Gerard Jackson
BrookesNews.Com
Monday 10 May 2004

Although it has been many years since the Austrian school of economics explained the nature and benefits of free markets the lesson has yet to sink in with socialists, despite the determined efforts of supporters of Austrian economics.

Real socialists cannot grasp the benefits of privatization because they just don't understand the nature of markets. Now it's not enough to empirically demonstrate that genuine privatization has generated benefits. One must explain why free markets produce these results, and this is where Austrian economics has been exceptionally successful.

Socialists argue that privatisation imposes unnecessary burdens on the community because profits are a cost. (It's a pity they don't take the same attitude to taxes). Confusion about profits arises because most people, including some economists who should know better, think of profits as net revenue. This is not so. Profits are maladjustments (another Austrian insight) between supply and demand.

This means that when profits are being made factors are being priced below the value of their marginal product and the supply of the product is lagging behind demand. The market process signals this situation to other entrepreneurs who then move in to eliminate the maladjustment by competing away the profits until only enough is being earned to maintain equilibrium. (Most economists mistakenly call this a normal profit when reality it is an interest return).

It follows that if any state firm is making genuine profits then there is an obvious maladjustment between supply and demand. Consumers are getting too little of the product at high prices while factors are under priced. As we have seen, the market's solution is to compete away the profits by increasing investment, expanding output and hiring more labour.

This makes nonsense of the socialists' argument that profits are a cost on the community that can be taxed away without damaging economic welfare. So what would happen if a state-owned firm was ordered not to make profits even though its monopoly situation allowed it to do?

The result would be wasted and misallocated resources, gross over manning, a great deal of on-the-job consumption (perhaps much of it disguised as R&D), expansion into peripheral activities, etc. But allowing the market to eliminate profits would have the reverse effect and also speed up technological change.

This brings us to entrepreneurship, an activity that can be neither nationalized nor replicated within a state structure. To speak of entrepreneurship, therefore, is to state that ownership not only matters but that it is absolutely vital to economic and social progress. Without it, as the Austrians point out, there is only poverty and degradation.

What socialist economists ignore is that even when operating in a competitive environment, state companies are not presented with the same range of opportunities that private companies face as well as create for themselves.

This is because the decision-making scope of state managers is not only more limited than that of managers in private companies it is also operates on different levels. It is ownership that makes this difference because it is ownership that affects choice.

When making a choice the owner, or one acting for the owner, has to think in terms of displaced revenue, i.e., his opportunity costs. Without the ability of being able to freely dispose of property in any way he sees fit his range of choice is clearly limited. It means alternative opportunities of using the firm's property (in the form, for example, of shares) to acquire or dispose of income are denied to state managers.

Hayek, a leading member of the Austrian school of economics, pointed out that the market is also a discovery process, the costs of which are spread among thousands of firms and thus the economy. These firms innovate, invent, speculate, experiment and constantly change their factor combinations: each firm striving to win over consumers by providing them with products at attractive prices that still make profits. It should be self-evident that entrepreneurship stands at the heart of this process

Therefore, the absence of ownership denies state manages the means to make the kind of market calculations and decisions that made, for instance, Ford the pioneer in car production, Sony a Japanese colossus and Microsoft a software production giant. Without individual ownership these entrepreneurs could not have existed and their products would never have been born.

For the likes of Sharon Beder to argue otherwise (The myths that drive privatisation, The Age 30 April) is to argue that if the state had controlled computer development we would have the range and multitude of PCs, software, peripherals and IT equipment that we now take for granted.

The accounting approach on which state industries are basically forced to rely on as a substitute for entrepreneurship is based on calculating the monetary value of inputs and outputs and comparative rates of returns. It cannot, as Austrian economics stresses, take into account the lost opportunities caused by state ownership nor cannot it mimic entrepreneurship. Therefore it cannot measure market efficiency.

Socialists who consider otherwise are deluding themselves as well as revealing their ignorance of the nature of markets, entrepreneurship and the vital role of ownership.

Gerard Jackson is Brookes' economics editor