the simple reason that it would be unprofitable to do so.
As even the federal government's own post-mortem on the "Enron crisis" indicates, a chief element in that sordid episode was that the so-called "deregulation" in California applied only to wholesale energy prices; there were still price caps on the retail electricity market.10 Indeed, one of Enron's seemingly sinister strategies was to buy electricity from California markets (where the price was capped) and then "export" it to other states at a higher price.11 Rob Bradley, one of the world's experts on free-market energy economics, was Ken Lay's speechwriter at Enron when the crisis struck. As Bradley now summarizes the affair: "Enron lived, thrived, and perished in and through the mixed economy."12
While government ownership or management of roads leads to traffic jams, government ownership of forests leads to overlogging. Because government charges timber companies and other users artificially low prices for logging, trees are cut down faster than the natural resource can be replenished. Ironically, one of the biggest environmental worries—deforestation—is due not to capitalist "greed," but to inadequate property rights.13
When government officials control the ability to access timberland, they charge private logging companies artificially low prices ("stumpage fees") because these officials are in power only temporarily. If their decisions reduce the asset value of the land itself, it is of little direct concern to them because they don't actually own the land: "the government" does. Consequently, we observe private logging companies cutting down trees far more rapidly than "what the land can bear," but the problem is government ownership, not the profit motive per se.
Bodies of Water
For more information, see the Concise Encyclopedia of Economics entry on the "Tragedy of the Commons".
Finally, we see the same problem of underpricing in government management of water resources. Just as government control of forests leads to overlogging, government control of oceans, lakes, and rivers leads to overfishing.14 Marine biologists can think of few villains worse than commercial whalers who hunt endangered species on the open seas, but this, too, is ultimately a problem of ill-defined property rights. Just as ranchers solved the "tragedy of the commons" in the case of grazing land animals by enclosing pastureland and branding cattle, the tragedy in water resources can be resolved by the allocation and enforcement of property rights. For example, scholars have made serious proposals for auctioning off ownership in whales as a way to solve the feuds arising between those who want the right to hunt and those who want a vigorous enforcement of a ban on whale hunting.15
Millions of Americans directly observe the perversities of government water management in the form of fishing and boating restrictions on lakes. Rather than charging a true market price for the fish taken out of the bodies of water under their control, government officials invent various non-monetary hurdles to hinder citizens from removing the fish. For example, they impose "fishing seasons," and even when it is legally permissible to fish, a host of regulations hobble the productivity of the enterprise. To take just one example, consider the following excerpt from the Virginia Department of Game and Inland Fisheries:
Beyond aesthetic reasons (for example, to maintain a peaceful environment for citizens who wish to enjoy bodies of water for recreational purposes), government limits on the techniques of fishing are "necessary" to prevent the fish stocks from being depleted. It would be as if Red Lobster, seeing a huge surge in demand for salmon, changed its policies so that customers could order salmon only on Tuesdays between noon and 4 p.m. and had to eat it with a spoon.
Both theory and history indicate that government management of resources leads to waste and even absurdity. People view traffic jams, water shortages, power outages, deforestation, endangered species, and fishing rules as facts of life. But they are not necessary. On the contrary, they are perversities produced by government management. Private markets are not perfect, but competition and private ownership give the best possible framework for an efficient use of scarce resources.
A popular proposal for market socialism is Oskar Lange, (1936) "On the Economic Theory of Socialism: Part One," The Review of Economic Studies, Vol. 4, No. 1 (October), pp. 53-71.
Hayek's lecture was given in German in 1968, but an English translation made by Marcellus S. Snow is Friedrich A. Hayek, (2002) "Competition as a Discovery Procedure," The Quarterly Journal of Austrian Economics Vol. 5, No. 3 (Fall), pp. 9-23. Available at: http://mises.org/journals/qjae/pdf/qjae5_3_3.pdf.
Murray Rothbard, ( 1994) For a New Liberty (San Francisco: Fox & Wilkes), Revised Edition, p. 196.
The Texas A&M Transportation Institute results for the year 2011 are summarized in this press release: http://mobility.tamu.edu/ums/media-information/press-release/. Accessed November 22, 2013.
CBS News, "Dangerous Intersections," February 11, 2009, available at: http://www.cbsnews.com/2100-201_162-298602.html.
See the Wikipedia entry on "List of motor vehicle deaths in U.S. by year," available at: http://en.wikipedia.org/wiki/List_of_motor_vehicle_deaths_in_U.S._by_year. Accessed November 20, 2013.
Walter Block, (2009) The Privatization of Roads and Highways (Auburn, AL: The Ludwig von Mises Institute). Available at: http://library.mises.org/books/Walter%20Block/The%20Privatization%20of%20Roads%20and%20Highways.pdf.
I wrote about the incident at the time in Robert Murphy, (2002) "Blame It on the Rain," Mises Daily, February 14, 2002. Available at: http://mises.org/daily/894/.
See the Wikipedia entry on "Rolling blackout," available at: http://en.wikipedia.org/wiki/Rolling_blackout. Accessed November 20, 2013.
Federal Energy Regulatory Commission, "The Western Energy Crisis, Enron's Bankruptcy, and FERC's Response." Available at: http://www.ferc.gov/industries/electric/indus-act/wec/chron/chronology.pdf.
Jerry Isaacs, (2002) "Enron defrauded California out of billions during energy crisis," World Socialist Web Site, May 10, 2002. Available at: http://www.wsws.org/en/articles/2002/05/enro-m10.html.
Robert L. Bradley, Jr., (2008) Capitalism at Work (M & M Scrivener Press), p. 302.
See for example Charles. E. Palmer, (2000) "The Extent and Causes of Illegal Logging: An Analysis of a Major Cause of Tropical Deforestation in Indonesia," CSERGE Working Paper. Available at: http://www.cserge.ucl.ac.uk/Illegal_Logging.pdf.
For an example of a news story on overfishing, see Tom Levitt, (2013) "Overfished and under-protected: Oceans on the brink of catastrophic collapse," CNN, March 27, 2013. Available at: http://www.cnn.com/2013/03/22/world/oceans-overfishing-climate-change/.
Juliet Eilperin, (2012) "Researchers propose putting a price on whales," The Washington Post, January 11, 2012. Available at: http://articles.washingtonpost.com/2012-01-11/national/35439004_1_hunt-whales-iwc-fewer-whales.
The Virginia Department of Game and Inland Fisheries "General Freshwater Fishing Regulations" available at: http://www.dgif.virginia.gov/fishing/regulations/general.asp. Accessed November 22, 2013.
*Robert P. Murphy is a Senior Fellow in Business and Economic Studies at Pacific Research Institute, and an economist with the Institute for Energy Research where he specializes in climate change economics. He is the author of The Politically Incorrect Guide to Capitalism (Regnery, 2007). For more articles by Robert P. Murphy, see the Archive.