Public Policy and the Free Economy; T. DiLorenzo

and both Ronald Reagan and Mar garet Thatcher were elected on plat forms which called for a relative re duction in the size and scope of government and the encouragement of free enterprise. But a dangerous scenario is being constructed in the U.S. and the U.K. Entrenched government bureau cracies along with labor unions and other powerful interest groups have prohibited any significant reduc tions in government spending, and Dr. DiLorenzo is Assistant Professor of Economics at George Mason University, Fairfax, Virginia. d,q? The Fre:'t Econo~ the basic government regulatory in stitutions which have placed such heavy burdens on the private econ omies of the u.s. and Great Britain remain largely intact. Left-leaning politicians now publicly express a desire for higher inflation and un employment which they hope will help to restore their political power, and the media routinely reports, in correctly, that both the Thatcher and Reagan economic platforms have been implemented, and have failed.

The danger in this situation lies in the fact that it is customary to hold the chief executive responsible for the health of a nation's economy, re gardless of what the causes of cur rent economic problems might be. The problems of inflation and un employment, which are primarily caused by past government inter ventions in the market economy, are being widely sold as the direct result of policies which encourage free en terprise and attempt to restore in centives to work and invest. It is PUBLIC POLICY AND THE FREE ECONOMY 493 therefore of utmost importance to set the record straight, to clarify this is sue, and to strengthen public sup port for the free economy. This pa per attempts to make a contribution toward that end by discussing the virtues of the free economy. A major theme of the paper is that in the (free) market economy individuals, acting in their own self-interests, are in duced by the spontaneous forces of the market to act in ways which serve to maximize social welfare; by con trast, it is shown how government control over the allocation of re sources redirects the forces of ratio nal self-interest in a way that allows elite groups within government to impose forcefully their will upon others, which in turn causes a re duction in wealth and in individual welfare.

The Sovereigntyof the Consumer In the market economy the pro duction and distribution of goods and services is determined by the deci sions of entrepreneurs, and this fact has generated much wrath on the part of many members of society, es pecially intellectuals, and especially those in the social sciences and the humanities. Entrepreneurs are of ten portrayed as being hard hearted and callous, and responsible to no one. But in the free economy they are not. Economic affairs in the market economy may be directed by entrepreneurs, but co,nsumers are the ul timate decision-makers. Consumers determine what! is produced and, as Mises has said, ~t is they who" ... in their capacity as buyers and con sumers . . . are hard hearted and callous without consideration for other people."! 'That is, consumers patronize thos~ who can offer the highest quality products for the low est prices. Those who do not meet the demands oficonsumers will suf fer losses or go bankrupt and will therefore be re~oved from their "po sitions of eminence," while those who cater to the desires of consumers will be rewarded wi~h profits. Both the carrot of reward and the stick of punishment (for ignoring con sumers' prefereqces) contribute to the success of the market economy.

Not only are entrepreneurs in duced by the market to satisfy con sumers' preferences for goods and services, but they are also motivated to provide goods and services at the least possible cost, for in a competi tive economy tHose who fail to do so will not survive, Entrepreneurs who do not make the best use of avail able time, kno'\V:ledge,and resources bear the risk of bankruptcy or, al ternatively, off being replaced by "takeover raiderrs" via the market for corporate control. There always ex ist enterprising 1 individuals who are willing to take' over, through stock purchases, private enterprises that do not adequately meet the demands 494 THE FREEMAN August of consumers, for the substitution of more efficient for less efficient man agement promises the reward of higher profits. Those opposed to cor porate takeovers would have us abolish the market for corporate control, but fail to acknowledge the damage such restrictions would in flict upon the consumer. Arguments against the market for corporate control thus appear to be nothing other than disguised protectionism.

How the MarketFunctions In the market economy the con sumer determines not only the pat tern of prices and production, but also the distribution of income. That is, the consumer ultimately pays the wages of all workers, whether they be professional athletes or street vendors. The greater the consumer demand for a good or service, the more an employer will be willing to pay the worker who can produce the product, as long as labor markets are competitive. The employer who pays his em ployees less than their marginal contribution to the firm's profits will not do well and may very well fail. The baseball team owner, for exam ple, who pays gifted, star athletes the salary of a college professor will most likely bear the burden of a poor record and consequently, lower prof its. The same can be said for the management of steel mills, textile plants, grocery stores and all other private enterprises. Thus, in a free economy one's income depends upon one's ability to satisfy consumers. It is in this way that the spontaneous forces of the market serve to maxi mize individual welfare.

The Hazardsof Consumer Protectionism The virtues of the free economy are amplified once they're compared directly to the vices of intervention ism, and an appropriate starting point is the example of "consumer protection regulation" which is quite prevalent in the U.S. and exists in most other industrialized demo cratic countries as well. The federal government is inti mately involved in the regulation of trade in the U.S., and has been ever since such muckrakers as Upton Sinclair (author of The Jungle), Ralph Nader, and Senator Estes Ke fauver (whose investigations of the drug industry led to the expanded powers of the Food and Drug Ad ministration) began attacking the quality of products manufactured by private producers. Self-appointed "protectors" of the consumer now staff hundreds of government agen cies, and under the guise of con sumer protection perform tasks which unequivocally make the con sumer worse off, as can be illus trated by the example of the Con sumer Product Safety Commission, which serves as a prototype for scores 1982 PUBLIC POLICY AND THE FREE ECONOMY 495 of other "consumer protection agen cies."

The Commission is mandated to perform a task it cannot possibly achieve - "to protect the public against unreasonable risks of injury from consumer products ... " Its au thority covers "any article produced or distributed except for certain items already regulated by other govern ment agencies." The objective of safer products is desirable, but the impor tant question is: At what cost and by whose standards? A safer auto mobile which is slower, heavier, and more expensive than others may have some advantages, but how can a government bureaucrat possibly know how much safety individual consumers are willing to trade off for speed and lower prices? Besides, it is .not clear that "safer" vehicles cause fewer accidents. It may be true that safer vehicles induce careless ness by drivers which leads to more accidents which are mainly caused, after all, by human error. The gov ernmental banning of various "dan gerous" products deprives the con sumer the right to make the relevant tradeoffs, which only he can make, and therefore reduces his welfare.

A rather blatant example of how the "consumer protectionist mental ity" has gone to extremes is the ap pearance of the recently dethroned director of the National Highway Transportation Safety Administra tion on a popular television program. The ex-director was accom panied by a m1asked man with a sledge hammer and an automobile produced by a private engineering firm, employed ,by the government, which was alleg~dly crash-proof. Af ter observing the masked man fail to dent the automobile with the sledge hammer, the ex-director opined how wonderful it would be if the government were to require all automobiles to! be just as sturdy. When pressed by a member of the audience, the i ex-director reluc tantly stated that the cost of such a car is approximately $200,000 hardly a. price, which would "pro tect" the consumer. Only freedom of choice, and only a free market econ omy is capable of accomplishing that task. So-called consumer protection ism is merely a way of forcefully substituting the will of a few non elected government bureaucrats for that of the general public.

ProductInformationand the Free Economy There are m~ny who claim that private advertising is misleading, and induces consumers to purchase things they wQuld not otherwise purchase. Therefore, so it is claimed, advertising should be controlled or regulated by government, if not abolished, in order to avoid "con sumer exploitatjon." But how can a consumer be exploited if he volun tarily purchases one brand of say, 496 THE FREEMAN August toothpaste over another? As long as advertising is competitive, and the consumer is free to compare and contrast the competing claims of ad vertisers, it is impossible for him to be "exploited." In fact, quite the op posite is true. It is the absence of advertising which is detrimental to the con sumer, since one of the major rea sons for advertising is to publicize price and proQuct quality. Take, for example, the case of law firms in the U.S. which until recently were banned from advertising. Such a ban on advertising is nothing more than special interest legislation which benefited existing, established law firms at the time the legislation was put into effect, to the detriment of newer firms and consumers. The older, established firms had little need to advertise the price and qual ity of their product, for their repu tations had already been estab lished, and the most prominent members of the legal profession are much sought after by these firms not only for their skills, but also for the right to place their names on the firm's letterhead to send out the de sired market signal.

Newer, less established firms who must compete with the more expe rienced firms must do so by offering a "quality" product at a competitive (lower) price. The ability to adver tise lower prices is one way to. in duce consumers to make use of their services. After all, many consumers would prefer not to have "Cadillac quality" legal services at Cadillac prices, but would prefer a wider range of choice. Bans on advertising preclude the consumer from making any such choices and therefore allow the established firms to charge higher prices than otherwise. As another contemporary exam ple, it is difficult to believe that one of the largest hotel/motel chains in America is actively lobbying against roadside advertising "for the pur pose of enhancing the beauty of the environment" rather than a desire to stifle price competition from less well-known hotel chains. In sum, the idea that consumers can be led by the nose by advertising has been proven false time and again.

"Regardless of how much Ford Motor Company advertises another "Ed sel" automobile, it won't sell. As economist Harold Demsetz of UCLA has found, the profit maximizing firm will find it more sensible to first find out what consumers want, and then produce and advertise it. Surely, this would be more lucrative than spend ing millions trying to convince con sumers to buy green wigs or lead tennis balls. The Price System As the Friedmans have said, the key insight to Adam Smith's Wealth of Nations is misleadingly simple and, unfortunately, widely misun1982 PUBLIC POLICY AND THE FREE ECONOMY 497 derstood: In a free market economy, voluntary exchange will not take place between two parties unless both believe they will benefit from it.2 It is not true that one party can benefit only at the expense of another or that, in international trade, firms in one country benefit at the expense of those in another. Free trade is mutually advantageous. This in sight is obvious when one considers trade between two individuals, but it is more difficult to understand how people living all over the world can cooperate to promote their own in terests. It is the price system which accomplishes this task in a market economy, without any need for cen tral direction of prices or production by the coercive powers of the state.

Thus, Adam Smith's crowning achievement was to recognize that the prices which emerge from the voluntary transactions between buyers and sellers in a free market could coordinate the activities of millions of people in a way in which everyone, acting in his own self interest, is made better off. Two major functions of the price system are to transmit information and to provide incentives to adopt least-cost methods of production. Consider the effects of say, an in crease in the consumer demand for bicycles. Retailers will find that they are selling more bicycles and that consumers are willing to pay more for them. They will therefore order more from whoilesalers who in turn will order mo~e from manufactur ers. Manufacturers will order more steel, rubber, chrome, plastic, and all the other materials used to produce bicycles. In order to induce the sup pliers ofthese inputs to produce more, manufacturers will have to offer higher prices. The higher prices in duce input suppliers to employ more people to meet the increased de mand. To do so will require that they offer higher wages or fringe benefits or better working conditions. Thus, in this way the price system trans mits the message that there has been an increased demand for bicycles and that consumers now prefer the ad ditional use of 'resources to produce them. There is i. no need for anyone person or agency to "coordinate" any or all of the above activities. Such an effort would indeed be fruitless, since no one individual or group of computer programmers could possi bly gather and use all of the rele vant information.

Information Fldws Both Ways Prices not only transmit informa tion from consumers to retailers, wholesalers, manufacturers and re source owners; they also do the op posite. For example, if for some rea son imports of tubber into the U.S. were reduced Of cut off, the reduced supply would increase the price of rubber and of all rubber products. It will not pay to 'produce as many bi498 THE FREEMAN August cycles as before. The smaller supply of bicycles will increase the price which will inform consumers to take better care of their bicycles and to keep them longer or to consider al ternative forms of recreation. Any governmental controls which prohibit prices from expressing changes in supply and demand con ditions stifle the dissemination of important information. For exam ple, price ceilings placed on oil and other fuels in the U.S. prohibited in formation about the effects of the OPEC cartel from being conveyed to producers and consumers. Price ceil ings on oil artificially stimulated the demand for oil and gas and reduced supply, creating shortages which were compensated for by increasing imports even more. Because of price controls, the real price of gasoline actually fell from November 1973 to May 1979, which conveyed to con sumers the message that gasoline had not become more scarce, and that it was not worthwhile to conserve more energy than previously. The automobile industry, in responding to the demands of American con sumers, did not significantly in crease production of smaller, more fuel-efficient cars.

Now that the real price of gasoline has risen since the controls have been lifted, the auto industry finds itself at a severe competitive disadvan tage in international competition. American consumers were also forced, because of price controls, to finance through taxes the activities of a Department of Energy which spent about $10 billion in 1979, em ployed 20,000 people, and admits (optimistically) to having no posi tiveeffect on energy problems. A further virtue of the market economy is that the price system provides producers with incentives to seek the most efficient means of production-those means which use the least resources, leaving more re sources for other uses. For example, there are literally thousands of dif ferent types or grades of steel. When the supply of one type of steel is cur tailed, which raises its price relative to others, producers of automobiles and other products will substitute the less costly types of steel. Reducing the cost of production enables the producer to increase the gap be tween revenues and costs. Any gov ernmental controls over the prices of factors of production-via mini mum wage laws, by trade unions, taxes, subsidies-distorts informa tion transmitted by the price system and makes it impossible to discover least-cost production techniques.

ConsumerSovereigntyvs. Politician'sSovereignty In the market economy consumers are said to "vote with their dollars." Unlike the political market place, where one level of output is provided to all, producers provide different 1982 PUBLIC POLICY AND THE FREE ECONOMY 499 amounts of goods and services to consumers, depending on their in come and preferences. Those who are willing and able to pay can consume all they want at the existing market prices and, as described above, the production and distribution of goods and services is dictated by the wishes of consumers. There are many, of course, who are dissatisfied with the way in which the free market allocates resources. Among the most frequently cited ob jections are that the market gener ates "inequities," does not suffi ciently protect "the poor," is based on greed (read the profit motive) rather than selflessness, and leads to shortsighted outcomes which lack long-range perspectives. As a result of these alleged problems, so the in terventionists argue, there is a need for greater political control of the al location of resources by those who are wise enough, selfless enough, farsighted enough, and sufficiently egalitarian to correct these prob lems. In short, according to this view, social problems are best dealt with by a delegation of benevolent and omniscient despots, if any can be found. This is a caricature of the conventional view of public policy in the U.8. and in many other demo cratic countries, and illustrates the dominant themes of the "public ad ministration" literature from Con fucius and Plato to Woodrow Wilson and their contemporaries.

Failuresof Intervention The miserable failures of govern ments to effectively deal with the problems of poverty, the low quality of primary and secondary education, energy, housing, and so on are usu ally explained 'ip. terms of the per sonal attribut~s of politicians and bureaucrats: They are evil or stupid, lack sufficient authority and fund ing, or lack sufficient information. The problems of social policy are then merely a matter of selecting suffi ciently wise and benevolent despots and giving them power and knowl edge. But the harsh lessons of recent history have shown that good men do not guarantee good government. It is most unfortunate that much of the American public has become enchanted with :the "Platonian" view of government intervention and seems to have forgotten the impor tant principles upon which the fed eral constitution was based. Namely, the authors of the Federalist Papers were concerned with giving govern ment enough power to carry out its responsibilities, but not so much power that the rights of individuals would be infringed. They 'held that one cannot control the excesses of government by. merely electing the "right" people, as the following statement by James Madison illus trates.

It is in vain to say that enlightened statesmen will be able to adjust these 500 THE FREEMAN August clashing interests and render them all subservient to the public good. Enlight ened statesmen will not always be at the helm ... We well know that neither moral nor religious motives can be relied on as an adequate control. 3 Alexander Hamilton was also re luctant to rely on the innate good ness of man, for to do so ... would be to forget that men are am bitious, vindictive, and rapacious ... Has it not, on the contrary, invariably been found that momentary passions, and im mediate interests, have a more active and imperious control over human conduct than general or remote considerations of policy, utility, or justice?4 Because of these views, the fram ers of the Constitution were careful to adopt institutional arrangements which would constrain the coercive powers of government, for as Madi son argued, . . . what is government itself but the greatest of all reflections on human na ture? If men were angels, no government would be necessary. If angels were to govern men, neither external nor inter nal controls on government would be necessary. 5 In reflecting upon the secular growth of governmental powers in the U.S. a contemporary student of constitutional reform, James Bu chanan, has further observed, Politicians are politicians because they want to be. They are no more robots than other men. Yet the politician who would do nothing other than reflect the preferences of his constituents would, in fact, be robotlike in his behavior. Few, if any, politicians are so restricted. They seek office because they seek "profit," in the form of "political income," which will normally be obtained only if their behav ior is not fully in accord with the desires of electoral majorities. Those men who are attracted to politics as a profession are likely to be precisely those who have considerable interest in promoting their own version of good government, along with those who see the opportunities for direct and indirect bribes, and those who evaluate political office as a means to ward other ends. 6 PoliticalControl Thus, it has long been recognized that when political resource alloca tion replaces the market allocation of resources, the results are not likely to be either equitable or efficient, unless by sheer accident. How re sources are allocated depends largely on the different opportunities for "political profit" which alternative allocations present to the political decision-maker, for politicians, like all other human beings, act so as to pursue their own self-interests.

Consumers' sovereignty is replaced by the sovereignty of the politician/ bureaucrat, and the two often do not coincide. Consumer demand no longer determines the pattern of production and distribution. In stead, an individual or group's abil ity to receive goods and services de pends not only on their ability to 1982 PUBLIC POLICY AND THE FREE ECONOMY 501 "compete with their dollars," but on other forms of competition as well, which are expressed through politi cal power and influence, violence, and various forms of bureaucratic ma nipulation. Political resource allocation, con sequently, often entails effects which most would consider perverse and inequitable. As one example, con sider the decision made by the U.S. Congress in 1949 to grant the gov ernment a greater role in the provi sion of housing by embarking on a program of "housing and urban re newal" which was aimed at provid ing benefits for the poor. In the early history of urban renewal the evi dence clearly shows that more hous ing for the poor was demolished than was replaced. Between 1949 and 1963 the 106 completed urban renewal projects had demolished about twice as many units as were replaced, and only 8 percent of the replacement units were in public housing where "the poor" could gain access.7 Evi dently, middle and upper income groups are not only better able to vote with their dollars than are the poor, but are also more politically influential and have been major be neficiaries, along with government administrators, of the many urban renewal programs in the U.S. Simi lar outcomes have resulted from government interventions in the areas of energy, education, welfare, and so on.

The inequities which often stem from political resource allocation are made more cleaJrwhen one observes resource allocation in nondemo cratic, or socialist countries such as the Soviet Union where those in power, along with their families and friends, are at the top of the income scale, while in !the name of "egali tarianism," nearly everyone else is put in his place at the bottom, and is kept there by: threat of violence or imprisonment, ias recent events in Poland illustrate. Inequitableand Inefficient When the market allocation of re sources is repl,"ced by political re source allocation the results are of ten inequitabl~ and inefficient, in that more resoUrces tend to be ex pended on activities which merely redistribute wealth rather than cre ate wealth. Government, after all, does not produce much of anything; it takes from some and gives to oth ers, keeping as much as it can for itself in the form of discretionary revenues. 8 In democratic:countries there is an asymmetry between the benefit in cidence of politi~al decisions and the tax incidence. ffhat is, beneficiary groups or recipients of government financed transfers tend to be concen trated, or organized, and capable of influencing poUticians. By contrast, taxpayers tend to be widely dis persed, with little incentive to ac502 THE FREEMAN August tively oppose individual transfer programs. As a result of this asym metry there is a structural bias to ward expanded levels of government spending and taxing. As the govern ment sector expands, more and more resources are used by all the various interest groups to lobby for transfers rather than to produce goods and services, which serves to diminish the total wealth of nations. As wealth transfers increase, the private sec tor, which is the sole source of wealth creation, is increasingly crowded out.

The Problem of Monopoly The virtues of the market econ omy are partly undermined by tl,1e existence of monopoly power. A mo nopolist who, by definition, is the sole supplier of a product for which there are no close substitutes will restrict output, thereby raising his price above what would be paid if markets were competitive. Consumers are made worse off because some of their wealth is transferred to the monop olist, and because fewer resources are devoted to the production of the mo nopolized good (and more to other goods) than what consumers would prefer with freer trade. Over the past several decades many have claimed that the alleg edly increased concentration of in dustry in the U.S. and in other dem ocratic countries has led to increased monopoly power and therefore calls for a greater degree of governmental control, regulation, or outright own ership of industry. Even though there is no evidence that American indus try has become increasingly concen trated over the past century or that concentration per se leads to monop oly profits, such unfounded senti ments can be understood if one rec ognizes that it is the interventionists themselves who intend to become the regulators, the controllers, and the managers of nationalized indus tries.

The claims that government reg ulation of industry is a necessary condition for the prevention of mo nopoly power have ignored history and reality. Adam Smith himself was among the first to recognize that government regulation of industry is the sole cause of monopoly, not a remedy for its ill effects. Smith viewed the regulation of industry as a means of redistributing income to potential monopolists who would in turn provide political and economic support to the government. He ob served that the various trades in eighteenth-century Britain which were granted a monopoly status gained such status because ofa com parative advantage in lobbying. Country gentlemen and farmers, dis persed in different parts of the country, cannot so easily combine as merchants and manufacturers, who being collected into towns, and accustomed to that ex clusive corporation spirit which prevails in them, naturally to endeavour to ob1982 PUBLIC POLICY AND THE FREE ECONOMY 503 tain against all their countrymen, the same exclusive privilege which they gen erally possess against the inhabitants of their respective towns. They accordingly seem to have been the original inventors of those restraints upon the importation of foreign goods, which secure to them the monopoly of the home market. 9 Smith's strongest attack on mon opolies was aimed at the entire sys tem of mercantilism and protection ism in foreign trade. In his words, "Monopoly of one kind or another, indeed, seems to be the sole engine of the mercantile system."10And, "It is the industry which is carried on for the benefit of the rich and the powerful, that is principally encour aged by our mercantile system. That which is carried on for the benefit of the poor and the indigent, is too of ten, either neglected, or op pressed."ll And further, condemning mercantilism on moral grounds, To hurt in any degree the interest of anyone order of citizens, for no other purpose but to promote that of some other, is evidently contrary to that justice and equality of treatment which the sover eign owes to all the different orders of his subjects. 12 These lessons were well heeded in the latter eighteenth and early nineteenth centuries by many citi zens, and, as history reveals, one of the causes of the American Revolu tion was the attempt by the British government to enforce the Trade and Navigation Acts, which were intended to monQpolize certain acti vi ties for Englishmen living in the British Isles.

Modern Trade Restrictions Unfortuna tely, the modern -day mercantilists hiave succeeded in di verting the puli>lic'sattention away from this reality, and in imposing a vast array of "neomercantilist" pol icies of trade liestrictions. Perhaps the most regulated activity in the U.S. economyi is transportation, which serves aa an example ofmon opolies recently created by govern ment. 13 The Interstate Commerce Com mission (ICC) limits the number of firms allowed to engage in common carrier transportation. In addition, it actually sets, minimum rates be low which transportation companies are not allowed to sell, which per mits the companies to enforce a car tel pricing arrallgement. The Civil Aeranautics Board (CAB) has set minimu~ air cargo rates and passenger rates. It has even at tempted to reglilate the service pro vided at these rates to prevent one airline from offering a more com fortable seat or more legroom at a given price than another.

The Federal Maritime Board forces steamship lines into the ocean con ferences-the 1 privately operated cartels that regulate ocean freight rates and attempt to prevent rate cutting.

504 THE FREEMAN August Forty states regulate intrastate trucking and prevent rate cutting, and most cities regulate the taxicab business, with the same result. In terestingly, Washington, D.C., home of many of the regulators, is the only major city in the U.S. where one can enter the taxi business simply by demonstrating that the necessary li ability insurance is covered. Taxi fares in Washington are among the lowest of all major cities in the U.S. In sum, government regulation of industry is today, as it was in Adam Smith's time, often for the benefit of the regulated firms, to the detri ment of consumers, potential com petitors, and workers who are barred from employment by the various li censing restrictions which exist and apply to thousands of trades, from taxi driving to fortune telling and the practice of medicine. 14 Only with the sanction and coercion of govern ment can a producer, if a monopo list, reduce output and raise prices indefinitely. If the government does not prohibit competition, any mo nopoly profits will soon be bid away by competing entrepreneurs and workers. The free economy is incom patible with the existence of monop oly power.

Profit Management vs. Bureaucratic Management As mentioned above, one of the most basic virtues of the free econ omy is that the market induces private sector entrepreneurs to produce goods and services at least cost. Pri vate sector managers are the resid ual claimants to both profits and losses - cost reducing innovations which increase profits often lead to direct salary increases and enhance one's human capital as a manager, while economic losses cause one to forgo salary increases and run the risk of losing one's job tenure. In sum, the private sector manager is moti vated by both the carrot and the stick, in that he is rewarded finan cially and promoted for reducing costs, and may be "punished" for un satisfactory performance. By contrast, many goods and ser vices which are produced by private sector producers are also provided by government enterprises in many countries. As history shows, govern ment-operated enterprises in both democratic and non-democratic countries have been monumental failures when compared to private enterprise. The effects of bureau cratic (government) management have long been recognized. For ex ample, nearly four decades ago Lud wig von Mises began his book, Bu reaucracy in the following way: The terms, bureaucrat, bureaucratic, and bureaucracy are clearly invectives.

Nobody calls himself a bureaucrat or his own methods of management bureau cratic. These words are always applied with an opprobrious connotation. They always imply a disparaging criticism of 1982 PUBLIC POLICY AND THE FREE ECONOMY 505 persons, institutions, or procedures. No body doubts that bureaucracy is thor oughly bad and that it should not exist in a perfect world.15 The "bureaucratic methods" that Mises referred to are familiar to ev eryone. Less clear is why these methods persist. The basic reason is not that government bureaucrats are innately lazy, slothful, or dishonest, but that both the carrot and the stick are missing from the public sector. The public manager who reduces cost recei ves no reward, for there are no profits, by definition, in the public sector. In addition to this, it is diffi cult to terminate government em ployees for poor performance, as the low rates of employee turnover in the public sector attest. The manager of a government bureau has, at best, minimal incentives for economic ef ficiency. In fact, the incentive sys tem facing government bureaucrats in the U.S. and in most democratic European countries is rather per verse, for as Gordon Tullock ob served, ". . . in most American and European bureaucracies ... a bu reaucrat is rewarded for simply in creasing the number of persons he supervises."16 Increased Spending Increases Bureaucratic Power The budgets allocated by the leg islative sponsors of government bu reaus are typically exhausted by spending on perquisites of office, salaries of subordinates, and so forth.

If the bureaucrat' serves his own in terests, he will always spend the en tire budget allocated to his bureau, regardless of th~ cost of providing the service which is under his man agement. Promotions, prestige, and salary increases! depend largely on increasing the Dumber of subordi nates, which req~ires an increase in the appropriated budget. The bu reaucrat would !find it difficult to justify budget increases next year if he does not spen(1 his entire budget this year, and for this reason gov ernment enterprises tend to maxi mize rather than minimize produc tion costs, as do their private sector counterparts. Relative to the private sector, the incentive structure of the bureau cratic "public" manager is perverse, since every bure~ucrat is inherently an empire builder who seeks to en large the size ancl scope of his agency in order to increase his salary and prestige. Unlike: the private sector, where the managers and owners of inefficient firms 'bear the burden of poor performance themselves by for feiting profits, a government-owned monopoly, which most government enterprises are, can not only charge a monopoly pric~ and exhibit gross inefficiencies, but can also force tax payers to pay the price. Govern ment-operated enterprises therefore pose a major threat to the free econ omy and to personal freedom.

506 THE FREEMAN August The Myth of Stabilization Policy Despite all the world's dismal ex periences with attempts at replac ing the market economy with "cen tral planning," the dream of many an interventionist is to institute some form of "planning" in the U.S. That is, what is politically defined as "economic planning" is actually the "forcible superseding of other peo ple's decisions by government offi cers."!? It is often lamented that planning is needed to protect the public from "accident, chance, and uncoordinated institutions" which lead to "helplessness" as the econ omy lists. 18 Central planning is seen as simply a matter of "technical co ordination by experts" using "sys tematic analysis" whereby some un definable "public interest" can be discussed along with "objective analysis ... of what is really desir able."19 Although the U.S. has never ac tually experimented with compre hensive central planning, monetary and fiscal policies since the 1940s have been hybrid attempts at "fine tuning" the economy by small groups of planners. This predominant ap proach to economic policy, usually referred to as "Keynesianism," takes as its point of departure a philoso phy similar to that described in the above quotations of Nobel prize winning economist Wassily Leontief and the late Senator Hubert Hum phrey. "Stabilization policy," as a form of planning, is merely a matter of getting the "right" people into of fice, and providing them with ade quate technical information. In other words, this view is based on the pre sumed existence of a group of bene v olent and omniscient despots.

It is now widely recognized, how ever, that the so-called stabilization policies of the past have not worked, and have even destabilized the econ omy.20 One reason for this is that it is simply impossible to forecast the effects that changes in monetary and fiscal policies will have on an econ omy 2 years, 1 year, or even 6 months in the future with much precision, as the performance of economic fore casters demonstrates. A second rea son is that in a democratic country, the time lag between the recogni tion of a problem (high inflation, un employment) and the final impact of whatever policy is implemented to address the problem is unpredict able, due to political realities. A pol icy aimed at stimulating demand may not actually be felt until after the economy has emerged from a recession and entered into an infla tionary peak of the business cycle, which would only make things worse.

The failures of government stabili zation policies have been described, by their architects, as the result of simply not having sufficient infor mation at hand. But there is a strong basis for be lieving that stabilization policies 1982 PUBLIC POLICY AND THE FREE ECONOMY 507 have not worked simply because it is not in the interest of policymakers to make them work. For example, expansionary policies (such as gov ernment spending financed by money creation) increases political support by dispensing benefits on concen trated constituent groups now, and dispersing and deferring the costs, in the form of higher inflation, in the future. Federal politicians have every incentive to createinflation and the further economic instability (stagflation) which follows, espe cially since the "progressive" in come tax (a phrase coined by Karl Marx) generates additional in creases in real tax revenues with in flation-induced "bracket creep."

Policies Modified in Proximity to Elections Relatedly, there is good reason to believe that economic policy is based not on any long-term stability goals, but rather on the proximity to elec tions, which creates further insta bility. The theory of the "political business cycle" holds that by con centrating expansionary policies be fore an election, the incumbent party may be able to strengthen its elec toral prospects. 21 Expansionary pol icies will tend to be pursued more vigorously before an election, with the pursuit of contractionary poli cies left to after an election, the re sult being economic instability. In sum, it is the government's monopoly power over 'the money supply coupled with the pursuit of political self-interest which often creates eco nomic instability. The predominant view of the fail ures of stabilizatlion policy, which is informed by what one might call a "central planning mentality," is not that existing institutions create in centives for poli¢ymakers to gener ate economic instability, but that such failures are simply the result of accident or error. Economist Her schel Grossman> in reviewing the work of James Tobin, one of the chief archi tects of Keynesian economics over the years, summarizes this view: Tobin presume~ that the historical record of monetary and fiscal policy in volves a series of avoidable mistakes, rather than the: predictable conse quences of personal preferences and ca pabilities working through the existing constitutional process by which policy is formulated. Specifi¢ally, Tobin shows no interest in analysis of either the econom ically motivated behavior of private in dividuals in the pQlitical process or the behavior of the government agents who make and administer policy.22 In essence, the: predominant view of stabilization policy, like the so cialist dream of the centrally planned economy, is based on a vision of a utopian society run by angels who automatically serve the public in terest (however defined), and there is no agency problem. But if one ac cepts the notion· that policymakers 508 THE FREEMAN August are human beings, and therefore act in their own, self-interests, it be comes necessary to face the question of why governments would pursue any of the competing goals of mone tary and fiscal policy. As economist Paul Craig Roberts stated, What do policymakers, especially in a democratic political system, have to gain from an efficient, stable economy that is maximizing social welfare? Such a suc cessful economy would cut into their abilities, as entrepreneurs, to build the spending and regulatory constituencies that are the basis of their political power.

If people can get ahead through the mar ket, and the tax system allows them to accumulate wealth, what happens to the demand for all the welfare handouts, food stamps, housing subsidies, and income security programs? Without all these programs, what would government do? How would politicians carryon their demagogy and set group against group, class against class, and race against race if the tax system were actually used to bring about an equal distribution of in come and wealth?23 There is certainly much evidence of this. How else can one explain the extreme opposition by entrenched government bureaucracies to sup ply-side economics which attempts to restore incentives to work and in vest and to alleviate poverty by the only means known to man-stimu lating economic growth and wealth creation in the private sector? In short, those who benefit from public sector expansion have found it essential to undermine the activities of and public confidence in the pri vate sector.

Stabilization policy, a watered down version of central planning, has served, and will continue to serve to destabilize the private sector of the economy and to transfer resources and power to the government. After all, why should one expect govern ment bureaucrats to solve the prob lems which justify their very exis tence? While the free economy may not be void of economic fluctuations, government attempts at "fine-tun ing" have only destabilized the economy even more than what would have otherwise taken place, and will continue to do so as long as they are used. Conclusions The free economy is most condu cive to maximizing consumer wel fare, as defined by consumers them selves. In the free economy it is ultimately the consumer who deter mines the pattern of production and distribution, the distribution of in come, and induces entrepreneurs to produce goods and services at least cost. It is precisely for these reasons that interventionists are so opposed to the free economy. When political resource allocation replaces the market allocation of resources the result can only be the forceful im position of the preferences of gov ernmental agents for those of con1982 PUBLIC POLICY AND THE FREE ECONOMY 509 sumers, which is neither efficient nor equitable.

Political resource allocation, rela tive to the market, is wasteful and severely limits individual freedom and welfare. Furthermore, attempts at "fine-tuning" or "planning" are nothing more than attempts to sub jugate consumers and taxpayers to the preferences of those who have seized political power, and have se verely reduced the wealth of na tions. As a glance at any map of the world reveals, only the free economy is capable of achieving equity and prosperity. @ -FOOTNOTES1Ludwig von Mises, Human Action: A Trea tise on Economics, 3rd Ed., (Chicago: H. Reg nery Co., 1966), p. 270. 2Milton and Rose Friedman, Free to Choose: A PersonalStatement (NewYork: Harcourt Brace Jovanovich, 1979), p. 13. 3James Madison, The Federalist, 10. 4Alexander Hamilton, The Federalist, 6. 5James Madison, The Federalist, 51. 6James M. Buchanan, "Why Does Govern ment Grow?" in T. Borcherding, Ed. Budgets and Bureaucrats: The Sources of Government Growth, (Durham, N.C.: Duke University Press, 1977), pp. 3-18.

7Jerome Rothenberg, Economic Evaluation of Urban Renewal (Washington, D.C.: Brookings Institution, 1967), p. 65. 8This is a dominant theme of the economics of bureaucracy. See, for example, William Nis kanen, Bureaucracy and Representative Gov ernment (Chicago: Aldine, 1971). 9Adam Smith, The Wealth of Nations, Can nan Edition, (London, 1960), vol. II, p. 427. lOIbid,p. 129. llIbid, p. 143. 12Ibid,p. 152. 13The following examples are cited in Yale Brozen, Is Government the Source ofMonopoly? and Other Essays (San Francisco: The Cato In stitute, 1980). 14A detailed discussion of occupationallicen sing is found in Walter E. Williams, "Govern ment Sanctioned Restraints That Reduce Eco nomic Opportunities i for Minorities," Policy Review, (Fall 1977), pp. 1-29. 15Ludwigvon Mises; Bureaucracy (Westport, Conn.: Arlington Hou$e, Reprinted 1969), p. 1. 16Gordon Tullock, The Politics of Bureau cracy (Washington, D.C.: Public Affairs Press, 1965).

17Thomas Sowell, Knowledge and Decisions (New York: Basic Boo~s, 1980), p. 214. 18Wassily Leontief and Leonard Woodcock, "The Case for Planning," in The Politics of Planning, p. 348. 19Hubert H. Humphrey, National Economic Planning: Right or W~ong for the U.S.? (Wash ington, D.C.: American Enterprise Institute, 1976), p. 3. 2°Even Franco Modigliani, perhaps the chief inventor of Keynesiari economics in the U.S. came to this conclusion in his 1977 presidential address to the American Economic Association, "Should We Forsake Stabilization Policies?" American Economic Review (May 1977). 21See, for example, Itichard E. Wagner, "Eco nomic Manipulation for Political Profit: Ma croeconomic Consequences and Constitutional Implications," Kyklos, 'Vol. 30, (1977), pp. 395 409. 22Herschel Grossman, "Tobin on Macroecon omics: A Review Arti¢le," Journal of Political Economy 83 (August 1~75), pp. 845-46.

23Paul Craig Robert$, "Taxation and the In duced Demand for Lev~athan," paper presented at the 1980 meetings of the Mont Pelerin Soci ety, The Hoover Institt/.tion, Palo Alto, Califor nia.