Imagine you are the foreman of a factory. Inside the factory are two machines. Both machines consume materials, energy, and labor and produce the same product, perhaps cars, or toasters, or pencils. However, one of the machines, given the same inputs, produces far fewer of that product. Assume that inputs for maintenance to keep the machines running indefinitely are included in the consumption numbers. The question you need to answer as foreman is how to divide the resources between the two machines.
The answer seems obvious: Put all your resources into the better machine! Some fraction of the resources put into the inefficient machine will be wasted, so unless your inputs are extremely abundant and the demand for products is exceedingly desperate, leave the inefficient machine alone and just use the efficient one!
Then, if profits allow you to buy more machines, expand your capacity with more of the efficient ones!
This brings us to our real topic, the assertion by some Modern Monetary Theory proponents, like Bill Mitchell and Joan Muysken, that inflation is merely a way to transfer goods from the private sphere to the public sphere. What this assertion cleverly sidesteps is the difference in effectiveness that goods have in the private sphere versus the public sphere.
What MMT proponents don’t tell you is that there are several good reasons to assume that goods are wasted and misused much more frequently in the public sphere. Our purpose here is to outline several of these reasons so that MMT proponents cannot so easily get away with presenting such transfers as harmless.
Pareto inferiority
At first glance, a concept like “social utility,” meaning some kind of distilled macroeconomic representation of all the value in society, seems like a good idea. However, the impossibility of comparing interpersonal utilities makes calculating total social utility impossible as well.
However, that doesn’t mean we know nothing about social utility. Vilfredo Pareto described something in 1906 that has come to be called the Pareto rule. In its most basic form, it says we know that voluntary transactions increase social utility because the parties to the transaction all agree they are better off after it is concluded. Such transactions are called Pareto superior.
In contrast, coerced interactions, such as those enforced by the state, are Pareto inferior because one or more of the parties is made worse off by the interaction.
To bring this back to our machines, the Pareto-superior transactions represent the more efficient machine.
Mises’ calculation problem
Complex economies require the ability to calculate profit and loss to function. The fluctuating prices of various commodities allow entrepreneurs to look for opportunities for profit — to transform goods from a form with relatively low money value to a form with higher money value.
In 1920, Ludwig von Mises published a groundbreaking paper in which he explained that state ownership of goods or industries hinders or eliminates those price signals. If the state owns all the types of goods, then no real market price can exist for them and entrepreneurs cannot calculate the differences in returns between different production processes.
This results in goods being used inefficiently in the sense that other uses would serve the consumer much better. Without prices, there is no way to measure these differences.
In a fully socialist economy, this would quickly bring the economy to its knees. Partial socialist economies of two types would suffer serious losses but might manage to stay afloat for some time. The two types of partially socialist economies are those with a few select nationalized industries, and those locally fully socialized economies with nonsocialized neighbors.
In partially socialist economies, central planners can use price data from nonnationalized industries or from nonsocialist neighbors to attempt economic planning, but the numbers are necessarily lacking, and efficiency would be expected to decrease anyway given that these numbers are not real prices but simple points of data. Again, the market economy, with full, dynamic price data for all goods represents the more efficient machine.
Hayek’s knowledge problem
Another problem with central planning was illuminated by Friedrich Hayek in “The Use of Knowledge in Society” and in many other writings. The crux of Hayek’s argument is that the knowledge a central planner would need to efficiently plan the economy — even knowledge that isn’t directly related to prices, as in Mises’ calculation problem — is so widely dispersed among so many different individuals that there is simply no hope of collecting, understanding, and using all of it.
Hayek argues that market prices send signals about such knowledge more easily around the economy, so that the individual holders of important information and valuable capital goods can go forward with or alter their plans in ways that help the economy function efficiently. In contrast, state central planners often simply ignore this distributed information and make their own uninformed decisions about the use of capital goods and the distribution of consumer goods.
It is easy to see why the central planners might be less efficient. Again, the market economy represents the more efficient machine.
Public choice theory’s argument
Public choice theory is the attempt to apply the methods of economics to better understand how politics and political bodies work. For our purposes, we are most interested in the argument that public choice theory makes about the motivations of politicians.
Essentially, public choice theory argues that politicians are generally incentivized to use goods in the public sphere for their own benefit and not for the people insofar as they can get away with it. Politicians might use public goods to buy votes from various interest groups, regardless of whether those goods are being used efficiently.
Governments, having the ability to levy taxes, are much freer to ignore profits and losses than market entrepreneurs. This has wide-ranging effects on how public goods are used versus private goods. From a neoclassical perspective, private entrepreneurs are generally less monopolistic and thus more efficient than the state. From an Austrian perspective, the argument that decentralization leads to higher social welfare is not valid, but the Pareto rule does still hold.
In Mises’ 1944 book “Bureaucracy,” one of his points concerns the relative sizes of bureaucracies in market firms versus the state. In market firms, profit and loss place limits on the size of any bureaucracy, and smaller competitive firms encourage larger firms to reduce their bureaucratic load. However, the state is insulated from profit and loss and from competition; therefore, one would expect state bureaucracies to be larger and less efficient, consuming more inputs and producing worse outputs. Once again, the private sphere represents the most efficient machine.
Conclusion
Transferring goods from the private sphere to the public sphere is not the harmless conversion that MMT proponents and other lovers of big government imply. When they say that they only want to make a few more goods public, what they’re not saying is that those goods will likely, if not certainly, be used to serve far fewer consumers and to satisfy far less urgent and valuable wants. Moving goods into the public sphere means they will be used in Pareto-inferior transactions, that their users will suffer from a lack of useful prices and other information and be less able to judge the most efficient uses, and that, lacking a profit motive, they will likely not use them for the satisfaction of consumers at all.
What happens when the state decides to inflate is that the people end up with more financial instruments but less wealth in real terms.
Instead, goods should remain as much as possible in the private sphere where they will be most useful, and the public sphere should be starved of resources as much as possible. Organizations in the public sphere should be disbanded or converted into private-sphere organizations, exposing them to consequences when they make mistakes, requiring them to make Pareto-superior transactions and preventing them from obscuring or ignoring the information that markets provide.
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