In his seminal article on economic calculation under central planning, Mises showed that a central planner cannot allocate productive factors in a manner consistent with consumer demand because the planner does not have the ability to calculate in terms of market prices. Market prices come about as the result of a competitive bidding process among decentralized private property owners who are seeking to earn profits.
In some cases, firms are not just being bailed out, they are being nationalized. Nationalization means that the ownership of the firm changes from the private sector to the government. This puts the Fed, or the Treasury, or whoever becomes the de-facto owner of these firms, in charge of them.
While the nationalization of the health care sector, the coal industry, the airlines, or any other industry would be bad enough, the nationalization of a single industry mainly destroys the ability of that industry to allocate capital rationally. But even within that industry, they have access to external market prices for their inputs and their outputs. And nationalized firms can still adopt technological advances that are generated by the competitive part of the economy.
The role of financial institutions within a market economy is to allocate capital. Banks, for example, borrow from small depositors and lend to home buyers or small businesses. Investment banks invest the equity of the share holders in asset markets, facilitate the issuance of new securities, and manage the capital of private investors.
This is why the recent round of bailouts of financial institutions is so damaging. The impact of these nationalizations is multiplied compared to the takeover of an industrial sector because the capital allocation function is so critical to a market economy. Financial institutions do not produce a physical good, they act entrepreneurially within the total capital structure of the economy to allocate productive factors. In no sense can this entrepreneurial function be replicated by a central planner operating outside of the profit and loss system.
I usually try to link to a news story at the start of a blog post, but for this point, any of the hundreds of articles archived by GATA would serve just as well.
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Yep,
I try to make this point all the time. For example, anytime the local teacher unions complains that it needs a pay raise/increase in benefits/whatever (happens quite often) I try to explain how the teachers actually have no idea if they are being paid too little because getting your salary from taxes inhibits economic calculation. Given the success of pubic schooling, I would venture to guess they are actually being paid too much!
Can you explain why if the US Treasury owns, say, Bank of America, then BofA will not be able to allocate capital effectively? Let’s say US Treasury will own 80% of BofA for 5 years and resell its holding after this period, wouldn’t it just be like another investor holding BofA stocks long-term? BofA will still be run by its management who are driven by financial incentives as before. So they tasks of capital allocation will still be done by individual banks who are driven by profits, even if those banks are owned by one owner, the government.
Can you explain why if the US Treasury owns, say, Bank of America, then BofA will not be able to allocate capital effectively? Let’s say US Treasury will own 80% of BofA for 5 years and resell its holding after this period, wouldn’t it just be like another investor holding BofA stocks long-term? BofA will still be run by its management who are driven by financial incentives as before. So the tasks of capital allocation will still be done by individual banks who are driven by profits, even if those banks are owned by one owner, the government.
ML — an owner will set the objectives for management. Usually a private owner has as an underlying objective to make a profit. A public owner may state this as the objective, but in fact the public owner doesn’t face the risk of bankruptcy.
I cannot imagine the political pressure that is to come on these newly acquired now-public companies. When they go to foreclose on a home, I can already see the news clip on the “government throwing out the poor homeowner.” You cannot seriously expect that management will act for profit when the owner will want to act for politics.
Management (who want to keep their jobs just like almost everyone else) will not act in a way counter to the shareholders’ desire.
Robert
Congratulations. I have been reading your columns for years, and everything you predicted would happen came true. They say that hindsight is 20/20. What I find most disconcerting is that mainstream economists, even with hindsight, would still qualify as being legally blind.
ML – concerning why can the UST not allocate capital, you should read the linked article by Mises on this point. The government does not really bear the risk of loss because there are not clear equity holders. There are managers but the true risk of loss is shifted to the taxpayers. Secondly, Mises emphasized the competitive nature of the price system. If an entire sector is run by the government, then there are no competing bids for productive factors. Mises emphasized that prices need to come about through a competitive bidding process because each entrepreneur has different knowledge about their industry, different ideas about what products or capital combinations will work, and different forecasts of what their costs and revenues will be. The “intellectual division of labor” among competing property owners is not present when there is a monopoly.
Danny,
I understand your point about different owners may put on different types of pressure on management. But I would imagine that can be circumvented by the contract between the Treasury and Congress. A provision could be set to keep all compensation plans the same. I would think political intervention can be significantly reduced by setting specific financial guidelines for the rescue effort and specify when Congress can interfere with the effort. It can be set up so that the only time Congress can interfere is when the rescue effort is not meeting its financial objectives.
ML – You really need to read Mises’ article and some of the supplementary literature. The plan you are outlining is called “market socialism”. Your plan, and others like it, were proposed by socialist “economists” in response to Mises original paper. There was a huge debate over this in the journals that lasted for about a decade. Even if the profit/loss incentive problem could be solved, which it can’t, the planners wouldn’t know what to do because, without market prices, there are no means for evaluating alternative uses of productive resources.
ML please read this quote from Mises-
“The managerial function is always subservient to the entrepreneurial function. It
can relieve the entrepreneur of a part of his minor duties; it can never evolve
into a substitute for entrepreneurship. This fallacy to the contrary is due to the
error confusing the category of entrepreneurship as it is defined in the
imaginary construction of functional distribution with conditions in a living
and operating market economy. The function of the entrepreneur cannot be
separated from the direction of the employment of factors of production for the
accomplishment of definite tasks. The entrepreneur controls the factors of
production; it is this control that brings him either entrepreneurial profit or
loss.”
Meaningful prices are impossible in the absence of private property.Therefore economic calculation is also impossible even under the fairy tale of market
socialism.Some Austrians have fallen for this,eg Kirzner.
but in this present case aren’t we talking about the Fed taking control not the US Treasury?
I find it very telling that there has been a debate over nationalizing health care in this country for years but both Democrates and Rebuplics have been slient as the financial system has been nationalized while they all sleep.
Mikey, Robt. Blumen, and Danny:
You’re entirely correct and , especially, to cite the Mises passages. The single criticism I’d make (for the benefit of the guy you’re addressing–ML, I think) is that it’s not entirely clear to someone reading what you’ve said (or even what Mises has written) that an integral element of the “private property” and “market” is the stock market itself. I know you understand it–but not everybody does. The stock market is what enables a given entrepreneur to compare valuations. The same process is possible in its absence–but much crippled insofar as informational efficacy be concerned.
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