October 7, 2015

Entrepreneurs, Profits, and the Social Welfare: The Entrepreneur and the Bureaucrat

By In Blogs, Brian Jacobson

Entrepreneurs and Bureaucrats (Part 5 of this series: see 1, 2, 3, 4)

It should be clear by now in this series how entrepreneurs–constantly driven by the profit motive–order and shape the structure of production and the economy as a whole, but what about government enterprises? If we compare a government agency of similar size to a private enterprise we notice a distinctively bureaucratized system riddled with inefficiency. What is this due to? It can’t simply be size and that largeness automatically entails slowness and bureaucratic inefficiency. Many large corporations and businesses are able to adjust to market forces and restructure very quickly whereas in some federal department changes may take months and year for things to be approved. In large multi-layered corporations specific departments or firms have relative independence in the direction of their affairs whereas decisions in bureaucracies require multiple levels of oversight, approval, and strict explicit procedural changes.

Bureaucracy_ePubMises defined a bureaucracy not simply as a large inefficient firm but in its difference in management from a for-profit firm. A bureaucratic firm’s administrative actions “have no cash value on the market.”[1] It has no price on the market because it is not bought and sold voluntarily on the market. There are not various packages of police protection subscriptions to choose from on a varying degree depending on the level one is willing to pay. Each citizen pays by law his required taxes and it is expected that services will be rendered to all citizens equally. The “revenues” (if they may be called that) of a department are not the result of consumers willingness to buy but of legislative budgetary discretion or in some cases fines and fees. Thus there is no objective metric of success–profit in the business world–against which the decisions of department administrators can be weighed against. Categories of profit and loss are meaningless if not perverse when applied to a government bureaucracies like police, courts, or regulatory agencies.

This is both a difference of a management structure and accounting. It lies in the possibility of profit and loss. A corporation as a whole is subject to profit and loss and through monetary calculation each specific department’s or plant’s action alike can be evaluated by the same measure–profitability. The cost of inputs can be set and weighed against revenue from outputs and evaluated. As Mises explains the innovation of elaborate methods of accounting and double-entry bookkeeping “provide the enterpriser with a faithful image of all his operations…business transactions are examined by shrewdly calculating profit and loss. New projects are subject to a precise scrutiny of the chances they offer. Every step toward their realization is reflected in entries in the books and accounts.”[2] The entrepreneur, because of prices and the possibility of profits, is able to do cost accounting and eliminate waste, ensure that resources are directed to their most highly valued ends, and respond to price signals and shortages. “He is in a position to learn how successful or unsuccessful everyone of his transactions was…the figures provide a faithful reflection of all that is going on in every branch or department. The books and the balance sheets are the conscience of business. They are also the businessman’s compass.”[3] Profit and loss accounting then also grant him an invaluable management approach that allow a business to “grow quite large without suffering from the problems typically ascribed to bureaucracy because each unit can be isolated and evaluated in terms of profitability. The millions of decisions that must be made on a daily basis to run a large enterprise can be divided and delegated to various subordinates.”[4] Mises similarly explains:

“Within this system of business calculation each section of a firm represents an integral entity, a hypothetically independant business, as it were.  It is assumed that this section “owns” a definite part of the whole capital employed in the enterprise, that it buys from other sections and sells to them, that it has its own expenses and its own revenues, that its dealings result either in a profit or in a loss which is imputed to its own conduct of affairs as distinguished from the result of the other sections. Thus the entrepreneur can assign to each section’s management a great deal of independence. The only directive he gives to a man whom he entrusts with the management of a circumscribed job is to make as much profit as possible. An examination of the accounts shows how successful or unsuccessful the managers were in executing this directive. Every manager and sub-manager is responsible for the working of his section or subsection. It is to his credit if the accounts show a profit, and it is to his disadvantage if they show a loss. His own interests impel him toward the utmost care and exertion in the conduct of his section’s affairs.”[5]

Consider the difference between this and a government agency. Since a government entity does not have to convince their customers to purchase their services and can prevent competitors from entering the market Robert Murphy points out in his new book Choice that the self-interested profit motivation, benign in the private sector, becomes sinister in the public sector. For instance an executive may tell a sales manager, “look I really don’t care you do it, how many phone calls you make each day, or how many sales persons you hire, just increase our sails and show me the bottom line.” This may be appropriate and harmless, but imagine telling a local police chief “look I don’t care how you do it, we just need more revenue.” They will institute new excessive fines, institute regular speed traps, ignore pursuing crimes which bring no monetary reward, and will(have) become a menace to the public. The incentive problem is obvious, for the government operated bureaucracy income does not equal a job well done or satisfied customers.

Murphy gives another good example:

“In the private sector, airlines may offer their customers the option of joining an ‘elite’ club, in which they have access to fancy lounges at the airports, ride in nicer seats on the plane, and can check-in and board in the special lines while the other passengers flying coach must wait in usually longer lines. Although this state of affairs might cause resentment among some of the people flying coach, ultimately the outcome is socially beneficial:The two-tiered framework allows the airlines to extract more revenue from those customers willing to pay more for such conveniences, which translates into lower ticket prices for the people flying coach…In contrast, suppose a city’s police department adopts an implicit two-tiered scheme, whereby squad cars respond much more quickly to calls coming from households that have contributed to that year’s Police Benevolence Fund Drive. This is by no mean a socially beneficial outcome, but instead reeks of corruption and a shakedown of the citizenry. The citizens of the community are not free to withhold a portion of their taxes if they don’t think the police department is earning its budget.”[6]

The way to manage or to run, according to Mises, a coercively monopolized service (right or wrong) like the police, courts, or departments is to lay out very strict strongly enforced formal rules and procedures for each circumstance and scenario and limit the ability to make decisions on the fly. It is acceptable to do X in Y circumstance, but you may not a, b, or c. They must commit their duty with strict compliance to the rules and with extreme oversight.

The profit and loss system allows managers and sub-managers to subsume some entrepreneurial functions within their role. Yet the manager is not the entrepreneur for while he may benefit from a successful quarter through bonuses or employee dividends the manager is never answerable for losses. These losses are solely those of the owner of the capital employed. No matter how much control and leeway is given to the manager he is merely a steward and not the owner and therefore risks relatively little. One of the benefits Mises notes of the profit system and the natural self-interest of entrepreneurs and managers is that society can freely leave care for best possible use of capital goods to their owners. Since they are exposing their own savings and property they are even more interested in the success and efficiency of their own ventures than society is as a whole. “For society as a whole the squandering of capital invested in a definite project means only the loss of a small part of its total funds; for the owner it means much more, for the most part the loss of his total fortune.”[7] This is one of the serious pitfalls of public bureaucratic entities–there are no entrepreneurial losses. Indeed this is true of all political expenditures of capital. No mayor, governor, or senator is risking his own capital beyond the unlikely possible of being recalled faces no consequences for wasteful and inefficient use of capital. In fact often in political entrepreneurship failure is success. No department seems to have its funds doubled faster than one that fails miserably, and departments that steward resources wisely to the point of a budget surplus find next year’s budget decreased to that degree. In this sense the public sector functions just the opposite of the private sector. In the private sector unprofitable ventures are ceased and profitable ventures are expanded and invested in.

As Mises explained a profit-seeking business determines the amount of money expended and invested in every branch according to the behavior of consumers in the past and as forecasted in the future.[8] Bureaucratic institutions however have no sales receipts. There fundamentally can be no objective record of consumers demonstrated preferences since it is a public good for all equally and is funded through automatically and coercively deductive taxes. They have no metric for determining what areas of a department ought to be more heavily investing or which ones are actually unnecessary and undesired by the public. “The methods of economic calculation, and especially those of double-entry bookkeeping, are not applicable to them. success or failure of a department’s activities cannot be ascertained according to the arithmetical procedures of profit-seeking business. No accountant can establish whether or not a police department or one of its subdivisions has succeeded.”[9]

Consider a department which to my mind is the most comparable to many similar private enterprises: The Department of Parks and Recreation. Many non-governmental entities provide a variety of parks from amusement and waterparks parks like Disney or Six Flags all the way to your local Legion and VFW ball field. Many real estate developers and private conservation groups also build and design parks similar to the ones created by Department of Parks and Recreation. These privately created parks have little trouble determining how and if resources are being allocating to their most urgent areas or satisfying consumer demand. If these park-entrepreneurs (let’s say the private owners of a soccer complex) decide that they should invest and build a large aquatics park and rock climbing area in successive stages to branch out as a more broad recreation facility. They will find out relatively shortly if this was a good idea since actual consumer use and willingness to pay will limit the size and profitability of the new venture. If it is unsuccessful the entrepreneurs may conclude that either not enough people in the area desire these amenities or that others in the area have already sufficiently served those who do enjoy those amenities. Or, if one thinks of a place like California, the resources to build and run these facilities are too badly needed elsewhere to make the venture profitable. They are at all times limited by almighty consumer. “No such limitation is enjoined upon the allocation of funds for the performance of the tasks incumbent upon government activities.”[10]

If the Department of Parks and Recreation’s budget was quadrupled next year there is no doubt they would build many wonderful and even beautiful parks, but there is no way to determine that these parks reflect consumer wishes. Nor would it be possible to determine if the capital expended was more urgently needed elsewhere in society. All the capital and labor employed building parks is capital, labor, and land that cannot be used elsewhere. There is “no accountant [that] can establish whether or not a department or one of its subdivisions has succeeded.”[11] The question expands even beyond what the private sector could have done with said capital. What about other departments within the government? All resources allocated to building more parks are resources not going to police departments, sanitation, or schools (not that I care as libertarian).  The question of whether or not the service rendered is enough to justify the restriction of all other government services and the restriction on the private consumption of taxpayers cannot be answered without the profit and loss system and the voluntary choices of consumers.

It should also be patently obviously why it is an absurdity to attempt to “run government like a business.”

[1] Ludwig von Mises, Human Action, 305.

[2] Ludwig von Mises, Bureaucracy, 31.

[3] Ibid, 32.

[4] Robert Murphy, Choice: Enterprise, Cooperation, and Human Action, 144.

[5] Ludwig von Mises, Human Action, 301-302.

[6] Robert Murphy, Choice: Enterprise, Cooperation, and Human Action, 144-145.

[7] Ludwig von Mises, Human Action, 303.

[8] Ibid, 305.

[9] Ibid.

[10] Ibid, 306.

[11] Ibid, 305.

Written by Brian Jacobson

Brian Jacobson works as a quality technician for a manufacturing company in St. Louis, Mo where he lives with his new bride. He studied biblical and theological studies at Reformation Bible College under R.C. Sproul in Orlando, FL. He’s an Old-School Presbyterian who enjoys the simple means of grace, Machen, and living the high life on a budget. Follow him @briankjacobson on Twitter.