TGIF: Efficient Bureaucracy?

With all the talk about government efficiency, it would be useful to remind ourselves why bureaucracies differ radically from for-profit businesses. Ludwig von Mises devoted a short but enlightening volume to this subject in 1944, Bureaucracy. Elon Musk and Vivek Ramaswamy, who will co-chair the nongovernmental Department of Government Efficiency, should do some homework by reading that book.

Mises, as an advocate of limited government, did not argue that bureaucracy has no place in a free society. In contrast to anarcho-capitalists, he thought government and therefore some bureaucracy was necessary to protect what he valued most: peaceful social cooperation through the division of labor—that is, the market economy. Violence against persons and property was clearly antithetical to the continuing welfare-enhancing collaboration we call the market process. But Mises did not want bureaucracies trying to do what free, private, and competitive enterprises could do better. Moreover, if the government went beyond its mere peacekeeping duties, it would undermine the market process and make us all less well off despite any good intentions.

Mises began by reminding readers (or perhaps teaching them from scratch) what the free market is and what it accomplishes. It's a great primer for those who lack the time to read his longer works. He wrote:

Capitalism or market economy is that system of social cooperation and division of labor that is based on private ownership of the means of production. The material factors of production are owned by individual citizens, the capitalists and the landowners. The plants and the farms are operated by the entrepreneurs and the farmers, that is, by individuals or associations of individuals who either themselves own the capital and the soil or have borrowed or rented them from the owners. Free enterprise is the characteristic feature of capitalism. The objective of every enterpriser—whether businessman or farmer—is to make profit.

The uninitiated might ask who runs things. He replied: "The capitalists, the enterprisers, and the farmers are instrumental in the conduct of economic affairs. They are at the helm and steer the ship."

However, let's not jump to conclusions about who really runs things, Mises advsed:

But [the capitalists, etc.] are not free to shape [the ship's] course. They are not supreme, they are steersmen only, bound to obey unconditionally the captain’s orders. The captain is the consumer.

Neither the capitalists nor the entrepreneurs nor the farmers determine what has to be produced. The consumers do that. The producers do not produce for their own consumption but for the market. They are intent on selling their products. If the consumers do not buy the goods offered to them, the businessman cannot recover the outlays made. He loses his money. If he fails to adjust his procedure to the wishes of the consumers, he will very soon be removed from his eminent position at the helm. Other men who did better in satisfying the demand of the consumers replace him.

All the conventional controversy about bosses and workers overlooks the critical point:

The real bosses, in the capitalist system of market economy, are the consumers. They, by their buying and by their abstention from buying, decide who should own the capital and run the plants. They determine what should be produced and in what quantity and quality. Their attitudes result either in profit or in loss for the enterpriser. They make poor men rich and rich men poor. They are no easy bosses.

Capitalism is not a profit system, Mises taught. It is a profit-and-loss system. If the consumers give thumbs down to a product, the entrepreneur could lose everything. He may have to seek a job from a superior entrepreneur.

The performance of businesses, Mises wrote, can be appraised only because private property in the means of production, free exchange, and the resulting money prices permit economic calculation and thus planning by economizing individuals. This was Mises's pathbreaking demolition of the economic case for central planning—socialism in its national and international forms—over a century ago.

Economic calculation matters when comparing a business to a bureaucracy. As Mises wrote:

The manager of the whole [business] concern hands over an aggregate to the newly appointed branch manager and gives him one directive only: Make profits. This order, the observance of which is continuously checked by the accounts, is sufficient to make the branch a subservient part of the whole concern and to give to its manager’s action the direction aimed at by the central manager....

As success or failure to attain this end can be ascertained by accounting not only for the whole business concern but also for any of its parts, it is feasible to decentralize both management and accountability without jeopardizing the unity of operations and the attainment of their goal. Responsibility can be divided. There is no need to limit the discretion of subordinates by any rules or regulations other than that underlying all business activities, namely, to render their operations profitable.

What about a bureaucracy? The answer is implicit in what has already been stated. By nature a bureaucracy faces no profit-and-loss test. It has money expenses in a market-oriented society: it hires willing workers and buys equipment and supplies from willing vendors. However, it does not offer its output to potential consumers, that is, people who are free to say no and take their money elsewhere. Instead of consumers, a bureaucracy has taxpayers, who must pay whether they want the output or not. This disconnect must have far-ranging consequences. (Government services for which user fees are charged differ in this respect, but the government typically forbids competition.)

Instead of the business directive "Make profits," Mises wrote:

Bureaucratic management is management bound to comply with detailed rules and regulations fixed by the authority of a superior body. The task of the bureaucrat is to perform what these rules and regulations order him to do. His discretion to act according to his own best conviction is seriously restricted by them....

The absence of the seller-buyer relationship makes a big difference:

The objectives of public administration cannot be measured in monetary terms and cannot be checked by accountancy methods.... In public administration there is no connection between revenue and expenditure....

In public administration there is no market price for achievements....

Now we are in a position to provide a definition of bureaucratic management: Bureaucratic management is the method applied in the conduct of administrative affairs the result of which has no cash value on the market. Remember: We do not say that a successful handling of public affairs has no value, but that it has no price on the market, that its value cannot be realized in a market transaction and consequently cannot be expressed in terms of money....

Bureaucratic management is management of affairs which cannot be checked by economic calculation.

This would be a valuable lesson for Musk and Ramaswamy to take to heart. Their task should not be primarily to search for ways to make the bureaucracies more efficient. Rather their task ought to be to identify those current functions the government should not be performing, those that should be turned over to free, private, profit-motivated, and competitive enterprise. We ought to replace coercion with consent.

We must, in other words, revisit the question: what is the proper role of government, if any, in a society that aspires to be free?

TGIF: Capitalist Exploitation or Interest?

The completely just proposition that the worker is to receive the entire value of his product can be reasonably interpreted to mean either that he is to receive the full present value of his product now or that he is to get the entire future value in the future. But ... the socialists interpret it to mean that the worker is to receive the entire future value of his product now.

—Eugen von Böhm-Bawerk

The free-market economy—laissez-faire capitalism—may be unpopular because people think it authorizes the exploitation of workers. They are not paid the full value of their product—or so it seems. This indictment has been wielded to justify not only full socialism but also substantial government interference with the market economy, including strong pro-union measures.

Few people realize, however, that the market economy was decisively acquitted of the exploitation charge back in 1884 by the second-generation Austrian economist Eugen von Böhm-Bawerk in his History and Critique of Interest Theories. The key to understanding the acquittal is time.

Ludwig von Mises, a student of Böhm-Bawerk, and Murray Rothbard, a student of Mises, refined Böhm-Bawerk's pioneering work when they examined the overriding importance of time in the market process. This sadly neglected matter is obviously relevant to the exploitation charge. Here's Mises in Human Action:

The prices of consumers’ goods are by the interplay of the forces operating on the market apportioned to the various complementary factors cooperating in their production. As the consumers’ goods are present goods, while the factors of production are means for the production of future goods, and as present goods are valued higher than future goods of the same kind and quantity, the sum thus apportioned ... falls behind the present price of the consumers’ goods concerned. This difference is the originary interest.... [Emphasis added.]

The difference between the sum of the prices of the complementary factors of production and the products which emerges ... is an outcome of the higher valuation of present goods as compared with future goods. As production goes on, the factors of production are transformed or ripen into present goods of a higher value. This increment is the source of specific proceeds flowing into the hands of the owners of the factors of production, of originary interest.

He went on:

Originary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remote periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods. [Emphasis added.]

In other words, all action takes place in time, including the production of consumer goods, which in an advanced economy takes place through many stages over long periods, each progressively closer to the final consumer-goods stage. It is helpful to think of all the factors of production as unfinished consumer goods to some degree. The capitalist pays factor owners in the present to combine their labor, land, and capital goods to advance the "ripening" of the factors into future finished consumer goods. Consumption is what the market process is all about. He can do this through free market exchanges because some people more eagerly prefer money sooner, before the goods are finished and sold, rather than later, after the finished goods are sold. Because we prefer money sooner rather than later, present money is discounted against future money. Waiting for a future payment requires a premium, that is, interest; advance payment requires a discount of the future amount.

What looks to the unschooled like exploitation, is not exploitation at all. The workers and landowner must have found the exchange worthwhile or they would not have agreed to it. If the capitalist's vision of the future is wrong and consumers don't like the final product or the asking price, the capitalist is out of luck. He suffers losses. He can't get a refund from the workers and landowners.

In Man, Economy, and State, Rothbard explained the structure of production and the remuneration of the factor owners in much greater detail, drawing on the pioneering work in capital, rent, and interest theory by the American "Austrian" economist, Frank A. Fetter (1863-1949). Joseph Salerno has noted that Rothbard's 1962 treatise was a major original contribution to our economic understanding. Rothbard wrote (all emphasis in the original):

An individual or a group of individuals acting jointly can..., at present, offer to pay money to the owners of land and labor, thus buying the services of their factors. The factors then work and produce the product, which, under the terms of their agreement, belongs to the new class of product-owners. These product-owners have purchased the services of the land and labor factors as the latter have been contributing to production; they [product-owners] then sell the final product to the consumers.

What has been the contribution of these product-owners, or “capitalists,” to the production process? It is this: the saving and restriction of consumption, instead of being done by the owners of land and labor, has been done by the capitalists. The capitalists originally saved, say, 95 ounces of gold which they could have then spent on consumers’ goods. They refrained from doing so, however, and, instead, advanced the money to the original owners of the factors. They paid the latter for their services while they were working, thus advancing them money before the product was actually produced and sold to the consumers.

That is known as a harmony of interests, not exploitation. Diverging time preferences create opportunities for mutual gains from trade.

The capitalists, therefore, made an essential contribution to production. They relieved the owners of the original factors from the necessity of sacrificing present goods and waiting for future goods. Instead, the capitalists have supplied present goods from their own savings (i.e., money with which to buy present goods) to the owners of the original factors. In return for this supply of present goods, the latter contribute their productive services to the capitalists, who become the owners of the product.

Or as he put it elsewhere, "[W]hen a capitalist hires a worker or rents land, he will pay now, not the factor’s full marginal product, but the expected future marginal product discounted by the social rate of time-preference."

Rothbard emphasized that what prompts the capitalist's offer to workers and landowners is the anticipated spread between what he pays now and what he expects to reap when he sells his goods later. That spread is the interest rate. The return is not to capital; it's to waiting. Time and time preference permeate the market process.

Rothbard made a crucial point about the ownership of capital goods that further debunks the exploitation theory:

[T]hese capital goods, it must be stressed, do [the owner] no good whatever. Thus, suppose that a capitalist has already advanced 80 ounces over a period of many months to owners of labor and land in a line of production. He has in his ownership, as a result, a mass of fifth-, fourth-, and third-order capital goods. None of these capital goods is of any use to him, however, until the goods can be further worked on and the final product obtained and sold to the consumer. [My boldface emphasis.]

The capitalist's vulnerability is not to be envied. What does he own? Goods-in-process-of-completion (capital goods), which may require many more stages over a long period before they are ready for the retail shelves—assuming shoppers will want them at the price asked. Consumers have no use for unfinished goods. Rothbard wrote:

Popular literature attributes enormous “power” to the capitalist and considers his owning a mass of capital goods as of enormous significance, giving him a great advantage over other people in the economy. We see, however, that this is far from the case; indeed, the opposite may well be true. For the capitalist has already saved from possible consumption and hired the services of factors to produce his capital goods. The owners of these factors have the money already for which they otherwise would have had to save and wait (and bear uncertainty), while the capitalist has only a mass of capital goods, a mass that will prove worthless to him unless it can be further worked on and the product sold to the consumers.

Another reason the capitalist's revenues might exceed his payments to factor owners is pure entrepreneurial profit. Profit, as opposed to interest, is a confirmation of the entrepreneur's hunch that the market had undervalued the factors of production with respect to consumers' wants. Israel Kirzner, a student of Mises, would say that the entrepreneur has improved market coordination. The entrepreneur might have been wrong and suffered a loss. The future is uncertain. Profits do not last, however, because they attract competitors, who bid up the factor prices and lower the price of the consumer good.

The socialists have it wrong. What they see is not exploitation. Rather, it is all-pervasive time, time preference, interest, and risk tolerance.

Production for Profit Is Production for People, part 2

"In his capacity as a businessman a man is a servant of the consumers, bound to comply with their wishes. He cannot indulge in his own whims and fancies. But his customers’ whims and fancies are for him ultimate law, provided these customers are ready to pay for them. He is under the necessity of adjusting his conduct to the demand of the consumers. If the consumers, without a taste for the beautiful, prefer things ugly and vulgar, he must, contrary to his own convictions, supply them with such things. If consumers do not want to pay a higher price for domestic products than for those produced abroad, he must buy the foreign product, provided it is cheaper. An employer cannot grant favors at the expense of his customers. He cannot pay wage rates higher than those determined by the market if the buyers are not ready to pay proportionately higher prices for commodities produced in plants in which wage rates are higher than in other plants.

"It is different with man in his capacity as spender of his income. He is free to do what he likes best."

—Ludwig von Mises, Human Action

Production for Profit Is Production for People

"Profit and loss can be expressed in definite amounts of money. It is possible to ascertain in terms of money how much an individual has profited or lost. However, this is not a statement about this individual’s psychic profit or loss. It is a statement about a social phenomenon, about the individual’s contribution to the societal effort as it is appraised by the other members of society. It does not tell us anything about the individual’s increase or decrease in satisfaction or happiness. It merely reflects his fellow men’s evaluation of his contribution to social cooperation. This evaluation is ultimately determined by the efforts of every member of society to attain the highest possible psychic profit. It is the resultant of the composite effect of all these people’s subjective and personal value judgments as manifested in their conduct on the market."

—Ludwig von Mises, Human Action