David R. Henderson  

Friedman's Law

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In his classic, The Machinery of Freedom (1973, 1989), David D. Friedman formulated Friedman's Law. The law states:

It costs any government at least twice as much to do something as it costs anyone else.

David Friedman is usually much more careful in his formulations: I doubt he really means "anyone else." But you get the gist. The Wikipedia article on The Machinery of Freedom states about Friedman's Law, "empirical research is still inconclusive." That's correct literally. But most of the data I know of support it when you take into account the deadweight loss (DWL) from taxes. Remember that if the government does it, it likely taxes people to do so.

Robert P. O'Quinn, in a study done for the Joint Economic Committee (a study I can't track down on the web), found that if all federal tax rates (excise taxes, personal income taxes, payroll taxes, corporate taxes, etc.) were raised by a small amount, the deadweight loss would be about 33 cents per dollar raised.

So if the apparent cost of having government do something is just 50% more than the cost for the private sector, there you have it. If x is the cost to the private sector, 1.5 x is the cost to the government. But taking into account DWL, the cost to the government is 1.5x*1.33 = 2x. QED.

Does it cost the government 50% more, not taking account of DWL? The studies I've seen say so. Check for example, data that Steven E. Rhoads references (in The Economist's View of the World) on garbage collection and claims processing where government provision costs anywhere from 43% more to 100% more.

Question: what are other cost comparisons between government and private that you know of and what are their findings?

Update: I forgot to give a Hat Tip to Charley Hooper. He was the one who, in a discussion last week, put the standard cost difference together with the deadweight loss.


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CATEGORIES: Cost-benefit Analysis



COMMENTS (19 to date)
SydB writes:

To what degree is the above analysis taking into account private sector failures as well as successes. In other words, take all the money invested in a particular area, consider all the players who won, and those who lost. Now compare that to the efficiency of government.

Usually, in analysis such as that above, I only see selective memory, picking out successes but forgetting all the failures in the private sector.

(Not that I'm arguing for the government to assume responsibility for much other than advanced research.)

EdM writes:

SydB,

Your statement seems to assume that government is always successful in its endeavors.

--Ed

SydB writes:

"Your statement seems to assume that government is always successful in its endeavors."

Not at all. But I am saying that the failures of government, the waste, are often discussed--rightly so. They are quantified--see Mr. Henderson's numbers above. Therefore I ask that he, for the sake of accuracy, quantify the failures of the private sector. E.g. ten companies may chase after a market, three may succeed, seven fail (say their designs are flawed or late). What's the efficiency of this system?

E.g. consider GSM in Europe versus CDMA/TDMA in the us. How much spent? Efficiency? Etc.

I doubt anyone has looked at issues such as this.

I'm not proposing the government do anyone. I just tire of cheerleaders. I prefer accuracy.

ed writes:

Aren't you mixing up different concepts of "cost" here?

When you talk about dead-weight loss, you are apparently talking about social cost as economists typically define it. But the studies on government costs probably use budgetary costs rather than social costs. To the extent that high government outlays are driven by high salaries and benefits, these are transfers and should not be counted as social costs.

Paul Zrimsek writes:

E.g. ten companies may chase after a market, three may succeed, seven fail (say their designs are flawed or late). What's the efficiency of this system?

You've already identified it yourself: "Seven fail".

Tom writes:

"Therefore I ask that he, for the sake of accuracy, quantify the failures of the private sector. E.g. ten companies may chase after a market, three may succeed, seven fail (say their designs are flawed or late). What's the efficiency of this system?"

That is a good question, but if a private firm fails and goes out of business what happens to the resources that a failed firm owns. The building, machinery, and labor that the firm uses do not just disappear with bankruptcy. Another successful firm may come in and purchase the machinery - possibly at a discount. The building the failed firm operated in still exists and may soon become occupied by another business. The labor moves on to be hired by other businesses. All this and it doesn't cost me the taxpayer a dime.

Is there wealth destruction with failure? Most likely in the short-run to these particular failed firms, but in the long-run scarce resources are moved from inefficient owners, managers, and uses to more efficient owners, managers, and uses. The private sector has incentives to use resources efficiently by staying in business, making profits by satisfying customers, and keeping costs low. I would say because firms are allowed to fail, this is what makes the private sector so efficient. Government, on the other hand, does not “fail” and go out of business, does not need to satisfy its "customers" to make money (it can just tax them), and has little incentive to keep costs low (use it or lose it budgeting).

EdM writes:

For me, coercion is at the heart of it. It doesn't much matter to me if someone makes a bet with THEIR own money and looses. It matters very much to me when I am FORCED to pay for someone else's well-meaning project.

Money being spent inefficiently on competing mobile phone standards doesn't bother me. No one forced money out of my hands to build one network or the other. Different companies bet on different technologies and some did very well others not so good. Ultimately that inefficient allocation of capital was up to the individuals making their own choices.

When government, using someone else's money (and the threat of violence) produces something, it usually ends up being more expensive and worse than the free market alternative.

Just look at public versus private schools. By any metric, public schools are more expensive and perform much, much worse.

--Ed

Paul Zrimsek writes:

As Oscar Wilde almost said: There is only one thing worse than a wasteful competitor failing, and that is a wasteful competitor not failing.

El Presidente writes:

I don't know about specific studies that demonstrate this. I do have a question though. If the suggested effect is valid and accurate, it seems important to ask why government is more expensive.

There might be many reasons, but I wonder if we have good analysis at a micro level of the costs of government operations, economies/diseconomies of scale and scope, etc. Government does a lot of stuff. Describing the whole of government as more expensive is not necessarily helpful for cost containment or advocating reduction of government budgets and increased outsourcing/contracting unless we know what cost issues we are up against. I am sort of optimistic about what government CAN do. I am not pollyannaish about what government DOES do. I think it behooves us to be thoughtful about what government SHOULD do. And, I think we need good information to engage that question effectively. The things I have read about government cost disadvantages take issue with civil service protections, the substitution of seniority for performance as a key critera in advancement or workforce reduction decisions, rent-seeking, etc.

There are many ways in which government CAN be less efficient. You'll get no argument from me on that. However, it doesn't meant that government IS less efficient in each instance, nor does it mean that the private sector WOULD produce the specified goods and services if not directed to do so and provided with a franchise or contract. Cost is certainly an important factor in deciding whether government should do something. It is not the only factor.

I don't buy the deadweight loss argument without some serious caveats. Deadweight loss is observed as a result of change. It is not necessarily a long-run efficieny loss, but rather a short-run transitional cost in many instances. It doesn't preclude government's usefulness or effectiveness, but it should make us aware of our need to make long-run decisions carefully so that we will recover the short-run costs and more. The cost structure of the activities government engages in is more of a concern to me. Agencies certainly need to examine their cost structures more closely and figure out how to be more efficient. This should be a constant imperative of public sector management just as it is in the private sector. We generally do pretty well, in my experience, but we can certainly do better.

Mark writes:

This reminds me of the OMB's website, expectmore.gov, which shows their evaluation of which federal programs are "effective". (Surprise, only about a dozen are "not effective".) Nowhere on the website do they say whether any programs are "cost-effective". Thus, a program to pay 20 people to screw in a light bulb would count as "effective" once the light bulb got screwed in (and, hey, 20 jobs were "created").

King Banaian writes:

The deadweight cost of taxation estimates tend to be all over the place, though your 1/3 estimate is perhaps a decent median. This survey is rather old:

http://www.house.gov/jec/hidden.pdf

cff http://www.gao.gov/products/GAO-05-878

David R. Henderson writes:

Hey guys,
I'd just like to repeat the question I asked at the end:
Question: what are other cost comparisons between government and private that you know of and what are their findings?
Best,
David

SydB writes:

Tom: I concur. I think the resources will move from the failed companies or projects to those that will make better use of them. But there is a loss in terms of R&D, salaries, etc and I think it would be interesting to know what that loss is.

I'm not arguing that the government is more efficient. It certainly isn't. Arnold Kling argues here--rightly so--that the problem with the government is that it doesn't fail. I agree. Dead weight can continue in the government--not unlike dead or useless organs or DNA in our bodies. In the private sector, dead weight is sold to the highest bidder--or for scrap.

But the dead weight--or dead wood--of failed projects and companies should be considered in the analysis.

Arare Litus writes:

This doesn't answer the question, but the Laffer curve discusses the optimal "fleecing" of society at a given moment (i.e. static state), but surly there is an equivalent study of the optimal level of public service in order to allow wealth generation (and thus more wool...)?

This is more generic than the efficiency of a given service, but rather rather to the reach of a given service - i.e. it might be better to shell out more money to "pull up" an entire society and ensure more long term wealth (for example, it is pretty much impossible to argue that public sanitation did not vastly improve the life expectancy and wealth of society).

While one might argue that perhaps nongovernmental approaches would work for such efforts, we do see evidence that governmental approaches do work.

Are there examples of private sanitation on a large scale? That endured for a long time? [or other such services]

The reason I bright this up is that this more generalized issue is what people really care in answering. Few would argue that private approaches can be more inexpensive and of better quality, many would however argue that this is achieved by providing only the "easy cases" and ignoring important, but unprovided, sectors. One might not buy this argument, but that is the argument that must be confronted.

Sanitation/vaccines offer compelling support for these type of arguments, where a huge gain can be obtained at a low reduction in "freedom" (i.e. increased lifespan, for marginal taxes).

BTW - I have previously emailed Dr. Friedman regarding this law, after my own searches came up empty. No studies in the literature came to his mind.

Garett Jones writes:

The link in my name goes to a free version of a 2001 JEL survey on the productivity benefits of privatization. It's quite quantitative, so you should be able to dig up the numbers you're looking for.

This piece by Shleifer isn't as quantitative, but refer to some useful numbers:

http://www.marketobservation.com/blogs/media/blogs/c_f/20070304OverviewPrivatizationWorldBank.pdf

A former-Communist-country survey (JEL, 2002) here:

http://econ-server.umd.edu/~murrell/articles/Enterprise%20Restructuring%20in%20Transition.pdf

Hope these are useful!

David R. Henderson writes:

Thanks much, Garett.
David

Julie Green writes:

"As Oscar Wilde almost said: There is only one thing worse than a wasteful competitor failing, and that is a wasteful competitor not failing."

Thats almost true!

Charley Hooper writes:

What about this Reason study by John Hilke from 1993?

http://reason.org/files/b987e7bd89f4c4e21c8a73857b7001e8.pdf

Barrett writes:

The only reason government programs do not "fail" is because losses can be funded indefinitely by extorting additional taxes from the citizenry.

The fact that the deadweight loss can be quantified only drives home the point that government is the least efficient means of providing [fill in the blank].

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