David R. Henderson  

Robert Murphy on Why Government Can't Run Like a Business

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We often hear people, including businessmen, lament the fact that the government doesn't seem to be run like a business. Many of them want it to.

In one of the two December Feature Articles, "Why Government Doesn't--and Can't--Manage Resources Like a Private Business," Robert P. Murphy explains why that can't work.

An excerpt:

However, more-practical economists recognize the limits of their textbook diagrams with elegant marginal revenue and marginal cost curves. In reality, we operate in a world of uncertainty. The "least cost" method of producing a good or service is never obvious, nor is what consumers will be willing to pay for various items. In a famous lecture, "Competition as a Discovery Procedure," Friedrich Hayek explained how markets in the real world stumble upon this hidden knowledge. Various people with access to different information make piecemeal discoveries and constantly modify their operations accordingly; they receive feedback from market prices in the form of profit or loss. Firms mimic particularly profitable innovations, and if a firm does not adapt quickly enough, it will go out of business. Hayek thus viewed competition as a process rather than a condition or end-state. The state of "perfect competition" described in the textbooks--which includes the property that all firms in an industry use the identical "least-cost" method of production--is actually something that would emerge over time only because of the competitive rivalry between the firms, and only if the conditions in the real world remained static long enough for all firms to fully adapt.

From this Hayekian perspective, we have little reason to expect government provision of a good or service to reduce costs, if only because such an institutional arrangement limits the number of minds brainstorming on how to cut costs. Under competitive free entry into an industry, and even into a "natural monopoly," an outsider always has the freedom to supplant the established firms if he or she comes up with a new, cost-saving idea. Thus, in principle, the entire society contributes to solving the problem of minimizing costs in the particular industry.

In contrast, with government provision (or government anointment of one firm as a regulated monopolist), there may be only a few people who can contribute to cost-saving innovations. This insight provides a strong reason to expect government-managed enterprises to have higher costs of operation than a private-sector firm would have--out of sheer ignorance. In this view, government officials waste money and offer shoddy output relative to private managers, simply because they don't know any better.


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COMMENTS (15 to date)
Hunter writes:

Still doesn't explain why cities are so poorly run. Maybe we should give city coucil memebers and mayors a percentage of any budget surplus and the rest of the surplus sent back to the property tax payers as a "dividend".

Phil writes:

The differences between government and for-profit businesses are manifold. The lack of competition is one of the more salient. Here are a few others:

There is not a company-client relationship between the purveyor and consumer of government services, instead an individual's relationship with his government is often a benefactor-beneficiary relationship, or official-constituent, or country-citizen. These are not economic relationships analogous to a for-profit business.

With a government, one's exchange of money for services is often involuntary and unrelated. With rare exception, the logic used to collect revenue is divorced from the logic used to allocate those resources.

Government does not use its assets to generate revenue; it merely confiscates "revenue." Government uses its assets to perform missions which are typically not sold to those who receive the benefit of the mission.

Few goals of government are measured in financial terms. Thus, efficiency is only one of many virtues sought by government. Imagine you are falsely accused of a crime, do you want to be tried in the most efficient courtroom or the one that ensures due process?

More broadly, government means are often more important than ends: EEO offices, audit agencies, Buy American provisions, and many other appurtenants of government are purposefully and inherently inefficient.

Government divides and checks power. No one, even the CEO, has the authority to hire and fire at will, move into or out of lines of business, enter long-term strategic partnerships, or raise capital. Implementation of programs is as politically challenging as initial approval, maybe even more challenging. It is hard for a manager to be efficient if he lacks the necessary tools.

Efficiency in government is often measured by looking at budget variances, but government budgets serve many purposes beside cost estimating: they are political scorecards, aspirational expressions of policy aims, tools of foreign policy, social contracts, etc. They serve as poor benchmarks.

Government is (well...should be) in the business of providing public goods, not private goods. The economic differences are well known to the readers of this blog.

Perhaps most importantly, there is no residual ownership interest with a stake in government efficiency. If a corporation goes bust, the owners have a residual interest. It is the Shareholder's Equity part of the balance sheet. That interest is measurable and capable of being exchanged. The government's balance sheet has no logical equivalent. What a company earns, it keeps or distributes to owners. No such mechanism exists with government. There is no "saving" in government; there is only reallocation.

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As an aside, I notice that Robert Murphy's article primarily addresses government's role in managing common pool resources. I was surprised he does not cite the work of Eleanor Ostrom with respect to those mechanisms that can achieve positive outcomes, specifically in the domains of water supplies and fishing. See "Rules, Games, & Common Pool Resources" by Ostrom, Gardner & Walker.

Thomas DeMeo writes:

This idea of hidden knowledge is badly oversold.

Far and away, the biggest obstacle to government efficiency is the democratic process of decision making itself. To obtain majority consent, things are agreed to that are inherently inefficient.

Almost all of individual actors would know how to do better if they were allowed unilateral control.

MingoV writes:

Government cannot run like a business, but it could transfer many of its functions to businesses.

Pajser writes:

Title "Why Government Doesn't—and Can't—Manage Resources Like a Private Business" suggests that project organized by state cannot be efficient. Ever. However, price and performance of Cuban health system proves that state can build large and efficient projects. The number of efficient projects is described on net. For instance, Odeck concludes "Albeit public bus companies turned out to be more efficient than their private counterparts on average, a finding contradicting the property rights hypothesis, the difference is quite small and statistically insignificant."

In article, Murphy really doesn't argue that state cannot be efficient. He only lists the reasons why state projects are likely inefficient and some case studies. The socialist can live with that; social technology applied in successful state projects can be applied broadly.

James writes:

Pajser: Nothing here suggests that government programs cannot ever be efficient. You are arguing with an opinion no one expressed.

But cheer up because you don't need socialism to get the outcomes of the Cuban health care system. Just find some like minded people and pool your resources. Find the people who you think ought to be running government health enterprises. Pay them out of your own income to do whatever you think they would be doing in those enterprises. Most important, make sure that you use the same data collection techniques that are used in Cuba. As a bonus, you can quit participating at any time if you change your mind and no one will kill you and punish your family for counterrevolutionary activities.

Enial Cattesi writes:

@Thomas DeMeo:

Far and away, the biggest obstacle to government efficiency is the democratic process of decision making itself. To obtain majority consent, things are agreed to that are inherently inefficient.

There are some papers from Stigler and Gary Becker which argue that, due to democracy, the government's expenditures are efficient. And price controls ... And taxes ... And laws ...

Enial Cattesi writes:

@Pajser:

However, price and performance of Cuban health system proves that state can build large and efficient projects.

And the Soviet Union was about the outgrow US in five years for fifty years.

@Phil:
Eleanor Ostrom's work is not that good actually. The conclusion of her successful case studies was that private property is the secret ingredient, but, for some reason, they shy away from it.

Phil writes:

@ Enial Cattesi: Her work was good enough for a Nobel Prize.

Enial Cattesi writes:

@Phil:
And your point is? Looking at the list of Nobel winner (I am one of the guyes who doesn't think there is such a thing as a Nobel prize in economics, but even if there was, so what?), including this years's crop, it is hardly something to be proud of.

Rick writes:

Humbly, I don't know much about government or big business. However I do believe I know it's never a system or policy that fails: It's always the people...the decision-makers or decision-making unit, and us--who choose them as our leaders.

Just like the practice of medicine can never be a business per se, the business of running a medical practice must be. No, medicine can and must never be sold. At the same time, a true physician has a fiduciary obligation to his patients and to his community to be financially viable. Thus, inherent in the Hippocratic Oath of "Doing No Harm," there is the covenant of "doing well by doing good." What's right for patient care is also what's right for the financial viability of the medical facility.

This understanding is basic, yet takes a caring professional and a leader to exact.

Bob Murphy writes:

Thanks for the comments, everyone. Some quick reactions to criticisms:

==> Hunter, you proposed a mechanism (I think sarcastically?) for returning dividends to taxpayers. But that still suffers from the problem that the taxpayers don't start out with their money. To really become analogous with a private business, the government would have to cut taxes, period, then try to convince the citizens to voluntarily hand over some of it in exchange for services.

==> Phil made a bunch of good points, then asked why I didn't discuss Ostrom. The honest answer is that I have not read her work firsthand, so can't incorporate it into a piece like this.

==> Thomas DeMeo said hidden knowledge is overrated by (some) economists, and that democracy itself is to blame. But I think I handled that by saying government provision suffers from both a dispersed knowledge and an incentive problem. It's true that I didn't cite specifically the problem of incentives in voting procedures, but I think my article is compatible with your view.

==> Pajser argues that I didn't rule out the possibility of a government efficiently running an enterprise. Well, I showed that there are systematic forces at work that make it harder for a government agency to do what a private business can achieve. I suppose you're right that for completeness, I would have to rule out any offsetting factors--or show that they would always be swamped by the former set of factors--but in context, the title was meant to convey that this was no mere coincidence. I.e. there are systematic, theoretical reasons to expect the inefficiencies we actually observe in practice.

==> Rick, unfortunately I think you missed the point of the article. I'm saying it's NOT simply a matter of picking the right people, it really IS "the system" at fault. If you disagree, fair enough, but it seems you are just casually denying the entire point of the article without really saying what was wrong with my arguments.

Mark V Anderson writes:

Are there really still people out there saying that governments should be run like a business? Many businesses are run poorly, so I don't think that is a good idea. Of course those businesses usually fail, but there are always more out there making dumb decisions.

Both businesses and governments should attempt to run their organizations using best practices. But there is no benefit to a government to purposefully run itself like a business, unless the model is a particular business that is well run.

Phil listed a number of ways in which governments and businesses are inherently different. And he far from exhausted the topic. Most of these differences have a tendency to lead governments to be more poorly run than businesses (which is why I believe that as many functions as possible should be run by business, not government). But that in no way means that governments should be run like a business (whatever that means, since every business is run differently).

Brad writes:

Politicians are experts at talking about making government more efficient, but the incentives facing the bureaucrats running the agency are often at odds with the politician's proclamations.

Agencies have every incentive to spend every dime of appropriation, because not doing so will result in a lower budget next year.

Milton Friedman said "we have a government of the people, by the bureaucrats for the bureaucrats." Sadly, it’s true.

Thomas DeMeo writes:

Bob Murphy- thanks for the response.

I still think you are missing the most important point.

Government workers are much less free to apply "knowledge", while private sector workers often can.

It is a poor argument to cite lack of knowledge as a problem because we if we solve the knowledge problem we don't really accomplish anything.

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