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Thursday, October 28, 2010

The Irrelevance of Private-Sector Experience

Surgery in the dark.

In a recent interview Carl Paladino, the highly entertaining but otherwise scary Republican candidate for governor of New York, was asked about his plans to make state government more efficient.  Having lived in New York for over 20 years, I can certainly attest to the inefficiencies of the state government, so I was curious to hear his answer.  His response included much of the usual political boilerplate about cutting redundancies and waste, but then he added something like, “and I’ll get a bunch of folks in there with private-sector experience who know how to cut costs and make organizations more lean and efficient.”

This is a refrain we’ve heard quite a bit the last few decades, as government has grown enormously and the private sector has had to downsize and keep administrative costs as low as possible.  One of the first candidates to adopt this rhetoric was Ross Perot in the 1990s, who said that his own private-sector experience would enable him to “look under the hood” of the federal government and see what’s working and what’s not.  Paladino himself also has significant private-sector experience.

The problem with this argument is that people assume that the skills and aptitudes that lead to private-sector success are transferable to the public sector.  Unfortunately, it does not work that easily.  A great deal of what enables people to be successful in the private sector is not their own skills and knowledge in and of themselves, but the way in which the market enables them to employ those attributes effectively to generate innovation and keep costs low.

In his famous article on the impossibility of rational economic calculation under socialism, Ludwig von Mises recognized this point:

A popular slogan affirms that if we think less bureaucratically and more commercially in communal enterprises, they will work just as well as private enterprises. The leading positions must be occupied by merchants, and then income will grow apace. Unfortunately “commercial-mindedness” is not something external, which can be arbitrarily transferred. A merchant’s qualities are not the property of a person depending on inborn aptitude, nor are they acquired by studies in a commercial school or by working in a commercial house, or even by having been a business man oneself for some period of time. The entrepreneur’s commercial attitude and activity arises from his position in the economic process and is lost with its disappearance.

What makes it possible for the entrepreneur to succeed in the private sector and struggle in the public sector is precisely the same set of factors that makes economic calculation under socialism impossible:  the role that prices and profit and loss play in providing guidance to the entrepreneur’s decision making.

Economic Calculation

As Mises argued almost 100 years ago, the key to using resources rationally, or efficiently, is the ability to engage in economic calculation.  Economic calculation requires that we be able to compare the value of alternative outputs and methods of production.  The prices generated by market exchange enable us make such comparisons of value both prospectively, in terms of formulating a budget, and retrospectively, through profit and loss, which indicate whether we did in fact create value.  Market prices also make it possible for us to discover new ways of doing things that we otherwise would not have considered.

But as Mises noted, for prices to be meaningful in these ways, they have to emerge from market exchange, which in turn can only happen where property is privately owned.  Only then do the choosers reap the benefits and bear the cost of their choices, either directly as the entrepreneur who makes a profit or takes a loss, or indirectly as the employees or shareholders whose wealth depends on profits.  The institution of profit and loss rewards those who are good economic calculators and efficient resource users, and punishes those who are not.  Those who survive develop further the skills the system rewards.

Move those same people to the public sector and they lose the private property that connects their fate directly to the economic consequences of their decision making.  They also lose the prices and profit signals that inform them about which sorts of action might be the most efficient.  No matter how smart or skilled they were in the private sector, thrown into the public sector, businesspeople are denied the incentives and information that made their success possible.

Skilled surgeons know that their reputation depends on doing good work, and they also bring highly effective tools to operating rooms with bright lights and a sterile environment.  Put those same surgeons in dirty, dark operating rooms and give them inferior tools or none at all, and all their skill won’t be enough to do good work.  Expecting people with private-sector experience to fix government is as realistic as hoping a blindfolded doctor with rusty, ancient instruments can perform successful heart surgery.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.