Wednesday, 8 May 2013

Bill English discovers bureaucratic management doesn’t pay

Interesting to hear this morning Bill English saying the Government won’t continue to prop up failing State-Owned Enterprises.

Finance Minister Bill English has questioned the viability of Solid Energy as he considers a host of State-owned companies facing financial difficulties.
    Learning Media, which produces educational material, is the latest to join the list of struggling SOEs. It says a range of challenges is affecting the sustainability of its business…
    Solid Energy has debts of $400 million or more. New Zealand Post also faces challenges…

Bear in mind that “profit” indicates a company has produced more resources than it consumes. A good thing, right.  Whereas struggling enterprises, like Learning Media, NZ Post, Solid Energy etc., etc., ad nauseam, actually consume resources. A bad thing.

Since Karl Marx, the primary rationalisation behind governments running businesses has been the notion that running a business is so easy even hired bureaucrats can do it.  The whole Soviet Union relied (and, in the end, it failed) on this premise, Marx and Lenin both explicitly suffering from the long-standing delusion that economic organisation would become less complex once the profit drive and the market mechanism had been dispensed with. Lenin put the delusion best, saying about the running of state-owned enterprises:

The accounting and control necessary for this have been simplified by capitalism to the utmost, till they have become the extraordinarily simple operations of watching, recording and issuing receipts, within the reach of anybody who can read and write and knows the first four rules of arithmetic.

That describes the view of the simple-minded folk today who put their name to the petition opposing the Government’s partial sale of the power companies—that there is nothing much for these enterprises to do beyond following “best practice,” doing your books, and collecting the profits therefrom. But there is much, much more to running an enterprise than “the extraordinarily simple operations of watching, recording and issuing receipts” –-as Don Elder, failed head of Solid Energy, Michael Cullen, failing chair of NZ Post, and “the team” at the failing Learning Media have slowly been discovering.

Running an enterprise demands more than simple bureaucratic management; it demands an unswerving commitment to making the most of the resources, the precious capital, that the enterprises control. This involves being open to opportunity, inventing new ways to use existing capital, and new methods by which to do business.  Taking calculated risks, in other words, (which one should not be doing with other people’s property). In short, running an enterprise demands much, much more than being a bean-counter: it demands entrepreneurial ability.

An entrepreneur is someone who organizes, manages, and assumes the risks of a business or enterprise. An entrepreneur is an agent of change. Entrepreneurship is the process of discovering new ways of combining resources. When the market value generated by this new combination of resources is greater than the market value these resources can generate elsewhere individually or in some other combination, the entrepreneur makes a profit. An entrepreneur who takes the resources necessary to produce a pair of jeans that can be sold for thirty dollars and instead turns them into a denim backpack that sells for fifty dollars will earn a profit by increasing the value those resources create…
    Entrepreneurs who make a loss, however, have reduced the value created by the resources under their control; that is, those resources could have produced more value elsewhere. Losses mean that an entrepreneur has essentially turned a fifty-dollar denim backpack into a thirty-dollar pair of jeans. This error in judgment is part of the entrepreneurial learning, or discovery, process vital to the efficient operation of markets. The profit-and-loss system of
capitalism helps to quickly sort through the many new resource combinations entrepreneurs discover…
    Two notable twentieth-century economists, Joseph Schumpeter and Israel Kirzner, further refined the academic understanding of entrepreneurship. Schumpeter stressed the role of the entrepreneur as an innovator who implements change in an economy by introducing new goods or new methods of production. In the Schumpeterian view, the entrepreneur is a disruptive force in an economy. Schumpeter emphasized the beneficial process of creative destruction, in which the introduction of new products results in the obsolescence or failure of others. The introduction of the compact disc and the corresponding disappearance of the vinyl record is just one of many examples of creative destruction: cars, electricity, aircraft, and personal computers are others.
    In contrast to Schumpeter’s view, Kirzner focused on entrepreneurship as a process of discovery. Kirzner’s entrepreneur is a person who discovers previously unnoticed profit opportunities. The entrepreneur’s discovery initiates a process in which these newly discovered profit opportunities are then acted on in the marketplace until market competition eliminates the profit opportunity. Unlike Schumpeter’s disruptive force, Kirzner’s entrepreneur is an equilibrating force. An example of such an entrepreneur would be someone in a college town who discovers that a recent increase in college enrolment has created a profit opportunity in renovating houses and turning them into rental apartments.

The basic argument against state-owned enterprises is a moral one: that governments have no right to sequester resources and monopolise them at others’ expense.  But the moral is also the practical: entrepreneurial skill is rare, and unlikely to be found among bureaucrats—which means the resources they sequester are more likely to be frittered away or destroyed than they are to be increased in value and put to increasingly better use. 

It was Ludwig von Mises in his book Bureaucracy who drew the important distinction between "bureaucratic management" and "profit management," explaining why the former necessarily fails: "In public administration, there is no connection between revenue and expenditure … there is no market price for achievements." Says John Chapman in an article at the Mises Daily:

[Mises] explained that neither incentives nor exploitation of useful information are optimal under bureaucratic management, and by definition there could be no rational calculation via profit and loss...
Conversely, after privatization, operations and cost efficiencies improve because once incentives are in place and aligned, and people are empowered and incited (by the lure of profit) to utilize "particular knowledge" of markets, methods, competitive conditions, et al., performance improves.

Privatisation is not a panacea—it will not make profitable organisations that will never have real value (Kiwi Rail). But it does set free entrepreneurs to find the best way to put the enterprises’ resources at the service of more and more people—which is what it means to increase their value.

We might also take not of Mises’ warning of "a by-product of bureaucratic management": what he calls the gradual vanishing of the "critical sense."

When one sees ministers in charge of enterprises losing millions of dollars, pay-systems that fail to perform their most basic function, hospitals that kill, schools that spit out illiterates, and a security force unable even to work out who it’s allowed by law to spy on, but with no sense of shame at the manifest failure, what we're looking at is exactly what Mises warned about.


  1. Privatisation is not a panacea—it will not make profitable organisations that will never have real value (Kiwi Rail).

    On the contrary, it is a panacea precisely because it wipes out those organisations and throws those dependent upon them into the gutter.

    This is why governments must be prevented from interfering in the market at all costs, and especially interfering in employment markets or by providing welfare. If the miners in solid energy or pike river had known they'd be in the gutter with nothing, their houses forclosed, their families on the streets when the companies went down, they'd have quit working there long ago!

  2. This is an excellent post.

  3. SOEs were always a stepping stone to sale.

    Absolutely none of those opposed to privatisation offer a single solid reason as to why the state should own them, beyond xenophobia and a belief that somehow, the private sector would "rip them off" despite the evidence to the contrary seen in:
    - Contact Energy, competing with three state owned and one private electricity supplier;
    - Air NZ for 13 years;
    - Tranz Rail for 12 years;
    - Telecom


1. Commenters are welcome and invited.
2. All comments are moderated. Off-topic grandstanding, spam, and gibberish will be ignored. Tu quoque will be moderated.
3. Read the post before you comment. Challenge facts, but don't simply ignore them.
4. Use a name. If it's important enough to say, it's important enough to put a name to.
5. Above all: Act with honour. Say what you mean, and mean what you say.