From State to Society

Privatization—the transfer of functions and assets from the coercive “public” sector to the voluntary private sector—is a central part of the classical liberal program for radically reducing government influence in society. But not all privatization is created equal, and not everything that goes by that name would reduce the power and scope of the state. Some suggest that economic efficiency demands that the speed of transfer should take precedence over the manner of transfer, apparently on the assumption that by some “invisible hand” Coasean process assets will always end up with the “right” people. But we have good reason to believe that how privatization proceeds is important to satisfying both justice and efficiency criteria.

Is privatization even the right word for what classical liberals (henceforth liberals) want? Does it capture the essence of their objective? We shall see, but first let’s explore the virtues of getting functions and assets out of the hands of government officials.

One need not be an anarchist to appreciate that the state suffers two grave flaws in its provision of services. These have been dubbed the calculation/knowledge problem and the incentive problem.

The Calculation/Knowledge Problem

The elaboration of the knowledge problem occurred during the famous debate over the efficacy of state socialism launched in 1920 by Austrian economist Ludwig von Mises and extended in the 1930s by his student F. A. Hayek. The upshot of the critique is that outside the market—that is, the economic-political-legal environment in which the means of production are privately held and freely traded—those who make decisions to allocate scarce means among competing ends necessarily act without the indispensable ability to engage in the economic calculation that prices routinely accord market participants. Prices, Mises wrote, permit disparate resources to be expressed in terms of a common denominator—the monetary unit—enabling people to appraise and compare the profitability of various possible products and production plans.

One doesn’t engage in abstract production. Rather, one chooses to produce item X rather than item Y. But that’s just the beginning. Having decided on item X, should one use method A—with one combination of labor, raw materials, and producers’ goods—or method B—with a different combination? Mises showed that these questions cannot be rationally answered without the money prices that markets generate through the free exchange of labor services and privately owned land, raw materials, and capital goods. In the absence of prices for the means of production, even a dictator who cared nothing for what consumers wanted would be unable to calculate the most efficient way to produce all the things he thought should be produced.

Reeling from Mises’s body blows, the state socialist theorists conceded his point—even as they missed it—and revised their doctrine ostensibly to accommodate it. Yes, prices are necessary, they said, but markets are not necessary to have prices. Given a powerful enough computer, bureaucrats could use a system of simultaneous equations to impute prices to producers’ goods based on consumer demand and to achieve the conditions of general equilibrium.

At this point, Hayek grabbed the baton to argue that the “market socialists” failed to understand the true epistemological nature of prices. Much of the knowledge that motivates people’s actions is never articulated or even articulable. Thus there is no way that bureaucrats could acquire it for use in their equations. Indeed, critical “data” on which people act, far from being “given,” do not even exist before individuals are confronted with often-unanticipated alternatives. Socialist economists then regrouped and concocted schemes intended to arrive at market prices by nonmarket means—schemes Hayek demolished handily.

As Hayek wrote in his influential 1945 article, “The Use of Knowledge in Society”:

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate “given” resources—if “given” is taken to mean given to a single mind which deliberately solves the problem set by these “data.” It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.

What does it mean to produce, economically speaking? It obviously does not mean that something is created out of nothing. That power is denied the human race. Production, instead, is transformation, the conversion of resources from one form to another. As praxeological beings, we logically cannot wish to convert resources from a preferred form to a non-preferred form. That is, no one can want a production process that destroys rather than creates (subjective) value. However, in a world of fallible people, a process expected to create value could end up destroying it.

We should hope, then, that the economic system would facilitate the creation of value. In a world of scarcity, devoting resources to a process that turns out to be destructive has a cost not merely in the lost resources, but the loss of whatever those resources could have produced instead.

Mises elaborated the role of prices in this context. Market-generated factor prices enable entrepreneurs to envision productive plans whose final consumer goods are anticipated to pay returns that exceed the total money cost of the inputs. That return is pure entrepreneurial profit. If things work out that way, it is a sign that value has been created.

Such profit is the result of complex arbitrage. In simple arbitrage, one buys low, then turns around and sells high. With the complex arbitrage of entrepreneurship, one buys inputs low and after a period of production, sells the transformed product high. In other words, a successful risk-taking entrepreneur intuits that inputs are undervalued with respect to how consumers appraise the final product. Profit is the entrepreneur’s reward for his correct judgment.

Losses indicate that value has been destroyed. They force producers to revise their plans to better satisfy consumers or transfer their assets to those who will. As Mises liked to point out, in a market economy, devoid of all privilege, the people as consumers ultimately determine who controls the means of production. Ironically, it is the individualist free market that delivers on the state socialist’s collectivist promise.

The lure of profit in a competitive free market induces entrepreneurs to please consumers, often in ways the consumers never imagined, and aligns personal interest with social betterment. Moreover, profits and the price system are the principal way in which individuals in what Adam Smith termed a “great society” can coordinate their disparate plans and expectations with one another, which is critical to all people’s hopes of realizing their aspirations. As Hayek emphasized, the trial and error of competition is “a discovery procedure,” enabling us to learn things we couldn’t have learned otherwise.

The implications for government provision of services should be plain. The difference between a private, profit-seeking competitive enterprise in a freed market and a monopolistic government bureaucracy is vast, as Mises explained in his book Bureaucracy. In contrast to the enterprise, the bureaucracy obtains its revenue by compulsion—that is, taxation. While an enterprise must offer its products and services to potential consumers who are free to say no, a bureaucracy looks to the taxman. Saying no is not an option for “consumers” of government services. Aside from the moral defect in this arrangement, economics tells us a bureaucracy that can compel support will lack the feedback that free consumers constantly provide competitive enterprises. In other words, government services are not subject to market pricing, leaving no way to gauge relative consumer demand. It is hardly mysterious that government services are inferior to what a competitive market would provide.

In a mixed economy bureaucracies are not totally immune from market forces. Their inputs are, after all, purchased in the marketplace. However, the revenues that fund their operations are obtained coercively and allocated to them without regard to consumer demand, so they don’t face the same constraints that competitive enterprises face. And of course not all of the government’s inputs are purchased on the market—consider those obtained through eminent domain and conscription.

The Incentive Problem

Even if we assume away the calculation/knowledge problem, the prospects of government’s satisfactory provision of services would remain bleak. Could we expect bureaucracies ably to serve their “customers”? According to the Public Choice school of political economy, no. Why not? Because there is no reason to assume that “public servants” would have the incentive to serve the public even if they knew precisely what that required.

Public Choice brought a neglected realism to the study of government by introducing the assumption that politicians and bureaucrats are motivated much like everyone else. Without dismissing the possibility that some of them sometimes intend to do good, it is nevertheless the case that they see the world, as the rest of us do, through the prism of personal interest. They are pursuing careers—striving for higher incomes, security, prestige, influence, authority, and power. Separating the personal from the public good is not as simple as it might seem. Public Choice teaches that there are simply no grounds for assuming that people in the private sector tend to be “greedy” while people in the government sector tend to be altruistic.

This, however, is an incomplete statement of the incentive problem, which can be filled out by adding the “ruling-class factor.” This is the government’s inherent tendency to serve the interests of a well-connected elite, historically most often a business elite. This is not to say that politicians and bureaucrats ignore the masses; in a democracy they must do enough to obtain and retain power. But that is not incompatible with the fact that, as the iron law of oligarchy holds, a relatively small subset of society necessarily will emerge as most influential over government policy.

Public Choice has identified one reason for this: Government programs concentrate their benefits on well-organized and relatively small interest groups, while dispersing the costs of their proposals among the mass population. The cost to any individual of any particular program is small, though the aggregate cost of all programs is huge, as is the aggregate cost to the entire society. How much would a consumer be willing to spend to oppose, say, the restrictions on sugar imports (which benefit a few domestic sugar producers), if the program costs her a few dollars per year? That assumes she is even aware of the extra cost or its cause. (Government has myriad ways to raise political transaction costs.)

The system will tend toward interventions that socialize risk and cost, create artificial scarcities (such as intellectual “property”), and privatize the resulting “excess” profits. In contrast, the free market would privatize costs and through competition progressively “socialize” benefits. (Frédéric Bastiat has much to say about this in chapter 8, “Private Property and Common Wealth,” of Economic Harmonies.)

Given the power of government to distribute other people’s money, it is inevitable in a democracy that candidates and well-organized interest groups will gravitate toward one another, resulting in an environment in which government is reasonably seen as the “executive committee of the ruling class.” (Contrary to the apparently Marxian tone of this discussion, class analysis originated with French classical-liberal economists in the early nineteenth century, something of which Marx was quite aware.)

Privatization

Thus the state cannot be counted on to provide satisfactory goods and services to the general population. So what is to be done? The answer is for government to divest itself of assets and functions. Before discussing how, we should acknowledge that some things government does should not be privatized—simply because those things shouldn’t be done by anyone. For example, if a government conscripted men and women for the military (or civilian workforce), liberals would not propose privatizing the machinery of the draft in the name of efficiency. Rather, they would propose abolishing conscription because it amounts to slavery. Similarly with many other functions governments perform, including taxation, occupational licensing (as opposed to rating and certification), administration of the “war on drugs,” and foreign military intervention.

For more than a decade, prison administration has subject to privatization. According to Corey Mason of the Sentencing Project, author of “Too Good to Be True: Private Prisons in America”:

In 2010, private prisons held 128,195 of the 1.6 million state and federal prisoners in the United States, representing eight percent of the total population. For the period 1999–2010, the number of individuals held in private prisons grew by 80 percent, compared to 18 percent for the overall prison population. While both federal and state governments increasingly relied on privatization, the federal prison system’s commitment to privatization grew much more dramatically. The number of federal prisoners held in private prisons rose from 3,828 to 33,830, an increase of 784 percent, while the number of state prisoners incarcerated privately grew by 40 percent, from 67,380 to 94,365. Today, 30 states maintain some level of privatization, with seven states housing more than a quarter of their prison populations privately.

Private prisons combine the two negatives already mentioned: Rather than ceding a service to the competitive market, prison privatization constitutes merely the contracting-out of a government monopoly. Whatever efficiencies that may be realized through the competitive bidding for a monopoly government contract, the resulting service can hardly be considered “free market.”

Moreover, many prisoners are victims of a government function no one should perform: enforcement of victimless crime laws, including limits on immigration. Indeed, Corey writes:

Public policies adopted during the 1970s and 1980s facilitated an increase in prison privatization. The War on Drugs and harsher sentencing policies, including mandatory minimum sentences, fueled a rapid expansion in the nation’s prison population. The resulting burden on the public sector led private companies to reemerge during the 1970s to operate halfway houses. They extended their reach in the 1980s by contracting with the Immigration and Naturalization Service (INS) to detain undocumented immigrants. These forms of privatization “on the ‘soft’ end of the correctional continuum” were followed by the reappearance of for-profit prison privatization.

A better way to prevent burdens on the government prison system would be to abolish victimless crime laws and reserve prison sentences for habitually violent criminals, replacing punishment with restitution whenever feasible. The alternative is to give “private” companies an incentive to support imprisonment for a wider variety of offenses, both real and victimless. As Sean Gabb, director of the Libertarian Alliance in England, writes regarding the British experience with privatization:

[It] is leading to the abolition of the distinction between public and private. Security companies, for example, are being awarded contracts to ferry defendants between prison and court, and in some cases to build and operate prisons. This has been sold to us on the—perfectly correct —grounds that it ensures better value for money. But it also involves grants of state powers of coercion to private organisations. All over the country, private companies are being given powers of surveillance and control greater than the Police used to possess.

If we confine our attention to functions that may legitimately be performed in the marketplace, the label privatization is applied to a disparate group of measures. On the one hand, it is used to describe Great Britain’s and the Czech Republic’s programs to transfer state firms to private hands in the 1980s and 1990s, respectively. On the other, when Baltimore in the 1990s contracted with Education Alternatives Inc. to run nine city schools, that also was called privatization, despite the city’s maintenance of ownership and coercive funding of the schools. It was merely contracting out a government monopoly.

The word is also used in connection with the contracting out of the New Jersey state lottery, DMV, state parks, psychiatric hospitals, and turnpike toll booths, all of which ultimately remain government responsibilities.

This should lead us to refine our idea of what liberals seek. It’s not privatization per se, but free competition through voluntary exchange, that is desirable. It matters little whether the government calls people who perform its functions public employees or private contractors. In fact, when a company becomes a monopoly government contractor, to that extent it is an arm of the state rather than a private firm. (See Kevin Carson, “‘Private’ Versus ‘Public” Sector” and “Ephemeralization: A Weapon Against Capital” and Brad Spangler, “Recognizing Faux Private Interests that Are Actually Part of the State”)

For that reason, such ersatz “privatization” devices as contracting out and the operation of charter schools won’t be discussed here. These merely blur the line between “private” and “public” sector—which is in the nature of corporatism—and undermine the case for the genuine divestiture of state-held assets.

The problem is that we don’t have a suitable word for what liberals want. Charles W. Johnson suggests that “[w]hat we advocate is the devolution of state-confiscated wealth and state-confiscated industries back to civil society… . Now, given the diversity of cases, and all of the different ways in which government might justly devolve property from State control to civil society, privatization is really too limiting a term. So instead let’s call what we want the socialization of the means of production.”

As Johnson notes, state assets can be and have been divested in a variety of ways—some clearly better than others. Perhaps most egregious was what occurred in Russia after the fall of the Soviet Union. Russia’s “privatization,” Robert W. Poole Jr. writes, featured “a botched shares-for-debt scheme … that created an instant crop of politically connected billionaires.” Among former Soviet republics, on the other hand, the Czech Republic (which had been more collectivized than its fellow Warsaw Pact members) moved quicker than others, striving to avoid corruption and to enable widespread ownership of shares in formerly state-owned enterprises. Elsewhere in Eastern Europe (and in the developing world), Poole writes, “the privatization record was mixed with many cases of less-than-transparent sale processes (to firms well connected with government officials).”

One of the earliest and largest divestiture programs took place under British Prime Minister Margaret Thatcher in the 1980s. In Thatcher’s Britain, an effort was made to maximize individual participation and ownership. Poole writes:

Thatcher succeeded in making privatization politically popular while selling off the commanding heights of the British economy: British Airways, [the] British Airports Authority, British Petroleum, British Telecom, and several million units of public housing, to name only a few examples. Thatcher’s political strategy emphasized widespread public share offerings rather than auctions to other private firms. Over the decade, this approach tripled the number of individual shareholders in Britain, giving the policy a popular base of support. [Emphasis added.]

Britain set an example for many other countries: “By the end of the 1980s, the sale of SOEs had gone global, inspired in part by the British example. Governments in France, Germany, Japan, Australia, Argentina, and Chile all sold numerous SOEs.”

But this was not an unmixed blessing, since, Poole notes, “global privatization proceeds ran in the tens of billions of dollars each year.” Skeptics about the beneficence of government power can hardly thrill to the thought of politicians acquiring tens of billions of new dollars with which to make mischief. In addition, “[i]n the case of public utilities (airports, electricity, water, etc.), privatization generally led to the creation of some form of regulatory oversight if the company remained a monopoly provider.”

Moreover, Thatcher’s privatization was not all that it seemed on the surface. As Gabb observes:

As reconstructed in the 1980s … the new statism is different. It looks like private enterprise. It makes a profit. Those in charge of it are paid vast salaries, and smugly believe they are worth every penny.

Undoubtedly, there are benefits. We have the most open and deregulated telephone network in the world. The other utilities give better value for money than they did. The internal market in the National Health Service is beginning to cap the otherwise limitless rise in welfare budgets. Applied to policing, the same policies may be about to do the same for law enforcement.

But for all its external appearance, the reality is statism. And because it makes a profit, it is more stable than the old. It is also more pervasive. Look at these privatised companies, with their boards full of retired politicians, their cosy relationships with the regulators, their quick and easy ways to get whatever privileges they want… .

Ideally, then, truly competitive privatization would be effected without cronyism or privilege. How might that be accomplished? We should first specify the less-desirable methods.

While the sale of state assets either to private bidders or in the form of stock shares to the public at large seems desirable, one can make a libertarian objection. Since government possession of those assets originated in one form of usurpation or another, the requirement that they be bought back is unjust. It may be argued that the revenue could be used to benefit the general public (say, through tax cuts), but political incentives tend to work in the other direction. Politicians will see the new revenue as an opportunity to launch new programs that offer benefits to well-organized interest groups and hence it will function as the source of votes and campaign contributions.

Better, then, that state assets be seen as existing in a state of non-ownership (unless they were expropriated from identifiable legitimate owners or their successors in interest) and opened to homesteading in the spirit of John Locke. How might that work? Government elementary and secondary schools could be turned over to the people who work in them or the students’ parents, or both groups, who would be free to decide how to run them—without tax money. A government university could become the property of its students, members of its faculty and staff, or both. Some schools might organize as joint stock companies with tradable shares, while others might become consumer or producer cooperatives. Competition would determine which forms best satisfied consumers and attracted capable producers. This approach seems feasible for a variety of state-owned assets, such as post offices, airports, Amtrak, land, and buildings.

Not every state asset will be amenable to classic Lockean homesteading—interstate highways, for instance. On the other hand, residential and commercial streets could be more easily devolved via some form of homesteading by adjacent property owners, a possibility Walter Block has discussed in The Privatization of Roads and Highways, with its voluminous references to the history of private provision of roads. Also see his “Free Market Transportation: Denationalizing the Roads” (pdf); the streets of Disney World and elsewhere are working demonstrations of private provision. Since the market for roads and highways was not permitted to evolve spontaneously, we cannot know what shape this part of the economy would have taken; hence it would be impossible to create what might have been. Thus devolution to a competitive freed market may not satisfy the criteria of justice perfectly in every respect. But that should not be a barrier removing roads and highways from the inherently inefficient and unjust political realm.

Finally, we should take note of the de facto privatization that has occurred throughout history—particularly in dispute resolution. The Law Merchant was a complex, just, efficient, and spontaneously generated body of commercial law that fostered the revival of world trade after the fall of the Roman Empire. Though later codified and nationalized by states, it is instructive that when merchants of different nationalities and cultures needed an orderly process of conflict resolution, they were able to generate it without the assistance of governments. Similarly, the prevalence of private arbitration and private security (for instance in Disney World and shopping malls) constitutes de facto “socialization” of services typically associated with government.

Radically shrinking the scope of government will require the wholesale shedding of current functions. Thus genuine privatization should play an important role in the liberal project.

Also from This Issue

Response Essays

  • The Incremental Approach to Privatization by Leonard Gilroy

    Leonard Gilroy argues for the benefits of incremental privatization. The general public, he writes, must still be convinced that private entities can perform many of the services that have for a long time been provided by monopoly government entities. To win them over, demonstrations will be necessary, and these should be incremental in nature. Gilroy cites several such attempts and argues that they have successfully built support for the idea of privatization.

  • Nuanced Privatization by Dru Stevenson

    Professor Stevenson agrees that much so-called privatization does not deserve the name. It both fails to shrink the government and also creates new constituencies for government spending–the private firms who win lucrative contracts. That said, we must think very carefully about what a more privatized world would look like, and whether we would really prefer it in all cases. Are we comfortable, for example, with the largely religious education system that would likely replace state-run schools?

  • Paying Attention to Incentives by Randal O'Toole

    Randal O’Toole argues that the difference between success and failure in privatization is primarily a matter of incentives. He cites examples of failed incentive structures, like British Rail and New Zealand’s fishing quota system, as well as some successes: Denver’s Regional Transit District has contracted bus service that runs for half the cost of its government-operated lines, and Atlantic City has an entirely private bus fleet.

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