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Bureaucracy, Productivity, and Inflation

Mr. Isaacs is research economist with the American Institute for Economic Research, Great Barrington, Massachusetts. The views expressed here are his own.

What is wrong with this country? American-made products, once the world standard for superior workmanship and quality, are now regarded as “cheap and inferior.” Many American workers are grumbling and demanding more benefits, longer coffee breaks, and a voice in company affairs. Managers on the other hand often complain that today’s workers are less competent, dependable, and motivated than 10 or 20 years ago. Poor job performance, chronic absenteeism and theft of company equipment plague many domestic firms. Workers are now paid more than ever before (the average wage for a nonagricultural industrial worker during October 1981 was a record $258.55 a week) and yet, American workers are still unhappy. Money no longer seems to motivate, and traditional managerial methods no longer seem to be effective. It seems, from the perspective of the business world, that things are really falling apart. On the surface it appears the Protestant work ethic, with its traditional virtues of hard work and thrift, does not apply to the “complex modern world.”

In the past few years, an increasing amount of media attention has been focused on this latest domestic problem. Management experts, politicians, and other “opinion leaders” who professionally ponder and write about these momentous issues, have officially dubbed this the great “productivity crisis.” One common characteristic of the “crisis” literature produced by these authors is that it usually manages to trace the source of the problem to some anti-social group or some strange mass metaphysical affliction. When they are not blaming society as a whole these thinkers often blame inferior private sector management. Some claim it is the fault of greedy labor unions, others say it is the “new values” of the baby-boom generation, and a few attribute the problem to a lack of knowledge of Japanese management techniques. The solution, say these writers, must be found; it is an issue of “national pride,” and a problem that only a bigger federal government can solve.

Two Types of Management

This productivity problem that has recently received such wide media attention is not due to society, inferior private sector management, unions, “baby-boom” generation value shifts, or ignorance of Japanese culture. As interesting as these theories are, perhaps in their efforts to assign blame, these “crisis” experts have missed the main problem: the insurmountable problem of trying to manage, produce, and market goods in an economic environment polluted by the government’s depreciating fiat currency. To understand the ramifications of this, and its link to the “productivity problem,” we must examine two basic terms employed by Ludwig von Mises in his 1944 book, Bureaucracy. These terms are: profit management and bureaucratic management.

Ludwig von Mises described profit management as that form of management directed by the profit motive and measured by economic calculation. Economic calculation via the double-entry bookkeeping system is the device profit managers use to allocate scarce resources and to make rational business decisions. In an unhampered market economy, the objective of every manager is to direct production to achieve a profit and avoid a loss. Entrepreneurs hire managers (a specialized form of labor) for this expressed purpose. Economic calculation, measured in terms of money (the common medium of exchange) provides a standard unity of objective for the endless variety of private-sector firms found in a free economy. Employees of business ventures are clearly aware of this basically simple objective, i.e., “to make money.” Accounting records are kept in these standard units of exchange. These records provide profit managers with detailed information as to which area, or departments of the firm are in need of labor or capital reallocation. In this way, errors, which will occur in any human system, will be corrected early in the production process and inefficiency is thereby minimized.

Furthermore, because economic calculation is so precise, outstanding managers, employees, and departments can be directly and individually rewarded for their superior performance and hard work. Economic calculation also enables managers to identify individuals that are not performing up to expectations. Once identified, these individuals can be specially motivated, replaced, or transferred, depending on managerial discretion. This emphasis on direct reward for individual performance is the special and unique attribute of the profit management system. Therefore, because merit alone is the measure of each individual, and because labor is a scarce resource, sexism, discrimination, nepotism, and other employment evils commonly found in economic systems where profit management is suppressed, become a costly luxury few firms could afford.

Unchecked Bureaucratic Management

Ludwig von Mises described bureaucratic management as that form of management that cannot be measured and checked by economic calculation. In the private sector, profit managers must generate all revenues in voluntary transactions with free-willed consumers. Management decisions are directly linked to profit and loss figures. A bad management decision will be reflected as a decline in revenues. This direct relationship between satisfying consumer needs and the generation of revenues keeps profit managers “in tune” with their customers.

In the public sector, however, this direct relationship between serving consumer needs and sources of revenue does not exist. Governments are political organizations of coercion. When governments need money, they do not offer goods and services to the public in return for voluntary contributions. Governments generate revenues by levying taxes on the private- productive sector. In other words, public-sector revenues are derived by involuntary means, and are not linked in any way to positive performance or servicing consumer needs. As a result, the achievements and blunders of bureaucratic management are independent of monetary incentive and disincentive. Bureaucratic management decisions are therefore not restricted by “petty” consumer demands. In the public sector, the whims of political action displace economic calculation.

Since bureaucratic managers do not have the benefit of economic calculation as do their fellow private sector managers, public administration can never hope to be as efficient as the private sector management. In fact, it is hopeless to expect the public sector to even approach private sector efficiency levels. To manage at all, public administrators are forced to employ inferior non-monetary managerial methods. These methods are inferior for many reasons, but the most glaring is that the direct link between performance and revenue sources has been severed.

Performance of public employees can not be measured in precise monetary terms, so subjective yardsticks like peer review or political judgment must be used instead. These methods are inferior because subjective standards of measurement vary from manager to manager and from bureau to bureau. It is not surprising then to see how at times these non-monetary “standards” can clash and cause conflicts between various bureaus or departments.

In the public sector, because the concrete measuring mechanism of economic calculation is missing, inefficiency becomes chronic, and limited resources are wasted keeping tabs on various non-monetary standards. Red tape chokes the system, and corruption becomes rampant. Administrative costs grow unchecked, and errors go undetected and are compounded.

The Anarchy of Central Planning

Despite reams of historical evidence documenting the total impossibility of a successful non- monetary management method, the quest for the “ideal” non-monetary method continues unabated. Socialist and interventionist academics are experts at producing elaborate non- monetary schemes that attempt to manage and allocate resources. During the past 150 years, socialists of all parties have produced literally hundreds of various schemes that exclude economic calculation and replace it with a variety of more “humane” methods such as central planning by elite bureaucrats working in the “public interest.” Indeed, this is the very cornerstone of socialist theory, to rid the world of despised money and the social evils it allegedly causes. The problem is, once money has been destroyed, nothing remains but the anarchy of central planning to fill the void.

So what does bureaucratic management, and profit management, have to do with the so-called productivity problem in America today? Everything! Consider this. In 1944 Ludwig von Mises wrote “Bureaucratic management is the only alternative available where there is no profit and loss management.” The problem with productivity in America today is that the private sector has become bureaucratic. The private sector has become bureaucratic not because of some natural tendency of capitalism to form giant inefficient monopolies (as some interventionists have charged). Rather, the private sector has become bureaucratic in reaction to years of systematic governmental intervention. Government intervention of course takes many forms, but the form we are concerned with here is inflationism.

Profit management presupposes sound money. Sound money is the yardstick profit managers use to perform their economic calculations. Inflation (an increase in the quantity of money) alters this yardstick. Money no longer is a standard unit of value, but instead a flexible unit; controlled by political forces, it can rapidly depreciate over short periods of time.

Inflation alters the real profits and losses of a firm. Profits are overstated, which attracts greater amounts of capital, which is then malinvested by misinformed managers. Depreciation figures tend to be understated, and capital accumulation is retarded or eroded. The private sector’s double-entry bookkeeping system is basically crippled. Accounting data become so blurred that rational economic calculation becomes merely a business school theory. Inflation then is more than just an attack on sound money, it is an attack on profit management itself. For without economic calculation, profit managers are no better off than their hapless public sector counterparts who are forced to blindly manage and measure the bureaucracy by non-monetary methods.

Real Earnings Decline

Let’s restate the basic problem once again: (1) workers are unhappy, (2) money no longer seems to motivate, (3) job performance is poor, (4) absenteeism is ‘chronic, and (5) younger employees seem to have abandoned traditional values. As we stated above, workers are paid more now than ever before. On the surface, it would appear that today’s workers have adopted new values and goals. This record wage figure however, is in current or nominal dollar units. When inflation is factored out, and average wages are measured in constant or real dollar terms (in this case 1967 dollars), a very different picture emerges.

The Department of Labor, Bureau of Labor Statistics, reported that during November 1972, the real weekly earnings of an average private nonagricultural worker was $110.22. This figure reported for November 1972 is significant because this was and still is the record for this series. Since November 1972, the average nonagricultural worker has taken a cut in real wages virtually every month. By October 1981, the average nonagricultural worker in real dollars earned only $92.41 a week. Today’s average worker then, earns $17.81 less in real dollars per week than he did during November 1972 for doing basically the same job!

This category is perhaps too general, because, of course, not every worker or employee fits into the “average.” But, during this period, almost every profession or job class has been affected by similar cuts in real wage rates. U.S. News and World Report recently cited several specific occupations whose real wages have been cut by inflation. U.S. News reported the average salaried lawyer suffered a 4.4 per cent loss in earnings between 1971 and 1981, the average journeyman engineer earned 7.5 per cent less between 1971 and 1981 and a mid-level accountant lost 5.2 per cent in real earning power during the same period. The point here is that average real American wages in the private sector are less than they were ten years ago. This means most people in most occupations are worse off financially than in 1972.

How Workers Respond

Individual workers react in different ways to these cuts in real incomes. Some complain, or some stay home more; they figure “What’s the sense in working when my money is worth less anyway.” Some workers no longer care, so they do sloppy work on the job. When inflation destroys their real incomes, employees adjust to new compensation conditions over time. “Minimum work for minimum pay” replaces honest work for honest pay. Money no longer seems to motivate because many employees have realized they are no longer paid in real money.

When real wages decline, underpaid workers feel stuck, exploited and used by their employers. (This is beneficial to union organizers.) Morale suffers, and worker discontent further disrupts production. Values have not shifted, as some writers suggest; today’s workers are rationally reacting to new market conditions just as their forefathers would have done. As in the past, today’s workers are merely substituting a more satisfactory state of affairs (leisure) for a less satisfactory one(declining wages). This is basically the productivity problem from the labor point of view.

In an inflationary business environment, behavior of profit managers also changes. Because of the destruction of economic calculation by the government’s inflationist policies the private sector is forced to employ non-monetary management methods in an effort to keep the wheels of production rolling. This is why Japanese management (Theory Z), management by objective, worker self-management, and other such non-monetary schemes are so popular in the private sector today. These methods are popular not because they are superior or more efficient, but because they are the only alternatives. When sound money has been destroyed, profit management and efficiency are destroyed along with it.

In closing, we should recall the words of Ludwig von Mises. In Human Action Mises wrote, “For more than a hundred years the substitution of socialist planning for private enterprise has been the main political issue.” The issue here is not “productivity,” but a continuation of this “planning” assault on the private sector, via depreciation of currency. Unless sound money and economic calculation are restored, “America’s great productivity problem” can only further deteriorate.

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