Is the Private Sector Always More Efficient?
Economic History Says No
An assortment of free market economists, EMH (efficient market hypothesis) fundamentalists, inflationist monetarists, crypto libertarians peddle the myth that government is a bumbling and incompetent misallocator of capital and that the private sector can always allocate capital more efficiently. This is historically illiterate because the simple facts of economic history of the last 200 years say so.
Ten examples of how the private sector is not always more efficient:
1. DARPA, which gave us the internet, was a public sector project. Throw in the GPS system in your smart phone, which is also public sector military tech. Facebook, Apple, Google, Twitter, etc. have never paid a penny in royalties for the publicly financed tech investments that made their businesses possible; the ultimate in corporate welfare.
2. The interstate highway system--in the capitalistic USA 100% public sector. Would you prefer privately owned freeways that charge high tolls, as in Italy and Spain? This PUBLIC investment rapidly paid for itself in the 1960s suburban development boom, as residential and commercial real estate investment followed the interstate highway system. The IHS also supercharged the franchising of the hotel and restaurant business.
3. Britain's superexpensive, inefficient and less safe trains are privately owned. Germany, France, Italy and Spain have publicly owned railway networks that are fast, low cost and have a far superior safety and on time record.
“New rail fare rises that come into force today have been described as a “kick in the wallet” by campaigners.
“Train ticket prices in England and Wales increase by an average of 3.1%, while fares in Scotland are up by almost 3%. The rises meant the price of some annual tickets have gone up by more than £200 this morning. The hikes come despite months of disruption that have seen delays across the network soar to their highest level in 13 years. The Times points out that fares have risen by 36% since 2010–2.6 times more than the increase in average earnings. Rail, Maritime and Transport union general secretary Mick Cash said fare payers are being “battered by the toxic combination of gross mismanagement and profiteering”. A report commissioned by Vouchercloud revealed that Britons pay 54p per mile to use the rail network, making it the second-most expensive nation in Europe for rail travel, after Norway. Privatisation has played a huge part in the high fares. Yahoo! News reports that since the privatisation of British Rail — which took place between 1994 and 1997 — ticket prices have “rocketed by 22%, with walk-on prices on some routes up by an eye-watering 245%” by 2016.” (https://www.theweek.co.uk/98201/why-are-uk-trains-so-expensive)
My last trip from Amsterdam to Berlin, a distance equivalent to New York to Chicago, took six hours and cost 34 euros ($41). The 261 km trip between Amsterdam and Cologne took 2 to 2 1/2 hours and cost 19–29 euros. The 310 km trip from Paris to Brussels took 75 minutes on the TGV and cost 19–34 euros. UK rail privatization is an indefensible loser, hands down. Italy’s state-owned high speed train network just drove Alitalia into bankruptcy and liquidation.
4. The TVA, the Tennessee Valley Authority, brought rural electrification to Appalachia, going where private capital would not go. Same for the Hill Country in Texas. The infrastructure the USA built during the New Deal that defeated fascism was built by the public sector and the loan guarantees that the federal government provided through the Reconstruction Finance Corporation. The TVA supercharged GDP per capita growth in the rural areas it operated in, even in the Republican-ruled 1950s and despite the GOP’s dislike for this enduring symbol of New Deal success. Here’s a portrait of the pre-TVA Tennesse Valley region:
“Prior to the creation of the TVA, large parts of the Tennessee Valley were in dire economic conditions. Soil erosion had ruined or damaged seven million acres of farmland. Per capita income in 1933 was only 44 percent of the national average. In Union County, Tennessee (near where the TVA built Norris Dam, its first project, 1933–36), for instance, there were no electrical utilities in 1926, crude birth rates were more than double the national average, and migration out of the area was heavy. Only 1 percent of farm owners had indoor plumbing, 4 percent telephones, and 8 percent radios.” (http://tnency.utk.tennessee.edu/entries/tennessee-valley-authority/)
Who resisted the TVA’s power generation and distribution enterprise? The private power companies, whose monopoly of this business was threatened by cheaper power and more universal distribution:
“opposition was mounting from outside the agency as well. The most serious challenges came from the private power interests who correctly saw Lilienthal’s plan of TVA power distribution through public boards and cooperatives as a death knell to its monopoly of electricity distribution. In 1934 stockholders in the Alabama Power Company sued the TVA to prevent the agency from buying facilities belonging to the power company on the grounds that the TVA was unconstitutional.” (http://tnency.utk.tennessee.edu/entries/tennessee-valley-authority/)
The president of the private power company suing the TVA was Wendell Wilkie, the Republican nominee for president in 1940. The Supreme Court dismissed the suit. The result:
“Total electric production capacity through hydroelectric and coal-fired steam and internal combustion plants equaled 2,513,102 kilowatts (an increase of 127 percent since 1940), which by 1946 provided electricity to 668,752 households. The new city of Oak Ridge, part of the important Manhattan Project which reached a high of 80,000 workers by 1945, was located in Anderson County, Tennessee, in part because of the availability of abundant electric power. Over 7,000 test demonstration farms had been set up to show valley farmers new agricultural and erosion control measures. TVA architecture in dams, power plants, and related facilities (under the supervision of Chief Architect Roland Wank) earned awe, respect, and prizes from other architects. By 1946 the TVA had acquired approximately 1.1 million acres (less than one-third of it inundated by the lakes) and had removed an estimated 72,000 people from their land, many of whom later admitted that, while they often opposed being removed, in the long run they were economically better off. In addition, malaria had been virtually removed from the Tennessee Valley. By 1953 per capita income had risen to 61 percent of the national average.” (http://tnency.utk.tennessee.edu/entries/tennessee-valley-authority/)
5. Land grant colleges that brought higher education to the masses in Middle America. Here’s the map, which includes MIT, Cornell, UMass, Penn State, Virginia Tech, Michigan State the University of California and hundreds of others:
“ A graduate of Montana State University went on to develop vaccines; researchers at Iowa State bred the key corn variety in our food supply; the first email system was developed at M.I.T. It’s easy to see why The Times looked to the Morrill Act as a blueprint for a more progressive future. But ask who paid for it, and who’s still paying today. The Morrill Act was a wealth transfer disguised as a donation. The government took land from Indigenous people that it had paid little or nothing for and turned that land into endowments for fledgling universities.” (https://www.hcn.org/articles/indigenous-affairs-land-grab-universities-land-grant-universities-should-acknowledge-their-debt-to-indigenous-people)
6. Public schools that made American education the envy of Alexis de Tocqueville and provided literate and numerate workers to growing 19th century industries. Not a private sector project. In France and Italy the rich send their kids to public schools because they're better. Private schools are for the dim sons and daughters of the rich who can't hack it in more demanding public schools. I was married to an Italian school teacher in Lecco and once gave a history lecture to her class of high school seniors. They were more educated and more capable of critical thinking than the UCLA undergraduates I taught from 1981-1983. Public sector wins, hands down.
7. The Manhattan Project. Relying on the private sector to build a nuclear weapon? Germany would have one first. Watch The Man in the High Castle on Amazon Prime to see what the consequences of that would have been.
8. The National Park System. Don't think you'd prefer privatization here, unless you'd prefer Bears Ears National Monument to be turned into a uranium mine. I live next to a beachfront Latvian national park with a forest honeycombed with dozens of mountain bike trails. I use it free of charge every day as if I owned it.
9. Healthcare: Public systems provide consistently better health outcomes at lower cost across the world. In countries with public options medical bankruptcy is unknown. Lower expenditures as a % of GDP with better health outcomes. Kenneth Arrow, in his landmark Nobel Prize-winning article, proved beyond doubt that information asymmetry leads to market failure in medical markets (https://www.researchgate.net/publication/11593063_Arrow_and_the_Information_Market_Failure_in_Health_Care_The_Changing_Content_and_Sources_of_Health_Care_Information/link/56f1fddb08ae1cb29a3d1f94/download). Add in the NIH's publicly financed research in universities that big pharma lives off. More corporate welfare for private capital reluctant to undertake early stage investments that only the government will. This is exquisitely documented in a 2004 article by former FDA regulator Marcia Angell: The Truth About the Drug Companies: https://www.nybooks.com/articles/2004/07/15/the-truth-about-the-drug-companies/ , later turned into her book:
What’s been done about this since its publication? Nothing. Socialism for Big Pharma is as durable a feature of Congress as gerrymandering and big money campaign finance. What’s stopping Senator Sinema from supporting Build Back Better? Its provision capping what Medicare will pay for drugs (https://www.vox.com/policy-and-politics/22702855/build-build-better-plan-medicare-negotiate-drug-prices). This is why my shares in Roche, Sanofy, Novo Nordisk, Novartis and Bristol-Myers Squibb have such predictable dividends.
10. Financial, housing and other bubbles and crashes: From the 1830s and 1840s railway bubble, to the 1920s stock market bubble, to the S&L fraud epidemic in the 1980s to the housing bubble of the naughts, the private sector has proven itself just as capable of misallocating capital as any government. Just ask any late stage investor in WeWork whose capital enabled Adam Neumann to walk away with a 1/2 billion dollar buyout. Markets, like the investors that feed their capital into them, are as inefficient as their players who often decide how to invest based on superficial heuristics and inadequate information. I won't list all the bad investments with misallocated capital I've made. The private sector is just as capable of being dumb money as the public sector. The entire venture capital industry, whose low returns and high fees have thrown it into terminal decline, richly deserves the disruption that AI and machine learning are about to do to it. It was too hidebound and inbred to make the investments in wind, solar and battery tech that Obama's cleantech funding did, which Tesla, Nio, the green energy REIT Hannon-Armstrong and other high flying stocks have flown off of. As the graphic above shows, the private sector comes late to the game after early stage public funding has derisked the investment. This is not a matter of ideology, but historical fact.
11. REITs (Real Estate Investment Trusts): Created in the early 1960s, REITs supercharged institutional investment in real estate by allowing publicly traded real estate companies to pass through 90% of their profits to investors tax-free. This federally established institutional investment structure allowed real estate investors to avoid the double taxation of dividends and allowed REITs to scale and standardize their design, development and construction process for their corporate clients as these scaled their businesses. Think of Equinix, Digital Realty and Cyrus One following their AWS and Microsoft Azure clients around the country and the world. Think of ProLogis following its corporate clients around the world. Without this federally-sanctioned pass-through structure, this scaling up would never have happened. I’m a happy recipient of lots of REIT dividends — federally sponsored socialism for the investor class.
12. The FHA (Federal Housing Administration): Without the federally guarantee for mortgages, the mortgage and the mortgage securitization market collapses back to 1930s levels. Without the federal guarantee to pay mortgage debts in April 2020, mortgage REITs collapse and a default cascade swamps the banking system.
Don’t like the Fed and its elastic money printing press? Go back to J.P. Morgan in walking onto the floor of the NYSE during the 1907 panic. That’s the only alternative to the Fed backstop and Keynesian public investment.
It’s not about socialism vs capitalism, but who gets socialism and who gets capitalism. Currently, we have socialism for the Bigs: Banks, Real Estate, Pharma, Insurance, Agribusiness, Energy, Tech and Sports — and cutthroat capitalism for the rest of us. That the system has allowed a little guy like me to pick a few crumbs off the plutocrats’ table doesn’t change this conclusion.
Winston Churchill once said “that democracy is the worst form of government except all the others that have been tried.” History tells us to reach the same conclusion about the Federal Reserve backstop and government investment in early stage high risk industries and infrastructure: all the known alternatives are worse.
