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Tuesday, August 23, 2011

Government, So Five Years Ago!

Government is inherently bureaucratic.

I saw this story about an ambitious public infrastructure project near my home town in Arizona:

Gray metal devices the size of small microwave ovens cling to light poles in Tempe and Chandler. There are about 1,400 of them. And they don’t do anything. The devices are remnants of outdated technology and a visionary service that began with big promise but fizzled in early 2008. They came before smartphones, iPads and 4g networks and are so 2006.

Being able to connect your laptop to the Internet wirelessly on a citywide or even regional basis was the wave of the future – five years ago. All you needed was a $4 million investment and a private partner. If ever there were a surefire “shovel ready” infrastructure project that our elected officials believed could extend into the foreseeable future, this was it. The problem is, the future is very hard to foresee.

In this case, the project lasted two years. Then everyone starting buying iPhones and iPads and Droids and – poof! – all of a sudden you don’t need a laptop anymore to access the New York Times or email or Facebook. The superfluous Wi-Fi devices today have zero scrap value.

All people, of course, have to try to predict the future to one degree of another, or their lives would be chaotic. To paraphrase Milton Friedman: Planning, whether each of us for ourselves or for someone we know intimately, is necessary and good, even when this is done a large scale. Planning for strangers with one’s own money, or especially with other people’s money, is very questionable. And when it’s done on a very large scale, it’s very, very questionable. The amount in this case, $4 million, is a pittance and came from private sources. As we all know, however, governments at the local, state, and national levels do spend much larger sums of tax money, and the basic problem is the same.

But is the Tempe/Chandler fiasco an isolated incident? Doesn’t the same problem plague private investments too? The future is inherently unknowable, and everyone makes mistakes, so there’s no getting around this problem, I’m afraid. What can we do?

Three Things

Three things at least. First, try to minimize the cost of the errors that you do make. Second, learn from your mistakes and adjust for the future. And third — this is probably the most important — become aware that you’ve made a mistake. The beauty of the free market is that it creates incentives to do all three.

When planning an investment in your business, you want to achieve a certain goal without spending any more than you have to. But you’re also aware that the contractor you planned on hiring may not be available. So beforehand you try to take into account as many contingencies as you deem relevant, as long as this itself doesn’t cost too much. If you do plan appropriately for contractors and such, but you don’t account for higher-than-expected labor costs, next time you have an incentive to do so — again, as long as it doesn’t cost too much. Finally, if you’re not making as much profit as you could be – say you’re charging too much so that potential customers go elsewhere – it’s costing you and you have an incentive to notice it. But just as important, your competitors have a strong incentive to notice it, too, and to respond by underpricing you and making sure the business you’re not getting is going to them.

The problem with government projects, even those that partner with a private investor, is that they dampen these incentives. It’s likely the Wi-Fi scheme in the story ended so abruptly because a private company did most of the financing and operation. That was lucky.

Bureaucratic Management

Limited-government libertarians believe that government should only do those things that on net promote the general welfare and that could not be done voluntarily. These tend to be very big projects such as national defense because large-scale financing is usually the main problem; and they tend to be a monopoly ultimately under the control of government at some level.

Ludwig von Mises explains in his book Bureaucracy that the management of government programs, even when they meet the limited-government libertarian’s criteria, is inescapably “bureaucratic management.” The central feature of bureaucratic management is rule-following, while the central feature of management in the free market is profit-seeking. The difference is profound. Managing for profit, ipso facto, is done to minimize cost and to discover new opportunities. Even a private monopoly with market power, which restricts output below what consumers are willing to pay for, would still seek new markets and to minimize production costs.

In contrast, bureaucratic management, precisely because it’s used in cases where the private costs would exceed private benefits (otherwise private firms not government would undertake them), is inherently inefficient. Or more precisely, the criterion of efficiency does not even apply. If it were possible in principle to measure costs against benefits, then private firms would do it. But since it’s not, government should do it. And because it faces no close competition, it has less of an incentive to innovate.

The bottom line is that when it comes to government programs justified under the limited-government approach, it’s not reasonable to expect them to be efficient or innovative. That’s one reason for limiting government to those particular activities. Indulge me while I make a another subtle but important point.

A Happy or Not-So-Happy Coincidence

Bureaucratic management is neither efficient nor inefficient so long as government is doing only those things that the limited-government criterion says it should. This is a sort of “happy” coincidence because people who are working in government bureaucracies don’t really have an incentive to be efficient anyway. And that’s because they operate under a “soft budget constraint”: The revenues for the agency don’t come from sales (otherwise a private firm could do it) but rather ultimately from the taxing power of the State. So if the agency makes losses, even for a very long time, there is little incentive to reduce costs or even to realize improvement is possible.

Now this situation becomes much less “happy” when the government moves into areas that a private firm could handle. If the government were to start a restaurant chain, for example, pretty much the same lack of incentives would operate as before. (We’ve seen this, for example, with the post office.) But because a restaurant business can measure costs and benefits, it’s possible to say whether the government restaurant is more or less efficient than a private one. And it would most probably be less efficient because of the lack of incentives mentioned earlier.

Again, although private firms aren’t perfect either, they have a far greater incentive to minimize costs, learn from mistakes, and discover errors.

Limited Government Is Bureaucratic Too

If you believe that government has any legitimate role in society at all, you will have to rely on bureaucracy. There’s the obvious question of how, if such cost-measurement is not possible, we could ever really know if government, minimal or not, ever promotes the general welfare. I doubt that we can tell (which is why I lean more toward the anarchist end of the libertarian spectrum).

In the meantime, I will endorse what Mises says in Bureaucracy: “What people resent is not bureaucratism as such, but the intrusion of bureaucracy into all spheres of human life and activity.” These days things change quickly, and you’ve got to be pretty light on your feet. That’s just not bureaucracy.

  • Sanford Ikeda is a Professor and the Coordinator of the Economics Program at Purchase College of the State University of New York and a Visiting Scholar and Research Associate at New York University. He is a member of the FEE Faculty Network.