Lesser-Known Economic Fallacies II

June 27, 2022
See Part I here.
It’s not uncommon for presidential candidates, especially those of a particular political persuasion, to tout their business experience, often claiming that they’ll “run government like a business.”
In an ancient blog post I recall reading but can no longer find, Paul Krugman torpedoed this idea but for all the wrong reasons. He noted that it’s “efficient” when a businessman can produce the same output with half the input.  But he argues that an economy-wide scenario like this would result in recession.  Evidently something that is efficient on a micro level becomes catastrophic for Krugman when the entire economy uses resources in more economizing fashion. In Krugman’s thinking, as the demands for those resources fall, the economy would hurdle towards the Keynesian unemployment equilibrium. Here, Krugman is invoking the confused idea of “idle resources.”
Running Government Like a Business
Many people sense there are errors in Krugman’s twisted logic, but mistakenly embrace the conclusion he discards. They intuit that a president with business experience is best because they expect him to run government agencies with the efficiency and consumer-minded zeal of business. They welcome the efficiency that Krugman deplores.
Alas, such an expectation is misplaced. All the business experience in the world is insufficient for government to replicate the efficiency of for-profit business.
The difference between government and business lies in the respective institutional environments within which decision-makers choose.
To see this clearly, it’s critical to understand what’s meant by “efficiency.” Krugman’s grasp of efficiency belies a technical understanding where a pre-determined task is achieved with the smallest physical number of inputs. However, this conception overlooks the critical question of what tasks ought to be undertaken in the first place.
There are an almost infinite number tasks that are technologically feasible (for example, sending people to Pluto). But only some of these tasks are economically feasible. Plan X being economically feasible means that pursuing Plan X won’t sacrifice the satisfaction of more intensely felt wants that could be satisfied by pursuing Plan Y. We could probably put a man on Pluto, but the majority of humanity would starve to death as a result.
Businesses actively pursue Plan X tasks—and only these tasks—and that’s precisely what makes them “efficient.” When a business earns a profit, that’s an indication that resources (inputs) have been bought at a low price and subsequently transformed into something that can be sold for a higher price. Consumers demonstrate by their willingness to pay for this product that resources have been used to satisfy an urgently felt want.
Business owners are “residual claimants” to what’s left over after a business has paid all its expenses, which is what provides the incentive for them to pursue Plan X projects. No business would earn profits (right now) by attempting to put a man on Pluto. That attempt would be met with massive economic losses. These losses would indicate that our firm has devoted society’s scarce resources to the pursuit of a plan that consumers do not value sufficiently to justify the use of those resources in this plan.
Not only do they think about which plans to accomplish, but business owners also have an incentive to think about the least-cost ways of accomplishing the tasks they believe will yield a profit. Should they make railroad tracks out of platinum, iron, or some other material? Should they produce bottled water synthetically (technologically feasible) or by cupping their hands in a stream or something in between (all technologically feasible)? These seem like silly questions, but that’s only because we have access to prices which inform us of the costliness of producing water in factories or making railroad tracks out of platinum.
Government bureaus—the public analogue to firms— must also determine what projects to pursue and how to pursue them. But their output isn’t traded in markets so while they can provide answers to both questions, those answers won’t be tightly tied to what consumers value.
Should the police patrol First Street or Main Street (when? how many officers?) Should your municipal police department hire one officer for every 100 citizens or one for every 500 citizens? (Or should every member of society have their own bodyguard?) Should the department’s cars trade off more crashworthiness to purchase more speed? And on and on.
Without prices—generated by consumers’ buying and abstention from buying—there are no non-arbitrary answers to these questions. Government bureaus don’t know which plans will create the most value, and when they do decide on a plan (patrol First Street), they don’t know how to do it in an economic fashion. That is, in a way that ensures they aren’t sacrificing the satisfaction of more important ends.
This argument has nothing at all to do with public servants being “bad people” or less intelligent than their private sector counterparts. In fact, the argument turns on exactly the opposite assumption, one of “behavioral symmetry,” that people are people, but that they find themselves making choices in different institutional contexts.
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Public bureaus can’t rely on profit-and-loss feedback, which is why they instead select other arbitrary “targets” to assess success or failure. To stick with the police bureau analogy, the head of the bureau might evaluate performance based on the number of stops or arrests performed. But do consumers value the resources devoted to more resources enough to justify their opportunity cost? Impossible to say.
This gets to the heart of why business experience for the president—or the manager of any government bureau—is next to irrelevant. Entrepreneurs earn profits or losses based on how well they answer the “what to produce?” and “how to produce it?” questions. The heads of government agencies increase their wealth by demonstrating to the relevant legislative assembly a need for funds—though that is a story for another time.
What is key here is that government bureaus’ wealth does not vary with their success in arranging production in a way that best satisfies consumer preferences. In fact, it cannot because bureaus do not sell their outputs in markets; instead, they “provide” it to the public, regardless of the public’s demands. Additionally, outside investors cannot buy a government agency’s assets and put them to use in a different line of production.
These considerations are precisely why the most consumer-minded “businessman-president” will find himself attempting to rudderless ship. It’s why a president with business experience may mean nothing at all.
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