Do Governments Produce?

When I first became involved with economics, especially when I started to write for Mises.org and get involved with the online community there, it was a common belief amongst us amateur economists that the government does not produce wealth. It’s a good thing that it didn’t take me too long to realize that this is wrong. Unfortunately, there are many other people who still believe this to be true. I suspect, though, that there is a nugget of truth in what people actually believe, but that they’re confusing two separate ideas. This post is a bit rushed, but hopefully it gets my thoughts across.

In early 2011, I wrote “Government Spending is Bad Economics,” which I mostly still agree with (although my understanding of the role of public goods has changed [improved] over time). The argument is that the market enjoys certain institutions that give it an advantage over alternative frameworks of exchange. Specifically, profit and loss is a disciplining process that constrains the damage of error, since those who plan poorly will suffer a loss and those who plan well will earn a profit. This allows for a continuous redistribution of wealth that follows success. In other words, profit and loss allow for superior plan coordination.

The are other, related, advantages that I don’t discuss in the article. For example, the market is typically more competitive than government. If we look at the economy from the perspective of planning — whether planning by part of the individual with no power or planning by part of some central agency, or somewhere in between —, a competitive planning process, competition allows for a broader set of plans to be tested, and it improves (through profit and loss) the ability for the market to reject bad plans and reward the good ones. There are theories of government competition, but real world political institutions do not approach this ideal (e.g. there is hardly real freedom of movement between countries). Planning doesn’t include just productive plans, but even how firms regulate themselves or regulate their peers (e.g. it would impact the rules a clearinghouse would enforce on member banks).

In short, there are many reasons to believe that the market, on average, does a better job at allocating resources than the state. Where we would look at alternative forms of resource allocation is when there is a market failure, but this is a totally separate topic and we don’t need to assume there are such things as public goods to see the merit in my argument below (of course, the existence of public goods doesn’t necessarily justify government provision of these goods, either). But, most economists, for the most part, accept the fact that the market is generally a better allocator than governments. The debate is over the range of public goods that the government is justified in providing.

None of this implies, however, that governments cannot produce wealth. It only means that, on average, there will be an opportunity cost that is higher than that of alternatives. A simple example might clarify my point. Assume we start off with $100 of real wealth (for the sake of simplicity, forget about whatever difficulty there is in translating nominal values to real values). We can invest a total of $60. If the market allocates the investment the result will be a return of $100, implying an increase in total wealth to $200. If the government allocates the investment the return will be $80, pushing total wealth up to $180. There is a clear $20 loss from government allocation, but society is still better off than it was originally — it’s just not as well off as it could have been. Had the government consumed those $20, total wealth would then be $80.

To make it even clearer, let’s define consumption and production in terms of real resources (actually, I borrow these, more-or-less, from George Reisman — IIRC, he refers to production as “productive consumption,” or something similar),

  • Consumption: The use of a real resource for direct satisfaction, such that at the end of that resource’s use it will no longer exist. Consumption lowers the real stock of wealth;
  • Production: The use of a real resource towards the production of new resources. Production is indirect consumption, and it can increase the real stock of wealth (assuming a successful plan).

There is probably a lot of government spending that can be categorized as consumption. But, it doesn’t follow that all government spending must necessarily be consumption. Investing in infrastructure is clearly production. Paying out subsidies to firms is clearly a subsidization of production. Again, none of this means that these investments pass a cost-benefit test — whether government spending does should always be open to debate, and skepticism here is very healthy —, but this is a very different statement to “government spending is always consumption.”

I figure that when most people claim all government activity is consumption they have the much more accurate belief that alternative investments could have lower opportunity costs in the back of their mind. But, once you look at it closely, these are two very different concepts, the latter of which is wrong and the former of which can be right.

22 thoughts on “Do Governments Produce?

  1. Pingback: Do Governments Produce? « Economics Info

  2. John S

    Yeah, I agree with the overall thrust of this post. That’s why I think libertarians should concentrate their limited firepower on the areas where I feel govt intervention is most egregious and harmful: education (K-12 and post-secondary); health care; and the provision of money. Each of these areas could benefit from greater use of the profit-loss mechanism and less govt interference.

    And while we may accept that there are some things that are best provided by govt, I would prefer to see more of those services provided at the local, rather than national, level. From my limited knowledge, Switzerland seems to best exemplify this ideal of a small central govt and strong local autonomy.

    Reply
    1. Stadius

      goo.gl/TaaIh6

      The facts do not agree with you re: healtcare. And are you seriously suggesting privatised education?

      Reply
      1. John S

        I’m not an expert in health care systems, but what I envision is something like the Singaporean system: more emphasis on individual payments for routine care, with govt insurance only for catastrophic events. As a % of GDP, Singapore’s system is cheaper than both the UK (8%) and the US (14%).

        http://www.forbes.com/sites/timworstall/2013/08/23/how-to-provide-health-care-to-all-americans-for-the-price-of-medicare-its-all-in-the-prices/

        Re: the US–I sympathize with Friedman’s criticisms:

        “Two simple observations are key to explaining both the high level of spending on medical care and the dissatisfaction with that spending. The first is that most payments to physicians or hospitals or other caregivers for medical care are made not by the patient but by a third party—an insurance company or employer or governmental body. The second is that nobody spends somebody else’s money as wisely or as frugally as he spends his own.”

        Why, by contrast, are most medical payments made by third parties? The answer for the United States begins with the fact that medical care expenditures are exempt from the income tax if, and only if, medical care is provided by the employer.”

        So getting rid of the tax exemption for employer provided health care would be one key step.

        Reply
        1. John S

          Re: education–I support the option of parents to receive vouchers, or preferably tax credits, in exchange for taking their children out of govt public schools. Andrew Coulson from the Cato Institute has written extensively on this issue, though in truth I haven’t examined his conclusions in depth:

          http://www.cato.org/people/andrew-coulson

          School vouchers are used extensively in Sweden, by the way (although I don’t agree with the prohibition on “topping up” voucher spending over a certain legal amount):

          http://en.wikipedia.org/wiki/School_voucher#Sweden

          My views on education are extreme, in the sense of being very different from commonly held opinion, but not irrational. In fact, I find that the factory schooling model makes little sense. I support the voluntary education model provided by the Sudbury Valley School, and other similar democratic schools:

          Reply
        2. Stadius

          The blog post you linked to is laughable, even for Worstall, and in no way challenges the overwhelming evidence provided by the article (peer-reviewed, published in a highly prestigious journal) I provided.

          1. Healthy life expectancy is not a valid measure of the effectiveness of a healthcare system; there are just way too many other relevant determinants; wealth, diet and lifestyle, violence, drug use, sanitation and water purity, occupation, etc.

          2. As well as having the lowest % health expenditure, Singapore has the second-lowest HLE (the lowest being the US). This probably indicates diminishing returns to health expenditure, rather than anything to do with efficiency.

          3. Stupidly small sample.

          Reply
          1. JCatalan

            The advantage of having an unequal provision of services is that the wealthy may be willing to afford a service that is too expensive to provide without an increase in the price — an increase the poor can’t afford. But, ultimately these new “technologies” (using it as an umbrella term) are made available to poorer members of society as they become less costly to produce. It’s the story of most goods we enjoy today.

          2. JosephFetz

            I read an article about Google Glass today where the author was saying one of the reasons why it will never catch on is that it is too expensive. The first thing I thought of was computers and cellphones. They too were far too expensive at first, but now everybody has them and they’re super cheap.

            Different context, but the same idea.

          3. John S

            Stadius, I don’t want to get into a link war over comparisons of health care systems. I think it’s fair to say that neither of us is an expert in this subject. However, it clearly seems to me no healthcare system in the world operates in a manner that remotely resembles a free market. It may indeed be that case that govt-run systems produce better outcomes at lower cost, as you contend. But I will withhold judgement
            until I’ve done some reading on potential ways to improve the US system (e.g. Arnold Kling’s “Crisis of Abundance”). Can you recommend a book length treatment of healthcare systems which supports the superiority of state-managed healthcare systems? I’ll add it to my reading list.

            Private education is unmeritocratic. Vouchers would confine the poorest to the worst schools

            It seems to me that poor children in the US are already confined to the worst schools under the current govt-run public school system. Also, I don’t propose forcing vouchers/tax credits on any family, only giving families the *option* to withdraw from state-run schools if desired. How does granting additional options harm poor families?

            while subsidising the private education of the wealthy.

            Vouchers could potentially be means tested, addressing this concern.

            You seem to oppose privatization of education mainly b/c it would, in your view, give wealthy children a permanent advantage over poor children. But a voucher system could be implemented in a way that provided proportionally more benefits to poorer families. Let’s say Anytown, USA gives poor families the option to accept vouchers equivalent to $11,000 (exceeding the nat’l avg per-pupil public spending of $10,560 in 2011) and that the voucher amounts are means tested on a sliding scale so that families in top tax bracket receive nothing. Would you still be opposed to such a system, or would it be unfair?

            http://www.census.gov/newsroom/releases/archives/governments/cb13-92.html

      2. JCatalan

        The problem with the U.S. system isn’t competition, it’s the lack of competition. It’s heavily regulated and there is a lot of rent-seeking.

        Reply
        1. Stadius

          @d7467c6055168cdb21765c37555b8286:disqus @JCatalan:disqus

          Let me just point out that according to the study, the most (least) efficient systems were less (more) competitive and more (less) regulated.

          In light of that, don’t you think that the conclusion that some outstandingly efficient healthcare sector lies on the horizon (if only politicians were bold enough to press on with further deregulation and competition), as implied by comments such as

          The problem with the U.S. system isn’t competition, it’s the lack of competition.

          and

          However, it clearly seems to me no healthcare system in the world operates in a manner that remotely resembles a free market.

          is an odd conclusion to draw from the available evidence? I get the impression that some people would never be satisfied no matter how much deregulation took place, and would instead continue to chase that pot of laissez-faire gold at the end of the rainbow.

          Re: education vouchers: a means-tested system such as the one you describe would undoubtedly be more progressive, though I don’t know if it would be more equitable. I think the best way to restore a more meritocratic system would be to replace the current (rigged) funding system with a flat per-pupil grant to state schools, adjusted for geographic differences in costs, and then to impose a percentage quota on university admissions from private schools (e.g. if 7% of pupils are schooled privately, then private school pupils could make up, at most, 7% of any given university’s intake). You could bet that you’d see a lot more rich kids in state schools, and a lot more rich parents on their governing boards (are there parent-governors in the US?), lobbying for greater funding etc.

          Reply
          1. John S

            Stadius,

            I can understand your exasperation with seemingly hard-headed free market types like me who doggedly maintain our views w/o revising them in the face of what seems to be incontrovertible evidence. However, let me ask you this: do you believe that free markets generally work best to provide us with the goods and services we need and want? You may not, but I do, and so it’s quite consistent for me to assume, until proven otherwise, that free markets would work best in the provision of health care products and services. Surely you can understand my mindset.

            This isn’t a position I intend to take to the grave. I’m open to changing my mind, and I did read the study linked to by the Guardian. However, I don’t think the healthcare issue can be settled by a single 10-page article, and even if it could, this isn’t that article.

            Re: meritocracy in education–a “pure” meritocracy can also have serious problems when the path to success consists of limited spots in a govt monopolized education pathway. Examples would be the “examination hell” endured by East Asian students (e.g. Japan and Korea) to get a coveted spot at Tokyo or Seoul Nat’l University.

            Tertiary education is especially where I would like to see less state involvement. I don’t think it’s ideal or effective to rely on the university system to transmit job skills to workers. Worker training and retraining needs to be much more flexible and more integrated with industry needs. Things like Skillshare.com and coding bootcamps like devbootcamp.com are what I would like to see instead. They would be both more effective and fairer to workers who missed the Ivy League train the first time around, imo.

          2. Stadius

            do you believe that free markets generally work best to provide us with the goods and services we need and want?

            In general, yes. But not in this specific case.

            I do, and so it’s quite consistent for me to assume, until proven otherwise, that free markets would work best in the provision of health care products and services.

            A couple of things here. Firstly, this suggests to me that you’re not distinguishing between general principles, which are right in most cases, and universal principles, which are right in all cases. I accept ‘markets work best’ as a general principle, but not as a universal principle. This means that one cannot jump from ‘markets are best’ to ‘markets are best for healthcare’, since there are exceptions to the general rule.

            Secondly, we can’t really ‘prove’ anything. The best we can do is to weigh up the available evidence (critically); you seem reluctant in this regard.

          3. John S

            The best we can do is to weigh up the available evidence (critically); you seem reluctant in this regard.

            I’m not reluctant at all. I’ve mentioned a couple of times that I’m completely willing to change my mind on the healthcare issue if shown compelling argument and data. The fact that I am not willing to unquestionably accept the 10-page article you cited as the final word on the subject doesn’t equate to my unwillingness to critically evaluation all available evidence. Can you cite a book or a substantially long article (50+ pages) to support your position?

            I don’t mean to be combative, but the analysis of the NHS you cited seems rather crude and hardly definitive. As it states on page 7, there are a number of factors that affect mortality rates, such as the high number of firearm wounds and deaths in the US. I can think of another factor: the US has far higher rates of obesity than other OECD countries (save Mexico).
            http://www.ncbi.nlm.nih.gov/books/NBK62367/

            https://www.cia.gov/library/publications/the-world-factbook/rankorder/2228rank.html

            Now I don’t mean to cite obesity as a silver bullet explanation. What I am saying is that there are lots of other factors to look at besides the structure of the healthcare system to find out the causes of mortality trends. And are mortality trends the only/best way to evaluate healthcare system performance? I’m doubtful. In short, it will take a much more in-depth treatment of the issue to convince me either way.

            And what of yourself, in terms of open-mindedness? You seem to take this single article as overwhelming proof against the viability of any conceivable privatized healthcare system. Yet a number of smart economists such as Arnold Kling, John Cochrane, and Tyler Cowen believe that greater privatization, done correctly, could improve the American healthcare system. Do you consider Cowen also to be reluctant to weigh evidence critically? Why do you aprioristically conclude that the US has nothing to learn from the Singaporean model, or that an even better, more privatized system could exist? For that matter, why do you assume that school vouchers will lead to greater inequality or poorer outcomes? Have you read Andrew Coulson’s book and critically evaluated his data and conclusions?

            I’d say my position can be stated thus: I have strong free market priors, but I’m willing to examine opposing arguments and studies and change my mind if necessary. Your position seems to be: Privatization in healthcare and education will never work, and I’m unwilling to consider the opposing viewpoint. I’m genuinely puzzled how you can regard my stance as the dogmatic one, and yours as scientific and open-minded.

          4. Stadius

            I base my arguments on the facts, you base yours on (naive) theory

            I have strong free market priors

            And appeals to authority

            a number of smart economists such as Arnold Kling, John Cochrane, and Tyler Cowen believe that greater privatization, done correctly, could improve the American healthcare system.

            And extremely laboured criticisms of opposing evidence

            the high number of firearm wounds and deaths in the US. I can think of another factor: the US has far higher rates of obesity than other OECD countries (save Mexico).

            And puzzling accusations

            you aprioristically conclude

            (Again, I’ve based my arguments solely on data and made no reference to theory)

            Your position seems to be … and I’m unwilling to consider the opposing viewpoint. I’m genuinely puzzled how you can regard my stance as the dogmatic one, and yours as scientific and open-minded.

            Really? Go back over what I’ve said, and think about that. Really think about it. Pure projection.

          5. John S

            Ok Stadius, it’s taken me longer to realize than it should have, but having a discussion with you is a waste of time.

          6. JCatalan

            Well, I don’t really know enough about the topic, but off the top of my head I can come with an explanation (that may or may not be right). “Competitive systems” tend to be heavily intervened in, because of the nature of the service they’re providing — from pharmaceutical companies, to insurance companies, to the medical providers themselves. This relationship also makes a competitive industry susceptible to rent-seeking. By making the system “less competitive,” the government can help avoid rent-seeking problems. I’ve always held that a universal healthcare system would be better than what the U.S. has now, which is the worst of both worlds.

  3. Hamsterdam Economics

    This is a bit of an unsophisticated response, but doesn’t a plant or industry nationalized by the government demonstrate that governments are capable of production of wealth?

    To use an oversimplified example, the fact that industry X exists on the market is decent evidence that it is producing something that people want. If the industry is then nationalized and run by the government but continues to produce the goods it was producing before, and the demand for these goods is unaffected by the state’s takeover of the plant/industry, then it seems like a straightforward conclusion is that the state is now producing wealth.

    I certainly don’t dispute any of the arguments against the state doing this, and agree with everything in your post. When reading it, this simply jumped out at me as a clear example of what you were trying to illustrate.

    Reply
  4. phil

    “those who plan poorly will suffer a loss and those who plan well will earn a profit. This allows for a continuous redistribution of wealth that follows success”.

    Do you believe that a person is poor because of their ‘poor planning’, and another person is wealthy because of their ‘good planning’?

    Reply
    1. JCatalan

      An entrepreneur who spends all his money on a single investment that takes a loss will be very poor. But, we have to be careful to distinguish between profit/loss and return to labor. A worker who is poor isn’t necessarily poor because of “poor planning,” rather they’re poor because the market has decided that their productivity (at least, in their current occupation) is low.

      Reply
      1. phil

        RIght-wing economists define “productivity” as simply “having lots of money”, so it’s pretty circular really.

        A person who makes a fortune out of compounding interest whilst doing absolutely nothing is considered “highly productive”, whereas someone who actually works to produce something of real value is considered “less productive” if their income is smaller.

        Essentially it boils down to the argument that wealthy people are “more productive” because the definition of “high productivity” is “having lots of money”, and poor people are “less productive” because the definition of “low productivity” is “being poor”.

        So when you say that “the market has decided that their productivity is low”, what you mean is “they are poor therefore their productivity is low because I define low productivity as the state of being poor”.

        Reply
        1. JCatalan

          “Right-wing economists” don’t define productivity any different from “left-wing economists.”

          I don’t know what “real value” is as opposed to “fake value.” I agree that a lot of people get more than what corresponds to their productivity. For example, I’ve argued that finance might get more than what its productivity really corresponds to.

          Also, again, we have to differentiate between return to productivity and profit/loss. Profit/loss is not a return to productivity. Profit occurs out of successful arbitrage between costs and output prices. The return to labor is part of that cost — labor is an input, entrepreneurs are allocators.

          So when you say that “the market has decided that their productivity is low”, what you mean is “they are poor therefore their productivity is low because I define low productivity as the state of being poor”.

          Only if you want to give a twisted definition that disattaches what I said from economic theory. Yes, people with low productivity tend to make lower incomes. Why would they make higher incomes? I don’t understand what you’re saying. Your argument would only make sense if you don’t think markets are good at adjusting returns to inputs to their marginal productivities.

          Reply

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