Government Cannot be Run Like a Business

by Michael Makovi, Guest Writer

We sometimes hear that government is inefficient and wasteful because it is not run like a business. The implication is that if only government were run in a more businesslike manner, its performance would not be so unsatisfactory. In a way, this criticism is true, but not in the way its advocates intend it. Government really would be more efficient if it were run like a business. But the only way to achieve this is through privatization and deregulation. By its constitutional nature, government cannot be run like a business.

In fact, even the most accomplished business person could never run government like a business. If a business person were ever elected or appointed to political office, he or she could not help but execute their office in a typically bureaucratic manner. Only businesses can be operated in a businesslike fashion. There is a fundamental constitutional distinction between government and business, and it is not not the person which makes the office, but it is the office which makes the person. Anyone occupying government office cannot help but behave as a bureaucrat, no matter how accomplished of a business person they might have been previously. The Austrian economist Ludwig von Mises (1881-1973) explained why in a passage worth quoting at length. The following comes from his landmark 1920 article, "Economic Calculation in the Socialist Commonwealth", translated from the original German and reprinted in F. A. Hayek's 1935 collection, Collectivist Economic Planning (https://mises.org/library/collectivist-economic-planning):

A popular slogan affirms that if we think less bureaucratically and more commercially in communal enterprises, they will work just as well as private enterprises. The leading positions must be occupied by merchants, and then income will grow apace. Unfortunately "commercial-mindedness" is not something external, which can be arbitrarily transferred. A merchant's qualities are not the property of a person depending on inborn aptitude, nor are they acquired by studies in a commercial school or by working in a commercial house, or even by having been a business man oneself for some period of time. The entrepreneur's commercial attitude and activity arises from his position in the economic process and is lost with its disappearance. When a successful business man is appointed the manager of a public enterprise, he may still bring with him certain experiences from his previous occupation, and be able to turn them to good account in a routine fashion for some time. Still, with his entry into communal activity he ceases to be a merchant and becomes as much a bureaucrat as any other placeman in the public employ. It is not a knowledge of bookkeeping, of business organization, or of the style of commercial correspondence, or even a dispensation from a commercial high school, which makes the merchant, but his characteristic position in the production process, which allows of the identification of the firm's and his own interests. It is no solution of the problem when Otto Bauer in his most recently published work proposes that the directors of the National Central Bank, on whom leadership in the economic process will be conferred, should be nominated by a Collegium, to which representatives of the teaching staff of the commercial high schools would also belong. Like Plato's philosophers, the directors so appointed may well be the wisest and best of their kind, but they cannot be merchants in their posts as leaders of a socialist society, even if they should have been previously.

Let us parse this passage more closely. "A merchant's qualities are not the property of a person . . . The entrepreneur's commercial attitude and activity arises from his position in the economic process and is lost with its disappearance." It is not the person which makes the office but the office which makes the person. A business person behaves as they do because of the institutional constraints of the position. A business person must satisfy voluntary and willing customers who are free to take their dollars elsewhere. It is the phenomenon of profit and loss which fundamentally shapes the character of the business person's activities. The free-market business enterprise faces no captive market and it can take nothing for granted. Either the firm produces products which willing customers voluntarily purchase, or else it goes bankrupt. The business person behaves as they do because of these institutional constraints, not because of anything peculiar to the person him- or herself. "It is not a knowledge of bookkeeping, of business organization, or of the style of commercial correspondence, or even a dispensation from a commercial high school, which makes the merchant, but his characteristic position in the production process, which allows of the identification of the firm's and his own interests." Therefore, "with his entry into communal activity he ceases to be a merchant and becomes as much a bureaucrat as any other placeman in the public employ."

By contrast, a government bureaucracy possesses a monopoly. Its customers cannot choose whether or not to purchase from the bureau. They have nowhere else to turn. Furthermore, the bureau is subsidized by taxes whether it satisfies customers or not. Compare a car insurance company to the DMV, for example: the insurance company must strive to serve its customers at least as well as its competitors, or else it must compensate for worse service with equivalently lower premiums. If it fails to do so, its customers will all abandon it for its competition. Contrariwise, the DMV has no fear that its "customers" will leave it for another. The citizens have nowhere else to turn to obtain their licenses. And whether the citizens are satisfied or not, the DMV receives its funds from taxation. The DMV is paid whether it does its job or not. Therefore, the DMV has no incentive to operate efficiently or to provide satisfactory customer service. The difference between the insurance firm and the DMV is not that the manager of the one is a better business person than the manager of the other. Rather, the fundamental distinction is the conditions under which each operates. Again, it is not the person which makes the office, but the office which makes the person. Therefore, it will do absolutely no good whatsoever to appoint a proven business person to political office. With the loss of their position in the market system, they lose everything it is that ever made them a business person. "Like Plato's philosophers, the directors so appointed may well be the wisest and best of their kind, but they cannot be merchants in their posts as leaders of a socialist society, even if they should have been previously."

Mises made a similar argument in his 1922 book, Socialism (https://mises.org/library/socialism-economic-and-sociological-analysis) and by now, the reader should be equipped to interpret it without assistance:

If the work of a body of officials appears unsatisfactory, there can be only one explanation: the officials have not had the right training, and future appointments must be made differently. It is therefore proposed that a different training should be required of future candidates. If only the officials of the communal undertaking came with a business training, the undertaking would be more business-like. . . . It is not difficult to expose the fallacies inherent in such notions. The attributes of the business man cannot be divorced from the position of the entrepreneur in the capitalist order. "Business" is not in itself a quality innate in a person; only the qualities of mind and character essential to a business man can be inborn. Still less is it an accomplishment which can be acquired by study, though the knowledge and the accomplishments needed by a business man can be taught and learned. A man does not become a business man by passing some years in commercial training or in a commercial institute, nor by a knowledge of book-keeping and the jargon of commerce, nor by a skill in languages and typing and shorthand. These are things which the clerk requires. But the clerk is not a business man, even though in ordinary speech he may be called a "trained business man."

In summary: if a political candidate ever promises he will run government like a business, do not believe him or her. He or she cannot run government like a business. It is simply impossible. The difference between government and business is the difference between monopoly and competition, between compulsory taxes and voluntarily paid fees. The institutional constraints of the office make all the difference, and the person him- or herself is almost an afterthought. This is not to say that free-market business enterprises are necessarily superior to government bureaus. Perhaps regulation and publicly-owned corporations are necessary. But let us not confuse the matter by believing that the one can be operated on the same basis as the other. Private and public firms operate within totally different contexts and the principles of one cannot be applied to the other. If regulation is necessary, so be it, but let us be frank and admit that insofar as government is necessary, it is precisely because it is not business like and it never can be.

Do Capitalists Manipulate, Deceive, and Cheat? Not as Much as Politicians Do

by Michael Makovi, Guest Writer

Real-world markets, according to Nobel laureate economist Robert Shiller, are all about manipulation and deception.

So he argues in a New York Times article summarizing his new book, coauthored with fellow Nobel laureate economist George Akerlof: Phishing for Phools: The Economics of Manipulation and Deception. According to Shiller, merchants and vendors regularly “phish for” ignorant consumers who they can mislead into acting less in their own interests and more in those of the phishermen.

Shiller claims that the theoretical defense of the free market depends on consumers being rational and well informed — a condition that doesn’t hold true in the real world. Drawing on behavioral economics, he argues that consumers are often possessed with cognitive biases that allow them to be systematically deceived by unsavory merchants. For this reason, Shiller argues, consumers need government regulation to protect their interests. The internal forces of the market are not sufficient.

Deus ex Nirvana

But government regulation is not an infallible deus ex machina. The question is not whether the market fails, but whether the government is more likely than the market itself to correct those failures. Economist Harold Demsetz coined the term “nirvana fallacy” to make this point: it is not enough to find flaws in the real world; one must prove that some feasible alternative is likely to be less flawed. James Buchanan, one of the fathers of public choice economics, compared advocates of government regulation to the judges of a singing contest who, after hearing an imperfect performance from the first contestant, immediately award the second contestant, reasoning that he must be better.

No, the market is not perfect, and consumers are often ignorant and manipulable. But the real question is this: Will government do any better?

Just because the first singer offered a less-than-perfect performance is no proof that the second singer will be any better. Ironically, Nudge author and former member of the Obama administration Cass Sunstein, no friend of economic freedom, accidentally makes this very point in his positive review of Shiller and Akerlof’s book.

According to Sunstein,

Bad government is itself a product of phishing and phoolishness, for “we are prone to vote for the person who makes us the most comfortable,” even when that person’s decisions are effectively bought by special interests.

So yes, people behave irrationally in their capacities as market participants, but they are no more rational in how they cast their votes than in how they spend their dollars.

Buying What You Don’t Want

The difference is that in a market, there are feedback signals, however attenuated. If a vendor cheats his customer by holding back information about his product, at least the customer will learn about the product’s faults after he purchases it, and he will buy from someone else next time. He will likely warn others, too. The consumer may have cognitive biases, but he has the opportunity to learn from his mistakes, prevent others from making them, and correct them in the future. The deceptive merchant will develop a bad reputation, and paying customers are motivated to learn about merchants’ reputations — especially as 21st-century technology develops ever-more-robust reputation markets, accessible through anyone’s smartphone.

By contrast, there are fewer feedback signals in politics and even fewer opportunities to act on that feedback. One vote barely counts, and each voter must vote not for specific policies, but for politicians with a range of policies. Electoral politics doesn’t really offer a choice so much as it imposes a bundle. A vote for a particular candidate implies endorsement of all the policies in that bundle, when the truth is more likely that the voter has selected the least bad option. In the market, customers can easily split their “dollar votes” to purchase only the specific products they want.

In Freedom and the Law, Bruno Leoni notes that we are all doubly unrepresented by politics: we vote for A, but B defeats A in the election. Then, when B is sitting in the legislature, he is outvoted on a bill by C. So in the end, a person is governed by politician C who beat B, who in turn beat the voter’s preferred choice, A.

When Phoolishness Is Rational

In such a situation, it makes sense for voters to be rationally ignorant of the effects of government policies they are helpless to affect. Politicians are free to peddle shoddy products when they know voters have few opportunities to learn from their mistakes — and even fewer opportunities to correct them.

Meanwhile, markets tend to concentrate benefits and costs on the consumers who use a specific product. This internalization of costs and benefits promotes learning and feedback. In a market, a person must bear the consequences of his or her own actions.

In politics, benefits are concentrated on those whom the politician wishes to favor — such as financial donors and special interests whose attention is narrowly focused — while costs are dispersed among those whose attention is elsewhere, including many who focus on producing wealth instead of transferring it.

The combination of rationally ignorant voters and informed and motivated special interests encourages rent seeking. Private benefit and social cost diverge as the political process encourages the creation of new externalities. While markets tend to internalize the costs, politics encourages externalities.

So yes, consumers are often “irrational” and deceived and make mistakes. But, as Sunstein himself tells us, this is true in both politics and markets. The question is, Which institutional environment is more likely to promote learning from mistakes? And which institution — the market or politics — maximizes a person’s ability to correct those mistakes? Shiller and Akerlof have failed to prove that government regulation will detect or correct mistakes better than the market itself can.

This article was written by guest writer Michael Makovi, and was originally published on the Foundation for Economic Education, and can be seen here.