The Fallacy of the Public Sector

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published in the Summer 1961 issue of the
Individualist Review

have heard a great deal in recent years of the "public sector,"
and solemn discussions abound through the land on whether or not
the public sector should be increased vis-à-vis the
"private sector." The very terminology is redolent of
pure science, and, indeed, it emerges from the supposedly scientific,
if rather grubby, world of "national income statistics."
But the concept is hardly Wertfrei; in fact, it is fraught
with grave, and questionable, implications.

the first place, we may ask: "public sector" of what?
Of something called the "national product." But note the
hidden assumptions: that the national product is something like
a pie, consisting of several "sectors," and that these
sectors, public and private alike, are added to make the product
of the economy as a whole. In this way, the assumption is smuggled
into the analysis that the public and private sectors are equally
productive, equally important, and on an equal footing altogether,
and that "our" deciding on the proportions of public to
private sector is about as innocuous as any individual's decision
on whether to eat cake or ice cream. The State is considered to
be an amiable service agency, somewhat akin to the corner grocer,
or rather to the neighborhood lodge, in which "we" get
together to decide how much "our government" should do
for (or to) us. Even those neoclassical economists who tend to favor
the free market and free society often regard the State as a generally
inefficient, but still amiable, organ of social service, mechanically
registering "our" values and decisions.

would not think it difficult for scholars and laymen alike to grasp
the fact that government is not like the Rotarians or the Elks;
that it differs profoundly from all other organs and institutions
in society; namely, that it lives and acquires its revenues by coercion
and not by voluntary payment. The late Joseph Schumpeter was never
more astute than when he wrote:

theory which construes taxes on the analogy of club dues or of
the purchase of the services of, say, a doctor only proves how
far removed this part of the social sciences is from scientific
habits of mind.1

from the public sector, what constitutes the productivity of the
"private sector" of the economy? The productivity of the
private sector does not stem from the fact that people are rushing
around doing something, anything, with their resources; it consists
in the fact that they are using these resources to satisfy the needs
and desires of the consumers. Businessmen and other producers direct
their energies, on the free market, to producing those products
which will be most rewarded by the consumers; and the sale of these
products may, therefore, roughly "measure" the importance
which the consumers place upon them. If millions of people bend
their energies to producing horses-and-buggies, they will, in this
day and age, not be able to sell them, and hence the productivity
of their output will be virtually zero. On the other hand, if a
few million dollars are spent in a given year on product X, then
statisticians may well judge that these millions constitute the
productive output of the X part of the "private sector"
of the economy.

of the most important features of our economic resources is their
scarcity; land, labor, and capital good factors are all scarce,
and may all be put to varied possible uses. The free market uses
them "productively" because the producers are guided,
on the market, to produce what the consumers most need; automobiles,
for example, rather than buggies. Therefore, while the statistics
of the total output of the private sector seem to be a mere adding
of numbers, or counting units of output, the measures of output
actually involve the important qualitative decision of considering
as "product" what the consumers are willing to buy. A
million automobiles, sold on the market, are productive because
the consumers so considered them; a million buggies, remaining unsold,
would not have been "product" because the consumers would
have passed them by.

now, that into this idyll of free exchange enters the long arm of
government. The government, for some reasons of its own, decides
to ban automobiles altogether (perhaps because the many tailfins
offend the aesthetic sensibilities of the rulers) and to compel
the auto companies to produce the equivalent in buggies instead.
Under such a strict regimen, the consumers would be, in a sense,
compelled to purchase buggies because no cars would be permitted.
However, in this case, the statistician would surely be purblind
if he blithely and simply recorded the buggies as being just as
"productive" as the previous automobiles. To call them
equally productive would be a mockery; in fact, given plausible
conditions, the "national product" totals might not even
show a statistical decline when they had actually fallen drastically.

yet the highly-touted "public sector" is in even worse
straits than the buggies of our hypothetical example. For most of
the resources consumed by the maw of government have not even been
seen, much less used, by the consumers who were at least allowed
to ride in their buggies. In the private sector a firm's productivity
is gauged by how much the consumers voluntarily spend on its product.
But in the public sector, the government's "productivity"
is measured – mirabile dictu – by how much it spends!
Early in their construction of national product statistics, the
statisticians were confronted with the fact that the government,
unique among individuals and firms, could not have its activities
gauged by the voluntary payments of the public – because there
were little or none of such payments. Assuming, without any proof,
that government must be as productive as anything else, they then
settled upon its expenditures as a gauge of its productivity. In
this way, not only are government expenditures just as useful as
private, but all the government need do in order to increase its
"productivity" is to add a large chunk to its bureaucracy.
Hire more bureaucrats and see the productivity of the public sector
rise! Here, indeed, is an easy and happy form of social magic for
our bemused citizens.

truth is exactly the reverse of the common assumptions. Far from
adding cozily to the private sector, the public sector can only
feed off the private sector; it necessarily lives parasitically
upon the private economy. But this means that the productive resources
of society – far from satisfying the wants of consumers –
are now directed, by compulsion, away from these wants and needs.
The consumers are deliberately thwarted, and the resources of the
economy diverted from them to those activities desired by the parasitic
bureaucracy and politicians. In many cases, the private consumers
obtain nothing at all, except perhaps propaganda beamed to them
at their own expense. In other cases, the consumers receive something
far down on their list of priorities like the buggies of our example.
In either case, it becomes evident that the "public sector"
is actually antiproductive; that is, subtracts from rather than
adds to the private sector of the economy. For the public sector
lives by continuous attack on the very criterion that is used to
gauge productivity: the voluntary purchases of consumers.

may gauge the fiscal impact of government on the private sector
by subtracting government expenditures from the national product.
For government payments to its own bureaucracy are hardly additions
to production; and government absorption of economic resources takes
them out of the productive sphere. This gauge, of course, is only
fiscal; it does not begin to measure the antiproductive impact of
various government regulations, which cripple production and exchange
in other ways than absorbing resources. It also does not dispose
of numerous other fallacies of the national product statistics.
But, at least, it removes such common myths as the idea that the
productive output of the American economy increased during World
War II. Subtract the government deficit instead of adding it, and
we see that the real productivity of the economy declined, as we
would rationally expect during a war.

another of his astute comments, Joseph Schumpeter wrote, concerning
anticapitalist intellectuals:

stands its trial before judges who have the sentence of death
in their pockets. They are going to pass it, whatever the defense
they may hear; the only success victorious defense can possibly
produce is a change in the indictment.2

indictment has certainly been changing. In the 1930s, we heard that
government must expand because capitalism had brought about mass
poverty. Now, under the aegis of John Kenneth Galbraith, we hear
that capitalism has sinned because the masses are too affluent.
Where once poverty was suffered by "one-third of a nation,"
we must now bewail the "starvation" of the public sector.

what standards does Dr. Galbraith conclude that the private sector
is too bloated and the public sector too anemic, and, therefore,
that government must exercise further coercion to rectify its own
malnutrition? Certainly, his standard is not historical. In 1902,
for example, net national product of the United States was $22.1
billion; government expenditure (Federal, state, and local) totaled
$1.66 billion or 7.1 percent of the total product. In 1957, on the
other hand, net national product was $402.6 billion, and government
expenditures totaled $125.5 billion, or 31.2 percent of the total
product. Government's fiscal depredation on the private product
has, therefore, multiplied from four- to five-fold over the present
century. This is hardly "starvation" of the public sector.
And yet, Galbraith contends that the public sector is being increasingly
starved, relative to its status in the nonaffluent nineteenth century!

standards, then, does Galbraith offer us to discover when the public
sector will finally be at its optimum? The answer is nothing but
personal whim:

will be question as to what is the test of balance – at what
point may we conclude that balance has been achieved in the satisfaction
of private and public needs. The answer is that no test can be
applied, for none exists…. The present imbalance is clear….
This being so, the direction in which we move to correct matters
is utterly plain.3

Galbraith, the imbalance of today is "clear." Clear, why?
Because he looks around him and sees deplorable conditions wherever
government operates. Schools are overcrowded, urban traffic is congested,
the streets littered and rivers are polluted; he might have added
that crime is increasingly rampant and the courts of justice clogged.
All of these are areas of government operation and ownership. The
one supposed solution for these glaring defects is to siphon more
money into the government till.

how is it that only government agencies clamor for more money and
denounce the citizens for reluctance to supply more? Why do we never
have the private enterprise equivalents of traffic jams (which occur
on government streets), mismanaged schools, water shortages, etc.?
The reason is that private firms acquire the money that they deserve
from two sources: voluntary payment for the services by consumers
and voluntary investment by investors in expectation of consumer
demand. If there is an increased demand for a privately-owned good,
consumers pay more for the product, and investors invest more in
its supply, thus "clearing the market" to everyone's satisfaction.
If there is an increased demand for a publicly-owned good (water,
streets, subway, etc.), all we hear is annoyance at the consumer
for wasting precious resources, coupled with annoyance at the taxpayer
for balking at a higher tax load. Private enterprise makes it its
business to court the consumer and to satisfy his most urgent demands;
government agencies denounce the consumer as a troublesome user
of their resources. Only a government, for example, would look fondly
upon the prohibition of private cars as a "solution" for
the problem of congested streets. Government's numerous "free"
services, moreover, create permanent excess demand over supply and,
therefore, permanent "shortages" of the product. Government,
in short, acquiring its revenue by coerced confiscation rather than
by voluntary investment and consumption, is not and cannot be run
like a business. Its inherent gross inefficiencies, the impossibility
for it to clear the market, will insure its being a mare's nest
of trouble on the economic scene.4

former times, the inherent mismanagement of government was generally
considered a good argument for keeping as many things as possible
out of government hands. After all, when one has invested in a losing
proposition, one tries to refrain from pouring good money after
bad. And yet, Dr. Galbraith would have us redouble our determination
to pour the taxpayer's hard-earned money down the rathole of the
"public sector," and uses the very defects of government
operation as his major argument!

Galbraith has two supporting arrows in his bow. First, he states
that, as people's living standards rise, the added goods are not
worth as much to them as the earlier ones. This is standard knowledge;
but Galbraith somehow deduces from this decline that people's private
wants are now worth nothing to them. But, if that is the case, then
why should government "services," which have expanded
at a much faster rate, still be worth so much as to require a further
shift of resources to the public sector? His final argument is that
private wants are all artificially induced by business advertising
which automatically "creates" the wants that it supposedly
serves. In short, people, according to Galbraith, would, if let
alone, be content with nonaffluent, presumably subsistence-level
living; advertising is the villain that spoils this primitive

from the philosophical problem of how A can "create" B's
wants and desires without B's having to place his own stamp of approval
upon them, we are faced here with a curious view of the economy.
Is everything above subsistence "artificial"? By what
standard? Moreover, why in the world should a business go through
the extra bother and expense of inducing a change in consumer wants,
when it can profit by serving the consumer's existing, "uncreated"
wants? The very "marketing revolution" that business is
now undergoing, its increased and almost frantic concentration on
"market research," demonstrates the reverse of Galbraith's
view. For if by advertising, business production automatically creates
its own consumer demand, there would be no need whatever for market
research – and no worry about bankruptcy either. In fact, far
from the consumer in an affluent society being more of a "slave"
to the business firm, the truth is precisely the opposite: for as
living standards rise above subsistence, the consumer gets more
particular and choosey about what he buys. The businessman must
pay even greater court to the consumer than he did before; hence
the furious attempts of market research to find out what the consumers
want to buy.

is an area of our society, however, where Galbraith's strictures
on advertising may almost be said to apply – but it is in an
area that he curiously never mentions. This is the enormous amount
of advertising and propaganda by government. This is advertising
that beams to the citizen the virtues of a product which, unlike
business advertising, he never has a chance to test. If cereal company
X prints a picture of a pretty girl declaiming that "Cereal
X is yummy," the consumer, even if doltish enough to take this
seriously, has a chance to test that proposition personally. Soon
his own taste determines whether he will buy or not. But, if a government
agency advertises its own virtues over the mass media, the citizen
has no direct test to permit him to accept or reject the claims.
If any wants are artificial, they are those generated by government
propaganda. Furthermore, business advertising is, at least, paid
for by investors, and its success depends on the voluntary acceptance
of the product by the consumers. Government advertising is paid
for by means of taxes extracted from the citizens, and hence can
go on, year after year, without check. The hapless citizen is cajoled
into applauding the merits of the very people who, by coercion,
are forcing him to pay for the propaganda. This is truly adding
insult to injury. If Dr. Galbraith and his followers are poor guides
for dealing with the public sector, what standard does our analysis
offer instead? The answer is the old Jeffersonian one: "that
government is best which governs least." Any reduction of the
public sector, any shift of activities from the public to the private
sphere, is a net moral and economic gain.

economists have two basic arguments on behalf of the public sector
which we may only consider very briefly here. One is the problem
of "external benefits." A and B often benefit, it is held,
if they can force C into doing something. Much can be said in criticism
of this doctrine; but suffice it to say here that any argument proclaiming
the right and goodness of, say, three neighbors, who yearn to form
a string quartet, forcing a fourth neighbor at bayonet point to
learn and play the viola, is hardly deserving of sober comment.
The second argument is more substantial; stripped of technical jargon,
it states that some essential services simply cannot be supplied
by the private sphere and that, therefore, government supply of
these services is necessary. And yet, every single one of the services
supplied by government has been, in the past, successfully furnished
by private enterprise. The bland assertion that private citizens
cannot possibly supply these goods is never bolstered, in
the works of these economists, by any proof whatever. How is it,
for example, that economists, so often given to pragmatic or utilitarian
solutions, do not call for social "experiments" in this
direction? Why must political experiments always be in the direction
of more government? Why not give the free market a county, or even
a state or two, and see what it can accomplish?

In the preceding sentence, Schumpeter wrote:

friction or antagonism between the private and the public sphere
was intensified from the first by the fact that…the state has
been living on a revenue which was being produced in the private
sphere for private purposes and had to be deflected from these
purposes by political force.



  1. Joseph A.
    Schumpeter, Capitalism,
    Socialism, and Democracy
    (New York: Harper and Bros.,
    1942), p. 198.
  2. Schumpeter,
    Capitalism, Socialism, and Democracy, p. 144.
  3. John Kenneth
    Galbraith, The
    Affluent Society
    (Boston: Houghton Mifflin, 1958), pp.
  4. For more
    on the inherent problems of government operations, see Murray
    N. Rothbard, "Government in Business," in Essays
    on Liberty (Irvington-on-Hudson, N.Y.: Foundation for Economic
    Education, 1958), vol. 4, pp. 183–87.

N. Rothbard (1926–1995), the founder of modern libertarianism
and the dean of the Austrian School of economics, was the author
of The
Ethics of Liberty
and For
a New Liberty
and many
other books and articles
. He was also academic vice president
of the Ludwig von Mises Institute and the Center for Libertarian
Studies, and the editor – with Lew Rockwell – of The
Rothbard-Rockwell Report

Rothbard Archives


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