The Fallacy of the 'Public Sector'

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This article
is excerpted from Economic
, chapter 21, "The Fallacy of the ‘Public
Sector’" (2011). It was originally in the New
Individualist Review
(Summer, 1961): 3–7.

We 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.

In 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.

One 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, "The 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]

Apart 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
that will be most rewarded by the consumers, and the sale of these
products may therefore roughly "measure" the importance
that 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.

One of the
most important features of our economic resources is their scarcity:
land, labor, and capital-goods factors are all scarce, and may all
be put to various 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

Suppose 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.

And 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
– 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
to 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.

The 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 it 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.

We 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 add it, and we see that the real productivity
of the economy declined, as we would rationally expect during a

In another
of his astute comments, Joseph Schumpeter wrote, concerning anticapitalist
intellectuals, "capitalism 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 a victorious
defense can possibly produce is a change in the indictment."[2]
The 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.

By 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 19th century!

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

There 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]

To 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 and
the streets littered, 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.

But 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,
and so on? 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, and so on), 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]

In 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!

Professor 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

Aside 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 choosy 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.

There 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 that, 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 Professor
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.

Most 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 sentences, Schumpeter wrote,

The friction
of 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. (Joseph A. Schumpeter, Capitalism,
Socialism, and Democracy
[New York: Harper and Bros.,
1942], p. 198)

Ibid, p. 144.

John Kenneth Galbraith, The
Affluent Society
(Boston: Houghton Mifflin, 1958), pp.

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) was dean of the Austrian
School, founder of modern libertarianism, and chief academic
officer of the Mises Institute.
He was also editor — with Lew Rockwell — of The
Rothbard-Rockwell Report
, and appointed Lew as his
literary executor. See
his books.

Best of Murray Rothbard

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