The Myth of Efficient Government Service

by Murray N. Rothbard via Mises Institute

[This excerpt from Man, Economy, and State, with Power and Market is an explanation and elaboration of points first made in Ludwig von Mises’s Bureaucracy—and provides an excellent example of how Murray Rothbard’s treatise built on Mises’s to employ and extend the core analytical framework. The footnotes have been shortened. The excerpt is from pages 1260–72.]

The well-known inefficiencies of government operation are not empirical accidents, resulting perhaps from the lack of a civil-service tradition. They are inherent in all government enterprise, and the excessive demand fomented by free and other underpriced services is just one of the many reasons for this condition.

Thus, free supply not only subsidizes the users at the expense of nonusing taxpayers; it also misallocates resources by failing to supply the service where it is most needed. The same is true, to a lesser extent, wherever the price is under the free-market price. On the free market, consumers can dictate the pricing and thereby assure the best allocation of productive resources to supply their wants. In a government enterprise, this cannot be done. Let us take again the case of the free service. Since there is no pricing, and therefore no exclusion of submarginal uses, there is no way that government, even if it wanted to, could allocate its services to the most important uses and to the most eager buyers. All buyers, all uses, are artificially kept on the same plane. As a result, the most important uses will be slighted, and the government is faced with insuperable allocation problems, which it cannot solve even to its own satisfaction. Thus, the government will be confronted with the problem: Should we build a road in place A or place B? There is no rational way by which it can make this decision. It cannot aid the private consumers of the road in the best way. It can decide only according to the whim of the ruling government official, i.e., only if the government official, not the public, does the “consuming.” If the government wishes to do what is best for the public, it is faced with an impossible task.

Government can either deliberately subsidize 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.” This 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 solution, however? It is often stated that a single government enterprise, operating within the sphere of a private market, buying from it, etc., 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 what the government’s intentions.

What is this fatal flaw? It is the fact that government can obtain virtually unlimited resources by means of its coercive tax power. Private businesses must obtain their funds from investors. It is this allocation of funds by investors on the basis of time preference and foresight that 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 investors who are willing to risk investment of their saved funds in anticipation of profit. In short, payment and service are, once again, indissolubly linked on the market. Government, on the other hand, can get as much money as it likes. The free market provides a “mechanism” 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 such optimum use. Government, however, has no checkrein on itself, i.e., no requirement for meeting a profit-and-loss test of valued service to consumers, to enable it to obtain funds. Private enterprise can get funds only from satisfied, valuing customers and from investors guided by profits and losses. Government can get funds literally 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 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 answer never offered on the free market? The reason is that money must be withdrawn from some other use in consumption or investment—and this withdrawal must be justified. This 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 the government, which has no rational way to decide how much money to spend, either in total, or in each specific line. The more money it spends, the more service it can supply—but where to stop?1

Proponents of government enterprise may retort that the government could 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 flaws in this theory. First, 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 skill, to really adjust to consumer demands. They do not risk loss of their money in the enterprise. Secondly, aside from the question of incentives, even the most eager managers could not function as a business. 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. An arbitrary element has been “built into” the very vitals of the enterprise. Further, any future expenditures may be made out of tax funds, and therefore the decisions of the managers will be subject to the same flaw. The ease of obtaining money will inherently distort the operations of the government enterprise. Moreover, suppose the government “invests” in an enterprise, E. Either the free market, left alone, would also have invested the same amount in the selfsame enterprise, or it would not. If it would have, then the economy suffers at 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 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 inherent 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, if it wishes can drive 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 the 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 government enterprise opens, it generates fears in other industries that they will be next, and that they will be either 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.

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

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. Thus, it has little incentive to be efficient. 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.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—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.

A further reason for governmental inefficiency has been touched on already: that the personnel have no incentive to be efficient. In fact, the skills they will develop will not be the economic skills of production, but political skills—how to fawn on political superiors, how demagogically to attract the electorate, how to wield force most effectively. These skills are very different from the productive ones, and therefore different people will rise to the top in the government from those who succeed in the market.

It is particularly absurd to call for “business principles” where a government enterprise functions as a monopoly. Periodically, 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. In order to do so, the price must be raised high enough to achieve a monopoly price and thus cover the costs of 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 decrease them. An outstanding example has been the New York subway system in recent years, which has been raising its fares in a vain attempt to end its deficit, only to see passenger volume fall so drastically that the deficit increased even further after a time.

Many “criteria” have been offered by writers as guides for the pricing of government services. One criterion supports pricing according to “marginal cost.” However, this is hardly a criterion at all and rests on classical economic fallacies of price determination by costs. For one thing, “marginal” varies according to the period of time surveyed. Furthermore, costs are not static, but flexible; they change according to selling prices and hence cannot be used as a guide to those prices. Moreover, prices equal average costs—or rather, average costs equal prices—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 a similar operation on the free market.

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 (a) the government will decrease production and living standards in the society by siphoning off potentially productive labor to the bureaucracy; (b) in using confiscated funds, the government 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) through high, tax-supported wages the government may well mislead workers and unions into believing that this reflects the market wage in private industry, thereby causing unwanted unemployment.

Moreover, government enterprise, basing itself on coercion over the consumer, can hardly fail to substitute its own values for those of its customers. Hence, artificially standardized services of poorer quality—fashioned to governmental taste and convenience—will hold sway, in contrast to those of the free market, where diversified services of high quality are supplied to fit the varied tastes of a multitude of individuals.

One cartel or one firm could not own all the means of production in the economy, because it could not calculate prices and allocate factors in a rational manner. This is the reason why State socialism could not plan or allocate rationally either. In fact, even two or more stages could not be completely integrated vertically on the market, for total integration would eliminate a whole segment of the market and establish an island of calculational and allocational chaos, an island that would preclude optimal planning for profits and maximum satisfaction for the consumers.

In the case of simple government ownership, still another extension of this thesis unfolds. For each governmental firm introduces its own island of chaos into the economy; there is no need to wait for socialism for chaos to begin its work. No government enterprise can ever determine prices or costs or allocate factors or funds in a rational, welfare-maximizing manner. No government enterprise can be established on a “business basis” even if the desire were present. Thus, any government operation injects a point of chaos into the economy; and since all markets are interconnected in the economy, every governmental activity disrupts and distorts pricing, the allocation of factors, consumption/ investment ratios, etc. Every government enterprise not only lowers the social utilities of the consumers by forcing the allocation of funds to ends other than those desired by the public; it also lowers the utility of everyone (including, perhaps, the utilities of government officials) by distorting the market and spreading calculational chaos. The greater the extent of government ownership, of course, the more pronounced will this impact become.

Aside from its purely economic consequences, government ownership has another kind of impact on society: it necessarily substitutes conflict for the harmony of the free market. Since government service means service by one set of decision-makers, it comes to mean uniform service. The desires of all those forced, directly or indirectly, to pay for the government service cannot be satisfied. Only some forms of the service can or will be produced by the government agency. As a result, government enterprise creates enormous caste conflicts among the citizens, each of whom has a different idea on the best form of service.

In recent years, government schools in America have furnished a striking example of such conflicts. Some parents prefer racially segregated schools; others prefer integrated education. Some parents want their children taught socialism; others want antisocialist teaching in the schools. There is no way that government can resolve these conflicts. It can only impose the will of the majority (or a bureaucratic “interpretation” of it) by coercion and leave an often large minority dissatisfied and unhappy. Whichever type of school is chosen, some groups of parents will suffer. On the other hand, there is no such conflict on the free market, which provides any type of service demanded. On the market, those who want segregated or integrated, socialist or individualist schools can have their wants satisfied. It is obvious, therefore, that governmental, as opposed to private, provision of services, lowers the standard of living of much of the population.

The degrees of government ownership in the economy vary from one country to another, but in all countries the State has made sure that it owns the vital nerve centers, the command posts of the society. It has acquired compulsory monopoly ownership over these command posts, and it has always tried to convince the populace that private ownership and enterprise in these fields is simply and a priori impossible. We have seen, on the contrary, that every service can be supplied on the free market.

The vital command posts invariably owned monopolistically by the State are: (1) police and military protection; (2) judicial protection; (3) monopoly of the mint (and monopoly of defining money); (4) rivers and coastal seas; (5) urban streets and highways, and land generally (unused land, in addition to the power of eminent domain); and (6) the post office. The defense function is the one reserved most jealously by the State. It is vital to the State’s existence, for on its monopoly of force depends its ability to exact taxes from the citizens. If citizens were permitted privately owned courts and armies, then they would possess the means to defend themselves against invasive acts by the government as well as by private individuals. Control of the basic land resources—particularly transportation—is, of course, an excellent method of ensuring overall control. The post office has always been a very convenient tool for the inspection and prohibition of messages by heretics or enemies of the State. In recent years, the State has constantly sought to expand these outposts. Monopoly of the mint and of the definition of money (legal tender laws) has been used to achieve full control of the nation’s monetary system. This was one of the State’s most difficult tasks, since for centuries paper money was thoroughly distrusted by the people. Monopoly over the mint and the definition of monetary standards has led to the debasement of the coinage, a shift of monetary names from units of weight to meaningless terms, and the replacement of gold and silver by bank or government paper. At present, the State in nearly every country has achieved its major monetary goal: the ability to expand its revenue by inflating the currency at will. In the other areas—land and natural resources, transportation and communication—the State is more and more in control. Finally, another critical command post held, though not wholly monopolized by the State, is education. For government schooling permits influencing the youthful mind to accept the virtues of the government and of government intervention. In many countries, the government does not have a compulsory monopoly of schooling, but it approaches this ideal by compelling attendance of all children at either a government school or a private school approved or accredited by government. Compulsory attendance herds into the schools those who do not desire schooling and thus drives too many children into education. Too few youngsters remain in such competing fields as leisure, home study, and business employment.

One very curious governmental activity has grown enormously in the present century. Its great popularity is a notable indication of widespread popular ignorance of praxeological law. We are referring to what is called “social security” legislation. This system confiscates the income of the poorer wage earners and then presumes to invest the money more wisely than they could themselves, later paying out the money to them or their beneficiaries in their old age. Considered as “social insurance,” this is a typical example of government enterprise: there is no relation between premiums and benefits, both changing yearly under the impact of political pressures. On the free market, anyone who wishes to invest in an insurance annuity or in stocks or real estate may do so. Compelling everyone to transfer his funds to the government forces him to lose utility.

Thus, even on its face, it is difficult to understand the great popularity of the social security system. But the true nature of the operation differs greatly from its official image. For the government does not invest the funds it takes in taxes; it simply spends them, giving itself bonds, which must be later cashed when the benefits fall due. How will the cash then be obtained? Only from further taxes or inflation. Thus, the public must pay twice for “social security.” The social security program taxes twice for one payment; it is a device to permit palatable taxation of the lower-income groups by the government. And, as is true of all taxes, the proceeds go into governmental consumption.

In weighing the question of private or governmental ownership of any enterprise, then, one should keep in mind the following conclusions of our analysis:

1. every service can be supplied privately on the market;
2. private ownership will be more efficient in providing better quality of service at lower cost;
3. allocation of resources in a private enterprise will better satisfy consumer demands, while government enterprise will distort allocations and introduce islands of calculational chaos;
4. government ownership will repress private activity in noncompeting as well as competing firms;
5. private ownership insures the harmonious and co-operative satisfaction of desires, while government ownership creates caste conflict.

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1. Cf. Ludwig von Mises, Bureaucracy (New Haven: Yale University Press, 1944), pp. 50–53.

Author: Murray N. Rothbard made major contributions to economics, history, political philosophy, and legal theory. He combined Austrian economics with a fervent commitment to individual liberty.

Reprinted with permission from Mises.org.