Australia is about to have a debate on the role of government in business. That debate is going to be spread over several issues – Qantas’ junk bond status, Holden’s Australian manufacturing decision, the ABC’s crowding out of private news. These are all issues that are going to challenge the Abbott government over the summer.

From a free market perspective the case for government intervention is quite limited. Economists talk about “market failure” as being a justification for intervention. This has a very precise definition – not that particular business models are failing, but that the market system itself cannot operate to provide the benefits of voluntary exchange.

Adam Smith famously argued that government should only provide those economic functions which were “advantageous to a great society” but not profitable to undertake. While recognising that these functions would change over time he nominated national security, the rule of law, and education as examples.

The free market position, however, is a minority view – perhaps even amongst economists. After all, there are plausible arguments why government should play a larger role in the economy. Indeed in the 1930s there was a great controversy – the socialist calculation debate – where it was argued government-owned enterprise could not only perform as well as private enterprise but even out-perform private enterprise. Others argued this was impossible.

The socialists won that debate.

Government Inc

There is no single conclusive theoretical argument against government ownership. To be sure there are arguments that free market economists find convincing that revolve around incentives and profit motives, yet the general population remains unconvinced.

The proof of the pudding is in the eating. We all understand that Soviet style economic planning doesn’t work. But what of planning at a more micro level? Would it matter much if the Australian government made (or continued to make) “co-investments” in Qantas, or Holden, or any other firm or industry?

It turns out that government is not particularly good at running businesses. Nor should we be surprised. Business is about customer satisfaction as measured by profit and entrepreneurial decision making.

Government doesn’t work on a profit basis and nor should it. Government works well when there are things that need be done that cannot be measured by profit. Good government is characterised by rules-based bureaucracy.

Profits matter

The easiest way to see the difference between government-owned firms and private firms is to look at the privatisation literature. The world’s leading expert in this area is William Megginson of the University of Oklahoma. After an extensive analysis of the data he concluded:

Almost all studies that examine post-privatization changes in output, efficiency, profitability, capital investment spending, and leverage document significant increases in the first four and significant declines in leverage.

The same firms are better managed and run post-privatisation than they were pre-privatisation.

The difference is the profit motive. Government has no profit motive and so it doesn’t matter much if firms make stuff nobody wants to buy. Similarly, when government only provides finance – this has the effect of blunting the profit motive. Again, it doesn’t matter much if firms can’t sell their output – as long as the government will keep pumping money into the firm it can survive.

The problem is that co-investment is a fraud on taxpayers and workers. Taxpayers end up losing their money while workers end up investing their human capital in dead-end industries. All up it is a lose-lose proposition.

Alan Porritt/AAP

Public interest or public choice?

What of organisations such as the ABC? Surely government ownership of the media provides a healthy balance to private interests? Well, that is one view.

The public interest theory of media ownership suggests state-owned media enterprise results in a better informed population as it promotes less biased and more complete information provision than the private sector would provide.

By contrast the public choice theory of media ownership suggests government ownership exists to allow political elites to divert resources to narrow interest groups or distort and manipulate information to benefit and entrench those elites.

Simeon Djankov, Caralee McLiesh, Tatiana Nenova, and Andrei Shleifer untangle those two theories using data from 97 countries (including Australia). They conclude the evidence tends to support the public choice interpretation over public interest explanations for government ownership.

This, of course, will come as a shock to an Australian audience. After all we keep hearing that a large percentage of the population believe the ABC provides a valuable service. It isn’t clear, however, what that actually means – a large percentage of the population doesn’t actually consume the ABC’s output. I think the steady stream of UK television re-runs has been very valuable. In a world of box DVD sets, and pay-on-demand video, that value will diminish somewhat over time.

The ABC fails Adam Smith’s test. To be sure, it isn’t profitable – but that is by choice, not an inherent feature of the business itself. Many of the ABC’s competitors are profitable. So here is the thing; the ABC does not provide many services the private sector couldn’t provide. But it does provide those services at a cost of some A$1.2 billion to the taxpayer.

The public interest argument for the ABC is those news and current affairs shows that it runs that the private sector wouldn’t run. The overwhelming majority of ABC activities are simply more-of-the-same activities that the private sector does just as well, and probably better. The government simply has no business in providing entertainment to the masses (or tiny elites in the case of the ABC). A review of the ABC would have to ask the question as to what exactly the public interest argument for the ABC is, and whether that is worth A$1.2 billion.

Government provision of goods and services is always likely to be captured by narrow interest groups. Service standards, however, have not increased in line with the volume of public funds that get poured into these areas. Government businesses simply do not make stuff people want to buy. These are not bugs, but rather a feature of government intervention.

In the end, it is easy to point to examples of apparent market failure and call for government intervention. The thing is that intervention fails too – it is only by comparing actual real world alternatives that we see that markets tend to work well and that the scope for successful government intervention is quite limited.