Public Policy and the Free Economy

Taxpayers in the United States, Great Britain, and several other democratic countries have become increasingly disenchanted with the unfulfilled promises of governments, the burdens of taxation and inflation, and the loss of individual freedom which public sector expansion has generated. New constitutional and statutory restrictions on governmental taxing and spending powers have been imposed in the U.S. and both Ronald Reagan and Margaret Thatcher were elected on platforms which called for a relative reduction in the size and scope of government and the encouragement of free enterprise. But a dangerous scenario is being constructed in the U.S. and the U.K.

Entrenched government bureaucracies along with labor unions and other powerful interest groups have prohibited any significant reductions in government spending, and the basic government regulatory institutions which have placed such heavy burdens on the private econ omies of the U.S. and Great Britain remain largely intact. Left-leaning politicians now publicly express a desire for higher inflation and unemployment which they hope will help to restore their political power, and the media routinely reports, incorrectly, that both the Thatcher and Reagan economic platforms have been implemented, and have failed. The danger in this situation lies in the fact that it is customary to hold the chief executive responsible for the health of a nation’s economy, regardless of what the causes of current economic problems might be.

The problems of inflation and unemployment, which are primarily caused by past government interventions in the market economy, are being widely sold as the direct result of policies which encourage free enterprise and attempt to restore incentives to work and invest. It is therefore of utmost importance to set the record straight, to clarify this issue, and to strengthen public support for the free economy. This paper attempts to make a contribution toward that end by discussing the virtues of the free economy. A major theme of the paper is that in the (free) market economy individuals, acting in their own self-interests, are induced by the spontaneous forces of the market to act in ways which serve to maximize social welfare; by contrast, it is shown how government control over the allocation of resources redirects the forces of rational self-interest in a way that allows elite groups within government to impose forcefully their will upon others, which in turn causes a reduction in wealth and in individual welfare.

The Sovereignty of the Consumer

In the market economy the production and distribution of goods and services is determined by the decisions of entrepreneurs, and this fact has generated much wrath on the part of many members of society, especially intellectuals, and especially those in the social sciences and the humanities. Entrepreneurs are often portrayed as being hard hearted and callous, and responsible to no one. But in the free economy they are not.

Economic affairs in the market economy may be directed by entrepreneurs, but consumers are the ultimate decision-makers. Consumers determine what is produced and, as Mises has said, it is they who “. . . in their capacity as buyers and consumers . . . are hard hearted and callous without consideration for other people.”[1] That is, consumers patronize those who can offer the highest quality products for the lowest prices. Those who do not meet the demands of consumers will suffer losses or go bankrupt and will therefore be removed from their “positions of eminence,” while those who cater to the desires of consumers will be rewarded with profits. Both the carrot of reward and the stick of punishment (for ignoring consumers’ preferences) contribute to the success of the market economy.

Not only are entrepreneurs induced by the market to satisfy consumers’ preferences for goods and services, but they are also motivated to provide goods and services at the least possible cost, for in a competitive economy those who fail to do so will not survive. Entrepreneurs who do not make the best use of available time, knowledge, and resources bear the risk of bankruptcy or, alternatively, of being replaced by “takeover raiders” via the market for corporate control. There always exist enterprising individuals who are willing to take over, through stock purchases, private enterprises that do not adequately meet the demands of consumers, for the substitution of more efficient for less efficient management promises the reward of higher profits. Those opposed to corporate takeovers would have us abolish the market for corporate control, but fail to acknowledge the damage such restrictions would inflict upon the consumer. Arguments against the market for corporate control thus appear to be nothing other than disguised protectionism.

How the Market Functions

In the market economy the consumer determines not only the pattern of prices and production, but also the distribution of income. That is, the consumer ultimately pays the wages of all workers, whether they be professional athletes or street vendors. The greater the consumer demand for a good or service, the more an employer will be willing to pay the worker who can produce the product, as long as labor markets are competitive.

The employer who pays his employees less than their marginal contribution to the firm’s profits will not do well and may very well fail. The baseball team owner, for example, who pays gifted, star athletes the salary of a college professor will most likely bear the burden of a poor record and consequently, lower profits. The same can be said for the management of steel mills, textile plants, grocery stores and all other private enterprises. Thus, in a free economy one’s income depends upon one’s ability to satisfy consumers. It is in this way that the spontaneous forces of the market serve to maximize individual welfare.

The Hazards of Consumer Protectionism

The virtues of the free economy are amplified once they’re compared directly to the vices of interventionism, and an appropriate starting point is the example of “consumer protection regulation” which is quite prevalent in the U.S. and exists in most other industrialized democratic countries as well.

The federal government is intimately involved in the regulation of trade in the U.S., and has been ever since such muckrakers as Upton Sinclair (author of The Jungle), Ralph Nader, and Senator Estes Kefauver (whose investigations of the drug industry led to the expanded powers of the Food and Drug Administration) began attacking the quality of products manufactured by private producers. Self-appointed “protectors” of the consumer now staff hundreds of government agencies, and under the guise of consumer protection perform tasks which unequivocally make the consumer worse off, as can be illustrated by the example of the Consumer Product Safety Commission, which serves as a prototype for scores of other “consumer protection agencies.”

The Commission is mandated to perform a task it cannot possibly achieve- “to protect the public against unreasonable risks of injury from consumer products . . .” Its authority covers “any article produced or distributed except for certain items already regulated by other government agencies.” The objective of safer products is desirable, but the important question is: At what cost and by whose standards? A safer automobile which is slower, heavier, and more expensive than others may have some advantages, but how can a government bureaucrat possibly know how much safety individual consumers are willing to trade off for speed and lower prices? Besides, it is not clear that “safer” vehicles cause fewer accidents. It may be true that safer vehicles induce carelessness by drivers which leads to more accidents which are mainly caused, after all, by human error. The governmental banning of various “dangerous” products deprives the consumer the right to make the relevant tradeoffs, which only he can make, and therefore reduces his welfare.

A rather blatant example of how the “consumer protectionist mentality” has gone to extremes is the appearance of the recently dethroned director of the National Highway Transportation Safety Administration on a popular television program. The ex-director was accompanied by a masked man with a sledge hammer and an automobile produced by a private engineering firm, employed by the government, which was allegedly crash-proof. After observing the masked man fail to dent the automobile with the sledge hammer, the ex-director opined how wonderful it would be if the government were to require all automobiles to be just as sturdy. When pressed by a member of the audience, the ex-director reluctantly stated that the cost of such a car is approximately $200,000—hardly a price which would “protect” the consumer. Only freedom of choice, and only a free market economy is capable of accomplishing that task. So-called consumer protectionism is merely a way of forcefully substituting the will of a few non-elected government bureaucrats for that of the general public.

Product Information and the Free Economy

There are many who claim that private advertising is misleading, and induces consumers to purchase things they would not otherwise purchase. Therefore, so it is claimed, advertising should be controlled or regulated by government, if not abolished, in order to avoid “consumer exploitation.” But how can a consumer be exploited if he voluntarily purchases one brand of say, toothpaste over another? As long as advertising is competitive, and the consumer is free to compare and contrast the competing claims of advertisers, it is impossible for him to be “exploited.” In fact, quite the opposite is true.

It is the absence of advertising which is detrimental to the consumer, since one of the major reasons for advertising is to publicize price and product quality. Take, for example, the case of law firms in the U.S. which until recently were banned from advertising. Such a ban on advertising is nothing more than special interest legislation which benefited existing, established law firms at the time the legislation was put into effect, to the detriment of newer firms and consumers. The older, established firms had little need to advertise the price and quality of their product, for their reputations had already been established, and the most prominent members of the legal profession are much sought after by these firms not only for their skills, but also for the right to place their names on the firm’s letterhead to send out the desired market signal.

Newer, less established firms who must compete with the more experienced firms must do so by offering a “quality” product at a competitive (lower) price. The ability to advertise lower prices is one way to, induce consumers to make use of their services. After all, many consumers would prefer not to have “Cadillac quality” legal services at Cadillac prices, but would prefer a wider range of choice. Bans on advertising preclude the consumer from making any such choices and therefore allow the established firms to charge higher prices than otherwise.

As another contemporary exam-pie, it is difficult to believe that one of the largest hotel/motel chains in America is actively lobbying against roadside advertising “for the purpose of enhancing the beauty of the environment” rather than a desire to stifle price competition from less well- known hotel chains.

In sum, the idea that consumers can be led by the nose by advertising has been proven false time and again. Regardless of how much Ford Motor Company advertises another “Ed-sel” automobile, it won’t sell. As economist Harold Demsetz of UCLA has found, the profit maximizing firm will find it more sensible to first find out what consumers want, and then produce and advertise it. Surely, this would be more lucrative than spending millions trying to convince consumers to buy green wigs or lead tennis balls.

The Price System

As the Friedmans have said, the key insight to Adam Smith’s Wealth of Nations is misleadingly simple and, unfortunately, widely misunderstood: In a free market economy, voluntary exchange will not take place between two parties unless both believe they will benefit from it.[2] It is not true that one party can benefit only at the expense of another or that, in international trade, firms in one country benefit at the expense of those in another. Free trade is mutually advantageous. This insight is obvious when one considers trade between two individuals, but it is more difficult to understand how people living all over the world can cooperate to promote their own interests. It is the price system which accomplishes this task in a market economy, without any need for central direction of prices or production by the coercive powers of the state. Thus, Adam Smith’s crowning achievement was to recognize that the prices which emerge from the voluntary transactions between buyers and sellers in a free market could coordinate the activities of millions of people in a way in which everyone, acting in his own self-interest, is made better off.

Two major functions of the price system are to transmit information and to provide incentives to adopt least-cost methods of production. Consider the effects of say, an increase in the consumer demand for bicycles. Retailers will find that they are selling more bicycles and that consumers are willing to pay more for them. They will therefore order more from wholesalers who in turn will order more from manufacturers. Manufacturers will order more steel, rubber, chrome, plastic, and all the other materials used to produce bicycles. In order to induce the sup pliers of these inputs to produce more, manufacturers will have to offer higher prices. The higher prices induce input suppliers to employ more people to meet the increased demand. To do so will require that they offer higher wages or fringe benefits or better working conditions. Thus, in this way the price system transmits the message that there has been an increased demand for bicycles and that consumers now prefer the additional use of resources to produce them. There is no need for any one person or agency to “coordinate” any or all of the above activities. Such an effort would indeed be fruitless, since no one individual or group of computer programmers could possibly gather and use all of the relevant information.

Information Flows Both Ways

Prices not only transmit information from consumers to retailers, wholesalers, manufacturers and resource owners; they also do the opposite. For example, if for some reason imports of rubber into the U.S. were reduced or cut off, the reduced supply would increase the price of rubber and of all rubber products. It will not pay to produce as many bicycles as before. The smaller supply of bicycles will increase the price which will inform consumers to take better care of their bicycles and to keep them longer or to consider alternative forms of recreation.

Any governmental controls which prohibit prices from expressing changes in supply and demand conditions stifle the dissemination of important information. For exam-pie, price ceilings placed on oil and other fuels in the U.S. prohibited information about the effects of the OPEC cartel from being conveyed to producers and consumers. Price ceilings on oil artificially stimulated the demand for oil and gas and reduced supply, creating shortages which were compensated for by increasing imports even more. Because of price controls, the real price of gasoline actually fell from November 1973 to May 1979, which conveyed to consumers the message that gasoline had not become more scarce, and that it was not worthwhile to conserve more energy than previously. The automobile industry, in responding to the demands of American consumers, did not significantly increase production of smaller, more fuel-efficient cars.

Now that the real price of gasoline has risen since the controls have been lifted, the auto industry finds itself at a severe competitive disadvantage in international competition. American consumers were also forced, because of price controls, to finance through taxes the activities of a Department of Energy which spent about $10 billion in 1979, employed 20,000 people, and admits (optimistically) to having no positive effect on energy problems.

A further virtue of the market economy is that the price system provides producers with incentives to seek the most efficient means of production—those means which use the least resources, leaving more resources for other uses. For example, there are literally thousands of different types or grades of steel. When the supply of one type of steel is curtailed, which raises its price relative to others, producers of automobiles and other products will substitute the less costly types of steel. Reducing the cost of production enables the producer to increase the gap be tween revenues and costs. Any governmental controls over the prices of factors of production—via minimum wage laws, by trade unions, taxes, subsidies—distorts information transmitted by the price system and makes it impossible to discover least-cost production techniques.

Consumer Sovereignty vs. Politician’s Sovereignty

In the market economy consumers are said to “vote with their dollars.” Unlike the political market place, where one level of output is provided to all, producers provide different amounts of goods and services to consumers, depending on their income and preferences. Those who are willing and able to pay can consume all they want at the existing market prices and, as described above, the production and distribution of goods and services is dictated by the wishes of consumers.

There are many, of course, who are dissatisfied with the way in which the free market allocates resources. Among the most frequently cited objections are that the market generates “inequities,” does not sufficiently protect “the poor,” is based on greed (read the profit motive) rather than selflessness, and leads to shortsighted outcomes which lack long-range perspectives. As a result of these alleged problems, so the interventionists argue, there is a need for greater political control of the allocation of resources by those who are wise enough, selfless enough, farsighted enough, and sufficiently egalitarian to correct these problems. In short, according to this view, social problems are best dealt with by a delegation of benevolent and omniscient despots, if any can be found. This is a caricature of the conventional view of public policy in the U.S. and in many other democratic countries, and illustrates the dominant themes of the “public ad ministration” literature from Confucius and Plato to Woodrow Wilson and their contemporaries.

Failures of Intervention

The miserable failures of governments to effectively deal with the problems of poverty, the low quality of primary and secondary education, energy, housing, and so on are usually explained in terms of the personal attributes of politicians and bureaucrats: They are evil or stupid, lack sufficient authority and funding, or lack sufficient information. The problems of social policy are then merely a matter of selecting sufficiently wise and benevolent despots and giving them power and knowledge. But the harsh lessons of recent history have shown that good men do not guarantee good government.

It is most unfortunate that much of the American public has become enchanted with the “Platonian” view of government intervention and seems to have forgotten the important principles upon which the federal constitution was based. Namely, the authors of the Federalist Papers were concerned with giving government enough power to carry out its responsibilities, but not so much power that the rights of individuals would be infringed. They held that one cannot control the excesses of government by merely electing the “right” people, as the following statement by James Madison illustrates.

It is in vain to say that enlightened statesmen will be able to adjust these clashing interests and render them all subservient to the public good. Enlightened statesmen will not always be at the helm . . . We well know that neither moral nor religious motives can be relied on as an adequate control.[3]

Alexander Hamilton was also reluctant to rely on the innate goodness of man, for to do so

. . . would be to forget that men are ambitious, vindictive, and rapacious . . . Has it not, on the contrary, invariably been found that momentary passions, and immediate interests, have a more active and imperious control over human conduct than general or remote considerations of policy, utility, or justice?[4]

Because of these views, the framers of the Constitution were careful to adopt institutional arrangements which would constrain the coercive powers of government, for as Madison argued,

. . . what is government itself but the greatest of all reflections on human nature? If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary.[5]

In reflecting upon the secular growth of governmental powers in the U.S. a contemporary student of constitutional reform, James Buchanan, has further observed,

Politicians are politicians because they want to be. They are no more robots than other men. Yet the politician who would do nothing other than reflect the preferences of his constituents would, in fact, be robotlike in his behavior. Few, if any, politicians are so restricted. They seek office because they seek “profit,” in the form of “political income,” which will normally be obtained only if their behavior is not fully in accord with the desires of electoral majorities. Those men who are attracted to politics as a profession are likely to be precisely those who have considerable interest in promoting their own version of good government, along with those who see the opportunities for direct and indirect bribes, and those who evaluate political office as a means toward other ends.[6]

Political Control

Thus, it has long been recognized that when political resource allocation replaces the market allocation of resources, the results are not likely to be either equitable or efficient, unless by sheer accident. How resources are allocated depends largely on the different opportunities for “political profit” which alternative allocations present to the political decision-maker, for politicians, like all other human beings, act so as to pursue their own self-interests. Consumers’ sovereignty is replaced by the sovereignty of the politician/ bureaucrat, and the two often do not coincide. Consumer demand no longer determines the pattern of production and distribution. Instead, an individual or group’s ability to receive goods and services depends not only on their ability to “compete with their dollars,” but on other forms of competition as well, which are expressed through political power and influence, violence, and various forms of bureaucratic manipulation.

Political resource allocation, consequently, often entails effects which most would consider perverse and inequitable. As one example, consider the decision made by the U.S. Congress in 1949 to grant the government a greater role in the provision of housing by embarking on a program of “housing and urban renewal” which was aimed at providing benefits for the poor. In the early history of urban renewal the evidence clearly shows that more housing for the poor was demolished than was replaced. Between 1949 and 1963 the 106 completed urban renewal projects had demolished about twice as many units as were replaced, and only 8 percent of the replacement units were in public housing where “the poor” could gain access.[7] Evidently, middle and upper income groups are not only better able to vote with their dollars than are the poor, but are also more politically influential and have been major beneficiaries, along with government administrators, of the many urban renewal programs in the U.S. Similar outcomes have resulted from government interventions in the areas of energy, education, welfare, and so on.

The inequities which often stem from political resource allocation are made more clear when one observes resource allocation in nondemocratic, or socialist countries such as the Soviet Union where those in power, along with their families and friends, are at the top of the income scale, while in the name of “egalitarianism,” nearly everyone else is put in his place at the bottom, and is kept there by threat of violence or imprisonment, as recent events in Poland illustrate.

Inequitable and Inefficient

When the market allocation of resources is replaced by political resource allocation the results are often inequitable and inefficient, in that more resources tend to be expended on activities which merely redistribute wealth rather than create wealth. Government, after all, does not produce much of anything; it takes from some and gives to others, keeping as much as it can for itself in the form of discretionary revenues.[8]

In democratic countries there is an asymmetry between the benefit incidence of political decisions an(] the tax incidence. That is, beneficiary groups or recipients of government-financed transfers tend to be concentrated, or organized, and capable of influencing politicians. By contrast, taxpayers tend to be widely dispersed, with little incentive to actively oppose individual transfer programs. As a result of this asymmetry there is a structural bias toward expanded levels of government spending and taxing. As the government sector expands, more and more resources are used by all the various interest groups to lobby for transfers rather than to produce goods and services, which serves to diminish the total wealth of nations. As wealth transfers increase, the private sector, which is the sole source of wealth creation, is increasingly crowded out.

The Problem of Monopoly

The virtues of the market economy are partly undermined by the existence of monopoly power. A monopolist who, by definition, is the sole supplier of a product for which there are no close substitutes will restrict output, thereby raising his price above what would be paid if markets were competitive. Consumers are made worse off because some of their wealth is transferred to the monopolist, and because fewer resources are devoted to the production of the monopolized good (and more to other goods) than what consumers would prefer with freer trade.

Over the past several decades many have claimed that the allegedly increased concentration of industry in the U.S. and in other democratic countries has led to increased monopoly power and therefore calls for a greater degree of governmental control, regulation, or outright ownership of industry. Even though there is no evidence that American industry has become increasingly concentrated over the past century or that concentration per se leads to monopoly profits, such unfounded sentiments can be understood if one recognizes that it is the interventionists themselves who intend to become the regulators, the controllers, and the managers of nationalized industries.

The claims that government regulation of industry is a necessary condition for the prevention of monopoly power have ignored history and reality. Adam Smith himself was among the first to recognize that government regulation of industry is the sole cause of monopoly, not a remedy for its ill effects. Smith viewed the regulation of industry as a means of redistributing income to potential monopolists who would in turn provide political and economic support to the government. He observed that the various trades in eighteenth-century Britain which were granted a monopoly status gained such status because of a comparative advantage in lobbying.

Country gentlemen and farmers, dispersed in different parts of the country, cannot so easily combine as merchants and manufacturers, who being collected into towns, and accustomed to that exclusive corporation spirit which prevails in them, naturally to endeavour to obtain against all their countrymen, the same exclusive privilege which they generally possess against the inhabitants of their respective towns. They accordingly seem to have been the original inventors of those restraints upon the importation of foreign goods, which secure to them the monopoly of the home market.[9]

Smith’s strongest attack on monopolies was aimed at the entire system of mercantilism and protectionism in foreign trade. In his words, “Monopoly of one kind or another, indeed, seems to be the sole engine of the mercantile system.”[10] And, “It is the industry which is carried on for the benefit of the rich and the powerful, that is principally encouraged by our mercantile system. That which is carried on for the benefit of the poor and the indigent, is too often, either neglected, or oppressed.”[11] And further, condemning mercantilism on moral grounds,

To hurt in any degree the interest of any one order of citizens, for no other purpose but to promote that of some other, is evidently contrary to that justice and equality of treatment which the sovereign owes to all the different orders of his subjects.[12]

These lessons were well heeded in the latter eighteenth and early nineteenth centuries by many citizens, and, as history reveals, one of the causes of the American Revolution was the attempt by the British government to enforce the Trade and Navigation Acts, which were intended to monopolize certain activities for Englishmen living in the British Isles.

Modern Trade Restrictions

Unfortunately, the modern-day mercantilists have succeeded in diverting the public’s attention away from this reality, and in imposing a vast array of “neomercantilist” policies of trade restrictions. Perhaps the most regulated activity in the U.S. economy is transportation, which serves as an example of monopolies recently created by government.[13]

The Interstate Commerce Commission (ICC) limits the number of firms allowed to engage in common carrier transportation. In addition, it actually sets minimum rates below which transportation companies are not allowed to sell, which permits the companies to enforce a cartel pricing arrangement.

The Civil Aeronautics Board (CAB) has set minimum air cargo rates and passenger rates. It has even attempted to regulate the service provided at these rates to prevent one airline from offering a more comfortable seat or more legroom at a given price than another.

The Federal Maritime Board forces steamship lines into the ocean conferences—the privately operated cartels that regulate ocean freight rates and attempt to prevent rate cutting.

Forty states regulate intrastate trucking and prevent rate cutting, and most cities regulate the taxicab business, with the same result. Interestingly, Washington, D.C., home of many of the regulators, is the only major city in the U.S. where one can enter the taxi business simply by demonstrating that the necessary liability insurance is covered. Taxi fares in Washington are among the lowest of all major cities in the U.S.

In sum, government regulation of industry is today, as it was in Adam Smith’s time, often for the benefit of the regulated firms, to the detriment of consumers, potential competitors, and workers who are barred from employment by the various licensing restrictions which exist and apply to thousands of trades, from taxi driving to fortune telling and the practice of medicine.[14] Only with the sanction and coercion of government can a producer, if a monopolist, reduce output and raise prices indefinitely. If the government does not prohibit competition, any monopoly profits will soon be bid away by competing entrepreneurs and workers. The free economy is incompatible with the existence of monopoly power.

Profit Management vs. Bureaucratic Management

As mentioned above, one of the most basic virtues of the free economy is that the market induces private sector entrepreneurs to produce goods and services at least cost. Private sector managers are the residual claimants to both profits and losses—cost reducing innovations which increase profits often lead to direct salary increases and enhance one’s human capita] as a manager, while economic losses cause one to forgo salary increases and run the risk of losing one’s job tenure. In sum, the private sector manager is motivated by both the carrot and the stick, in that he is rewarded financially and promoted for reducing costs, and may be “punished” for unsatisfactory performance.

By contrast, many goods and services which are produced by private sector producers are also provided by government enterprises in many countries. As history shows, government-operated enterprises in both democratic and non-democratic countries have been monumental failures when compared to private enterprise. The effects of bureaucratic (government) management have long been recognized. For example, nearly four decades ago Ludwig von Mises began his book, Bureaucracy in the following way:

The terms, bureaucrat, bureaucratic, and bureaucracy are clearly invectives. Nobody calls himself a bureaucrat or his own methods of management bureaucratic. These words are always applied with an opprobrious connotation. They always imply a disparaging criticism of persons, institutions, or procedures. Nobody doubts that bureaucracy is thoroughly bad and that it should not exist in a perfect world.[15]

The “bureaucratic methods” that Mises referred to are familiar to everyone. Less clear is why these methods persist. The basic reason is not that government bureaucrats are innately lazy, slothful, or dishonest, but that both the carrot and the stick are missing from the public sector. The public manager who reduces cost receives no reward, for there are no profits, by definition, in the public sector. In addition to this, it is difficult to terminate government employees for poor performance, as the low rates of employee turnover in the public sector attest. The manager of a government bureau has, at best, minimal incentives for economic efficiency. In fact, the incentive system facing government bureaucrats in the U.S. and in most democratic European countries is rather perverse, for as Gordon Tullock observed, “. . . in most American and European bureaucracies . . . a bureaucrat is rewarded for simply increasing the number of persons he supervises.”[16]

Increased Spending Increases Bureaucratic Power

The budgets allocated by the legislative sponsors of government bureaus are typically exhausted by spending on perquisites of office, salaries of subordinates, and so forth. If the bureaucrat serves his own interests, he will always spend the entire budget allocated to his bureau, regardless of the cost of providing the service which is under his management. Promotions, prestige, and salary increases depend largely on increasing the number of subordi nates, which requires an increase in the appropriated budget. The bureaucrat would find it difficult to justify budget increases next year if he does not spend his entire budget this year, and for this reason government enterprises tend to maximize rather than minimize production costs, as do their private sector counterparts.

Relative to the private sector, the incentive structure of the bureaucratic “public” manager is perverse, since every bureaucrat is inherently an empire builder who seeks to enlarge the size and scope of his agency in order to increase his salary and prestige. Unlike the private sector, where the managers and owners of inefficient firms bear the burden of poor performance themselves by forfeiting profits, a government-owned monopoly, which most government enterprises are, can not only charge a monopoly price and exhibit gross inefficiencies, but can also force taxpayers to pay the price. Government-operated enterprises therefore pose a major threat to the free economy and to personal freedom.

The Myth of Stabilization Policy

Despite all the world’s dismal experiences with attempts at replacing the market economy with “central planning,” the dream of many an interventionist is to institute some form of “planning” in the U.S. That is, what is politically defined as “economic planning” is actually the “forcible superseding of other people’s decisions by government officers.”[17] It is often lamented that planning is needed to protect the public from “accident, chance, and uncoordinated institutions” which lead to “helplessness” as the economy lists.[18] Central planning is seen as simply a matter of “technical coordination by experts” using “systematic analysis” whereby some undefinable “public interest” can be discussed along with “objective analysis . . . of what is really desirable.”[19]

Although the U.S. has never actually experimented with comprehensive central planning, monetary and fiscal policies since the 1940s have been hybrid attempts at “fine-tuning” the economy by small groups of planners. This predominant approach to economic policy, usually referred to as “Keynesianism,” takes as its point of departure a philosophy similar to that described in the above quotations of Nobel prizewinning economist Wassily Leontief and the late Senator Hubert Humphrey. “Stabilization policy,” as a form of planning, is merely a matter of getting the “right” people into of-rice, and providing them with adequate technical information. In other words, this view is based on the presumed existence of a group of benevolent and omniscient despots.

It is now widely recognized, however, that the so-called stabilization policies of the past have not worked, and have even destabilized the economy.[20] One reason for this is that it is simply impossible to forecast the effects that changes in monetary and fiscal policies will have on an economy 2 years, 1 year, or even 6 months in the future with much precision, as the performance of economic forecasters demonstrates. A second reason is that in a democratic country, the time lag between the recognition of a problem (high inflation, unemployment) and the final impact of whatever policy is implemented to address the problem is unpredictable, due to political realities. A policy aimed at stimulating demand may not actually be felt until after the economy has emerged from a recession and entered into an inflationary peak of the business cycle, which would only make things worse. The failures of government stabilization policies have been described, by their architects, as the result of simply not having sufficient information at hand.

But there is a strong basis for believing that stabilization policies have not worked simply because it is not in the interest of policymakers to make them work. For example, expansionary policies (such as government spending financed by money creation) increases political support by dispensing benefits on concentrated constituent groups now, and dispersing and deferring the costs, in the form of higher inflation, in the future. Federal politicians have every incentive to create inflation and the further economic instability (stagflation) which follows, especially since the “progressive” income tax (a phrase coined by Karl Marx) generates additional increases in real tax revenues with inflation-induced “bracket creep.”

Policies Modified in Proximity to Elections

Relatedly, there is good reason to believe that economic policy is based not on any long-term stability goals, but rather on the proximity to elections, which creates further instability. The theory of the “political business cycle” holds that by concentrating expansionary policies before an election, the incumbent party may be able to strengthen its electoral prospects.[21] Expansionary policies will tend to be pursued more vigorously before an election, with the pursuit of contractionary policies left to after an election, the result being economic instability. In sum, it is the government’s monopoly power over the money supply coupled with the pursuit of political self-interest which often creates economic instability.

The predominant view of the failures of stabilization policy, which is informed by what one might call a “central planning mentality,” is not that existing institutions create incentives for policymakers to generate economic instability, but that such failures are simply the result of accident or error. Economist Herschel Grossman, in reviewing the work of James Tobin, one of the chief architects of Keynesian economics over the years, summarizes this view:

Tobin presumes that the historical record of monetary and fiscal policy involves a series of avoidable mistakes, rather than the predictable consequences of personal preferences and ca pabilities working through the existing constitutional process by which policy is formulated. Specifically, Tobin shows no interest in analysis of either the economically motivated behavior of private individuals in the political process or the behavior of the government agents who make and administer policy.[22]

In essence, the predominant view of stabilization policy, like the socialist dream of the centrally planned economy, is based on a vision of a utopian society run by angels who automatically serve the public interest (however defined), and there is no agency problem. But if one accepts the notion that policymakers are human beings, and therefore act in their own self-interests, it becomes necessary to face the question of why governments would pursue any of the competing goals of monetary and fiscal policy. As economist Paul Craig Roberts stated,

What do policymakers, especially in a democratic political system, have to gain from an efficient, stable economy that is maximizing social welfare? Such a successful economy would cut into their abilities, as entrepreneurs, to build the spending and regulatory constituencies that are the basis of their political power. If people can get ahead through the market, and the tax system allows them to accumulate wealth, what happens to the demand for all the welfare handouts, food stamps, housing subsidies, and income security programs? Without all these programs, what would government do? How would politicians carry on their demagogy and set group against group, class against class, and race against race if the tax system were actually used to bring about an equal distribution of income and wealth?[23]

There is certainly much evidence of this. How else can one explain the extreme opposition by entrenched government bureaucracies to sup-ply-side economics which attempts to restore incentives to work and invest and to alleviate poverty by the only means known to man—stimulating economic growth and wealth creation in the private sector? In short, those who benefit from public sector expansion have found it essential to undermine the activities of and public confidence in the private sector.

Stabilization policy, a watered-down version of central planning, has served, and will continue to serve to destabilize the private sector of the economy and to transfer resources and power to the government. After all, why should one expect government bureaucrats to solve the problems which justify their very existence? While the free economy may not be void of economic fluctuations, government attempts at “fine-tuning” have only destabilized the economy even more than what would have otherwise taken place, and will continue to do so as long as they are used.


The free economy is most conducive to maximizing consumer welfare, as defined by consumers themselves. In the free economy it is ultimately the consumer who determines the pattern of production and distribution, the distribution of income, and induces entrepreneurs to produce goods and services at least cost. It is precisely for these reasons that interventionists are so opposed to the free economy. When political resource allocation replaces the market allocation of resources the result can only be the forceful imposition of the preferences of governmental agents for those of consumers, which is neither efficient nor equitable.

Political resource allocation, relative to the market, is wasteful and severely limits individual freedom and welfare. Furthermore, attempts at “fine-tuning” or “planning” are nothing more than attempts to subjugate consumers and taxpayers to the preferences of those who have seized political power, and have severely reduced the wealth of nations. As a glance at any map of the world reveals, only the free economy is capable of achieving equity and prosperity. []

1.   Ludwig von Mises, Human Action: A Treatise on Economics, 3rd Ed., (Chicago: H. Regnery Co., 1966), p. 270.

2.   Milton and Rose Friedman, Free to Choose: A Personal Statement (New York: Harcourt Brace Jovanovich, 1979), p. 13.

3.   James Madison, The Federalist, 10.

4.   Alexander Hamilton, The Federalist, 6.

5.   James Madison, The Federalist, 51.

6.   James M. Buchanan, “Why Does Government Grow?” in T. Borcherding, Ed. Budgets and Bureaucrats: The Sources of Government Growth, (Durham, N.C.: Duke University Press, 1977), pp. 3-18.

7.   Jerome Rothenberg, Economic Evaluation of Urban Renewal (Washington, D.C.: Brookings Institution, 1967), p. 65.

8.   This is a dominant theme of the economics of bureaucracy. See, for example, William Nis- kanen, Bureaucracy and Representative Government (Chicago: Aldine, 1971).

9.   Adam Smith, The Wealth of Nations, Can-nan Edition, (London, 1960), vol. II, p. 427.

10.   Ibid, p. 129.

11.   Ibid, p. 143.

12.   Ibid, p. 152.

13.   The following examples are cited in Yale Brozen, Is Government the Source of Monopoly? and Other Essays (San Francisco: The Cato Institute, 1980).

14.   A detailed discussion of occupational licensing is found in Walter E. Williams, “Government Sanctioned Restraints That Reduce Economic Opportunities for Minorities,” Policy Review, (Fall 1977), pp. 1-29.

15.   Ludwig von Mises, Bureaucracy (Westport, Conn.: Arlington House, Reprinted 1969), p. 1.

16.   Gordon Tullock, The Politics of Bureaucracy (Washington, D.C.: Public Affairs Press, 1965).

17.   Thomas Sowell, Knowledge and Decisions (New York: Basic Books, 1980), p. 214.

18.   Wassily Leontief and Leonard Woodcock, “The Case for Planning,” in The Politics of Planning, p. 348.

19.   Hubert H. Humphrey, National Economic Planning: Right or Wrong for the U.S.? (Washington, D.C.: American Enterprise Institute, 1976), p. 3.

20.   Even Franco Modigliani, perhaps the chief inventor of Keynesian economics in the U.S. came to this conclusion in his 1977 presidential address to the American Economic Association, “Should We Forsake Stabilization Policies?” American Economic Review (May 1977).

21.   See, for example, Richard E. Wagner, “Economic Manipulation for Political Profit: Ma- croeconomic Consequences and Constitutional Implications,” Kyklos, vol. 30, (1977), pp. 395 409.

22.   Herschel Grossman, “Tobin on Macroeconomics: A Review Article,” Journal of Political Economy 83 (August 1975), pp. 845-46.

23.   Paul Craig Roberts, “Taxation and the Induced Demand for Leviathan,” paper presented at the 1980 meetings of the Mont Pelerin Society, The Hoover Institution, Palo Alto, California.

Dr. DILorenzo is Assistant Professor of Economics at George Mason University, Fairfax, Virginia.

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