The Introduction follows.
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What kinds of goods and services should be provided by government employees as opposed to private firms? Should government workers make steel and cars in government-owned factories? Should teachers and doctors be publicly employed or should they work for private schools and practices? Should garbage be picked up by civil servants or employees of private garbage haulers? Should the whole economy be "socialized"? Although these are age-old questions in economics, the answers economists give to them, as well as the reasons for arriving at these answers, have been changing. In this paper, I describe some recent ways of thinking about government ownership.
Half a century ago, economists were quick to favor government ownership of firms as soon as any market inequities or imperfections, such as monopoly power or externalities, were even suspected. Thus Arthur Lewis (1949, p. 101), concerned with monopoly power, advocated the nationalization of land, mineral deposits, telephone service, insurance, and the motor car industry. For similar reasons, James Meade (1948, p. 67) favored "socialization" of the iron and steel, as well as the chemical, industries. Maurice Allais (1947, p. 66), always a step ahead of his English-speaking peers, argued for nationalization of a few firms in each (!) industry to facilitate the comparison of public and private ownership. At that time, privatization of such services as incarceration and education was evidently not even discussed by serious scholars.
These comments by the future Nobel laureates were part of a broader debate over capitalism, socialism and the role of planning in a market economy, which raged in the 1930s and 1940s. The views of serious economists ranged from advocacy of socialism (Lange, 1936; Lerner, 1944), to fierce opposition to socialism (Hayek, 1944; Jewkes, 1948), to a reluctant concession that socialism is bad but inevitable because capitalism was running out of steam (Schumpeter, 1942). A remarkable aspect of this debate is that even many of the laissez-faire economists focused overwhelmingly on the goal of achieving competitive prices, even at the cost of accepting government ownership in non-competitive industries. Thus Henry Simons (1934, p. 51), in "A Positive Program for Laissez Faire," writes "The state should face the necessity of actually taking over, owning, and managing directly, both the railroads and the utilities, and all other industries in which it is impossible to maintain effectively competitive conditions." Simons's advice is partly a response to the failures of regulation during the Depression, but the acquiescence of this libertarian economist to public ownership is symptomatic of the professional sentiment of the times. Pigou (1938), Schumpeter (1942) and Robbins (1947) were not too opposed to state ownership either, although Pigou recognized most clearly the dangers of bureaucratic control. In the first edition of his Economics text, Samuleson (1948) was more skeptical of socialism, writing (p. 604): "It is only too easy to gloss over the tremendous dynamic vitality of our mixed free enterprise system, which, with all its faults, has given the world a century of progress such as an actual socialized order might find it impossible to equal." Even Samuelson, however, focuses exclusively on the allocative role of prices, and does not say anything about ownership.
Consistent with the evident lack of aversion to state ownership, the postwar state assumed an enormous role in production throughout the world, owning everything from land and mines to industrial factories and communications to banks and insurance companies to hospitals and schools -- even in market economies! In some of these economies, such as Japan, the United States, and Germany, government ownership was restrained, while in others, such as Italy, In the prewar and predepression years, economists were a good deal more skeptical about state ownership. A truly brilliant statement of this skepticism, to which I return below, is by Alfred Marshall (1907).
France, and Austria, the state assumed control of significant parts of production. Most developing countries opted for state ownership of the so-called "strategic" sectors. In socialist economies, the state came to own not just the strategic sectors, but everything else as well.
How the world has changed! In the last 20 years, governments in market economies throughout the world have privatized the very state firms in steel, energy, telecommunications and financial services that the Nobel laureates approvingly saw nationalized a few decades earlier. Communism has collapsed almost everywhere in the world, and reform governments throughout the formerly socialist world have embarked on massive privatization programs. The economic policies of developing countries turned squarely to private ownership. In market economies, government provision of such basic services as garbage collection and education has come into question, and has increasingly been replaced with private provision, though still largely paid for from tax revenues.
Although some early voices, most notably that of Milton Friedman (1962), did rise to oppose state ownership, it is fair to say that post-war economists generally failed to anticipate its grotesque failure2. In recent years, however, the evidence on the failures of state ownership in economies around the world has begun to accumulate (World Bank, 1995), and advances in the theories of ownership and contracting have reopened the question of state versus private provision. The contracting perspective distinguishes sharply between the government paying for a particular service, such as education, and providing it inhouse. This perspective also permits to identify the opportunities for achieving social goals through private supply by a firm that may operate under a government contract or regulation. In a sense, the issues here are closely related to the vertical integration literature (Coase, 1937), except the question is that of the “make or buy” decision by the government rather than by a private firm.
When the opportunities for government contracting are exploited, the benefits of outright state ownership become elusive, even when social goals are taken into account. Moreover, it becomes clear that private ownership is the crucial source of incentives to innovate and become efficient, which accounts for what Samuelson (1948) called the "tremendous vitality" of the free enterprise system. The contractual perspective can serve as the basis of a theory of optimal provision when the government maximizes social welfare. It also allows us to think about an imperfect government, which maximizes political goals such as patronage or simply the income of politicians through bribes. Generally speaking, the case against state ownership becomes stronger when political considerations enter the calculation.
This paper begins by evaluating the case for in-house provision of goods and services by employees of a benevolent government. It argues that the conditions under which government ownership is superior in a country with good contract enforcement are very limited, and involve particular cases where soft incentives are extremely valuable and competition is very limited. I then turn to the more realistic case of a non-benevolent government, which helps to explain why the gains from privatization in many instances have been so enormous. Elementary and secondary education offer a particularly vivid example where I believe the case for near-monopoly government provision in an advanced democracy is indefensible.
The bottom line of this paper is simple. The 1940s case that government production is broadly desirable is no longer convincing. This case was motivated in part by such empirical observations as some successes of government control during the war, the failures of competition and regulation during the Great Depression, and the apparent success of Soviet industrialization, but also by a misunderstanding of the consequences of political control of firms, and by a substantial disregard of the importance of innovation in market economies. Today, the war and the Depression are no longer as vivid, and the communist economies have collapsed. As importantly, the quality of contracting and regulation have improved, competition has become more effective, the dangers of politicization of production have become self-evident, and the appreciation of the innovative potential of entrepreneurial firms is at a new high. For all these reasons, the benefits of reducing the role of government as a producer are becoming apparent and beginning to be exploited.
France, and Austria, the state assumed control of significant parts of production. Most developing countries opted for state ownership of the so-called "strategic" sectors. In socialist economies, the state came to own not just the strategic sectors, but everything else as well.
How the world has changed! In the last 20 years, governments in market economies throughout the world have privatized the very state firms in steel, energy, telecommunications and financial services that the Nobel laureates approvingly saw nationalized a few decades earlier. Communism has collapsed almost everywhere in the world, and reform governments throughout the formerly socialist world have embarked on massive privatization programs. The economic policies of developing countries turned squarely to private ownership. In market economies, government provision of such basic services as garbage collection and education has come into question, and has increasingly been replaced with private provision, though still largely paid for from tax revenues.
Although some early voices, most notably that of Milton Friedman (1962), did rise to oppose state ownership, it is fair to say that post-war economists generally failed to anticipate its grotesque failure2. In recent years, however, the evidence on the failures of state ownership in economies around the world has begun to accumulate (World Bank, 1995), and advances in the theories of ownership and contracting have reopened the question of state versus private provision. The contracting perspective distinguishes sharply between the government paying for a particular service, such as education, and providing it inhouse. This perspective also permits to identify the opportunities for achieving social goals through private supply by a firm that may operate under a government contract or regulation. In a sense, the issues here are closely related to the vertical integration literature (Coase, 1937), except the question is that of the “make or buy” decision by the government rather than by a private firm.
When the opportunities for government contracting are exploited, the benefits of outright state ownership become elusive, even when social goals are taken into account. Moreover, it becomes clear that private ownership is the crucial source of incentives to innovate and become efficient, which accounts for what Samuelson (1948) called the "tremendous vitality" of the free enterprise system. The contractual perspective can serve as the basis of a theory of optimal provision when the government maximizes social welfare. It also allows us to think about an imperfect government, which maximizes political goals such as patronage or simply the income of politicians through bribes. Generally speaking, the case against state ownership becomes stronger when political considerations enter the calculation.
This paper begins by evaluating the case for in-house provision of goods and services by employees of a benevolent government. It argues that the conditions under which government ownership is superior in a country with good contract enforcement are very limited, and involve particular cases where soft incentives are extremely valuable and competition is very limited. I then turn to the more realistic case of a non-benevolent government, which helps to explain why the gains from privatization in many instances have been so enormous. Elementary and secondary education offer a particularly vivid example where I believe the case for near-monopoly government provision in an advanced democracy is indefensible.
The bottom line of this paper is simple. The 1940s case that government production is broadly desirable is no longer convincing. This case was motivated in part by such empirical observations as some successes of government control during the war, the failures of competition and regulation during the Great Depression, and the apparent success of Soviet industrialization, but also by a misunderstanding of the consequences of political control of firms, and by a substantial disregard of the importance of innovation in market economies. Today, the war and the Depression are no longer as vivid, and the communist economies have collapsed. As importantly, the quality of contracting and regulation have improved, competition has become more effective, the dangers of politicization of production have become self-evident, and the appreciation of the innovative potential of entrepreneurial firms is at a new high. For all these reasons, the benefits of reducing the role of government as a producer are becoming apparent and beginning to be exploited.
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