D. The Fallacy of Government on a "Business Basis"

Government may either subsidize deliberately by giving a service away free, or it may genuinely try to find the true market price, i.e., to “operate on a business basis.” The latter is often the cry raised by conservatives—that government enterprise be placed on a business footing, that deficits be ended, etc. Almost always this means raising the price. Is this a rational solution, however? It is often stated that a single government enterprise, operating within the sphere of a private market and buying resources from it, can price its services and allocate its resources efficiently. This, however, is incorrect. There is a fatal flaw that permeates every conceivable scheme of government enterprise and ineluctably prevents it from rational pricing and efficient allocation of resources. Because of this flaw, government enterprise can never be operated on a “business” basis, no matter how ardent a government’s intentions.

What is this fatal flaw? It is the fact that government can obtain virtually unlimited resources by means of the coercive tax power (i.e., limited only by the total resources of society). Private businesses must obtain their funds from private investors. This allocation of funds by investors, based on time preference and foresight, “rations” funds and resources to the most profitable and therefore the most serviceable uses. Private firms can get funds only from consumers and investors; they can get funds, in other words, only from people who value and buy their services and from savers who are willing to risk investment of their saved funds in anticipation of profit. In short, payment and service are, we repeat, indissolubly linked on the market. But government, on the other hand, can get as much money as it likes. The free market therefore provides a “mechanism,” which we have analyzed in detail, for allocating funds for future and present consumption, for directing resources to their most value-productive uses for all the people. It thereby provides a means for businessmen to allocate resources and to price services to insure optimum use. Government, however, has no checkrein on itself, i.e., no requirement of meeting a test of profit-and-loss or valued service to consumers, to permit it to obtain funds. Private enterprise can get funds only from satisfied, valuing customers and from investors guided by present and expected future profits and losses. Government gets more funds at its own whim.

With the checkrein gone, gone also is any opportunity for government to allocate resources rationally. How can it know whether to build road A or road B, whether to “invest” in a road or a school—in fact, how much to spend for all of its activities? There is no rational way that it can allocate funds or even decide how much to have. When there is a shortage of teachers or schoolrooms or police or streets, the government and its supporters have only one answer: more money. The people must relinquish more of their money to the government. Why is this type of answer never offered on the free market? The reason is that money must always be withdrawn from some other use in consumption or investment—and this withdrawal must be justified. On the market, justification is provided by the test of profit and loss—the indication that the most urgent wants of the consumers are being satisfied. If an enterprise or product is earning high profits for its owners, and these profits are expected to continue, more money will be forthcoming; if not, and losses are being incurred, money will flow out of the industry. The profit-and-loss test serves as the critical guide for directing the flow of productive resources. No such guide exists for government, which therefore has no rational way to decide how much money to spend in total or in each specific line. The more money it spends, the more service, of course, it can supply—but where to stop?62

Proponents of government enterprise may retort that the government should simply tell its bureau to act as if it were a profit-making enterprise and to establish itself in the same way as a private business. There are two basic flaws in this theory: (1) It is impossible to play enterprise. Enterprise means risking one’s own money in investment. Bureaucratic managers and politicians have no real incentive to develop entrepreneurial skills, to really adjust to consumer demands. They do not risk loss of their money in the enterprise. (2) Aside from the question of incentives, even the most eager managers could not function as a business. For, regardless of the treatment accorded the operation after it is established, the initial launching of the firm is made with government money, and therefore by coercive levy. A fatally arbitrary element has been “built into” the very vitals of the enterprise. Furthermore, future decisions on expenditures will be made out of tax funds and will therefore be subject to the same flaw. The ease of obtaining money will inherently distort the operations of government enterprise. Moreover, suppose that the government “invests” in an enterprise E. Either the free market, left alone, would also have invested in this selfsame enterprise, or it would not. If it would have, then the economy suffers, at the very least, from the “take” going to the intermediary bureaucracy. If not, and this is almost certain, then it follows immediately that the expenditure on E is a distortion of private utility on the market—that some other expenditure would have brought greater monetary returns. It follows once again that a government enterprise cannot duplicate the conditions of private business.

In addition, the establishment of government enterprise creates an “unfair” competitive advantage over private firms, for at least part of its capital was gained by coercion rather than service. It is clear that government, with its subsidization, can drive a private business out of the field. Private investment in the same industry will be greatly restricted, since future investors will anticipate losses at the hands of privileged governmental competitors. Moreover, since all services compete for the consumer’s dollar, all private firms and all private investment will to some degree be affected and hampered. And when a new government enterprise begins, it generates fears in other industries that they will be next, that they will either be confiscated or forced to compete with government-subsidized enterprises. This fear tends to repress productive investment further and thus lower the general standard of living still more.

Another argument, used quite correctly by “leftist” proponents of government ownership, is this: If business operation is so desirable, why take such a tortuous route? Why not scrap government ownership and turn the whole operation over to private business enterprise? Why go to such elaborate lengths to try to imitate the apparent ideal (private ownership) when the ideal may be pursued directly? The call for business principles in government, therefore, makes little sense, even if that call could be successful.

Many “criteria” have been offered by writers as guides for the pricing of government services. One criterion supports pricing according to “marginal cost.” As we have indicated above, however, this is hardly a criterion at all and rests on classical fallacies of price determination by costs. “Marginal” varies according to the period of time surveyed. And costs are not in fact static but flexible; they change according to prices and hence cannot be used as a guide to the setting of prices. Moreover, prices equal average costs only in final equilibrium, and equilibrium cannot be regarded as an ideal for the real world. The market only tends toward this goal. Finally, costs of government operation will be higher than for similar operations on the free market.63

Government enterprise will not only hamper and repress private investment and entrepreneurship in the same industry and in industries throughout the economy; it will also disrupt the entire labor market. For the government (a) will decrease production and living standards in the society by siphoning off potentially productive labor to the bureaucracy; (b) using confiscated funds, it will be able to pay more than the market rate for labor and hence set up a clamor by government job-seekers for an expansion of the unproductive bureaucratic machine; and (c) the government’s high tax-supported wages may well mislead workers into believing that this reflects the market wage in private industry, thus causing unwanted unemployment.

The inefficiencies of government operation are compounded by several other factors. As we have seen, a government enterprise competing in an industry can usually drive out private owners, since the government can subsidize itself in many ways and supply itself with unlimited funds when desired. In cases where it cannot compete even under these conditions, it can arrogate to itself a compulsory monopoly, driving out competitors by force. This was done in the United States in the case of the post office.64 When the government thus grants itself a monopoly, it may go to the other extreme from free service; it may charge a monopoly price. Charging a monopoly price—now identifiably different from a free-market price—distorts resources again and creates an artificial scarcity of the particular good. It also permits an enormously lowered quality of service. A governmental monopoly need not worry that customers may go elsewhere or that inefficiency may mean its demise.65 It is particularly absurd to call for “business principles” where a government enterprise functions as a monopoly. Periodically, for example, there are demands that the post office be put on a “business basis” and end its deficit, which must be paid by the taxpayers. But ending the deficit of an inherently and necessarily inefficient government operation does not mean going on a business basis. To cover costs, the price must be raised high enough to achieve a monopoly price and so camouflage and compensate for the government’s inefficiencies. A monopoly price will levy an excessive burden on the users of the postal service, especially since the monopoly is compulsory. On the other hand, we have seen that even monopolists must abide by the consumers’ demand schedule. If this demand schedule is elastic enough, it may well happen that a monopoly price will reduce revenue so much or cut down so much on its increase that a higher price will increase deficits rather than reduce them. An outstanding example has been the New York City subway system in recent years.66

• 62Cf. Ludwig von Mises, Bureaucracy (New Haven: Yale University Press, 1946), pp. 50, 53.
• 63arious fallacious criteria have been advanced for deciding between private and state action. One common rule is to weigh “marginal social costs” and benefits against “marginal private costs” and benefits. Apart from other flaws, there is no such entity as “society” separate from constituent individuals, so that this preferred criterion is simply meaningless.
• 64See the interesting pamphlet by Frank Chodorov, The Myth of the Post Office (Hinsdale, Ill.: Henry Regnery Co., 1948). On a similar situation in England, see Frederick Millar, “The Evils of State Trading as Illustrated by the Post Office” in Thomas Mackay, ed., A Plea for Liberty (New York: D. Appleton Co., 1891), pp. 305–25. For a portrayal of the political factors that have systematically distorted economic considerations in setting postal rates in the United States, see Jane Kennedy, “Development of Postal Rates: 1845–1955,” Land Economics, May, 1957, pp. 93–112; and Kennedy, “Structure and Policy in Postal Rates,” Journal of Political Economy, June, 1957, pp. 185–208.
• 65Only governments can make self-satisfied announcements of cuts in service in order to effect economies. In private business, economies must be made as corollaries to improvements in service. A recent example of a cut in government service—in the midst of improving private services in most other fields—was the decline in American postal deliveries from two to one a day, coupled, of course, with perennial requests for higher rates.
       When France nationalized the important Western Railway system in 1908, freight was increasingly damaged, trains slowed down, and accidents grew at such a pace that an economist caustically observed that the French government had added railway accidents to its growing list of monopolies. See Murray N. Rothbard, “The Railroads of France,” Ideas on Liberty, September, 1955, p. 42.
• 66Ironically enough, the higher fares have driven many customers to buying and driving their own cars, thus aggravating the perennial traffic problem (shortage of government street space) even further. Another example of government intervention creating and multiplying its own difficulties! On the subways, see Ludwig von Mises, “The Agony of the Welfare State,” The Freeman, May 4, 1953, pp. 556–57.