The Fallacy of the 'Public Sector'

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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 by.

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.

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!

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 idyll.

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.

Day 17
of Robert Wenzel’s 30-day
reading list
that will lead you to become a knowledgeable
libertarian, this article is excerpted from Economic
, chapter 21, "The Fallacy of the ‘Public
Sector’" (2011). It originally appeared in the New Individualist
Review (Summer, 1961): 3–7.

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.

2012 by the Ludwig von Mises Institute.
Permission to reprint in whole or in part is hereby granted, provided
full credit is given.

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