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Government Produces Nothing, Ever

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06/12/2007Vladimir Menshikov

Can government spending contribute to macroeconomic stability and the higher productivity of labor? Many people say yes, because they believe that government spending can stimulate the aggregate demand and contribute to the accumulation of capital if it finances large public investment projects.

In one of my previous articles I argued (against the still-prevalent view, largely informed by Keynesian economic theory) that government spending, far from being an appropriate means to counteract economic downturns and unemployment, always and everywhere exacerbates the very economic problems it is called upon to solve.

In another article I tried to show that it is precisely the governmentally sheltered fractional-reserve banking system (with or without the institution of central banking) that has always been the source of fluctuations in aggregate demand.

In the present article I would like to make just two points:

  1. There is no such thing as public investment, only public consumption. This conclusion follows immediately once we clearly recognize:

    1. the distinctive character of government's economic position within a division-of-labor economic system, and

    2. the very nature of the principles of organization and management according to which the government carries out all of its operations.

  2. Since private investment is the only source of capital accumulation and economic progress, excessive taxation reduces capital and damages the economy.

Productive and Consumptive Activities under Division of Labor

To understand that government is a consumer, albeit of a special kind, is first to grasp the idea that all government spending, including spending for the category of so-called public goods (highways, bridges, harbors, tunnels, etc.), is consumptive; it is by no means productive in the sense we apply the term to private productive expenditures.1

To grasp the actual economic status of the government and its expenditures in the context of a division-of-labor society, we need to understand the criteria that would enable us to divide all economic activities into the two basic categories: productive and consumptive.

In thinking about a Robinson Crusoe economy, there may be good reason to distinguish between the two basic categories of economic activities — production and consumption — using criteria expressed in terms of units of physical goods or satisfaction derived from the consumption of these goods. But to transform the same criteria and the same reasoning to the case of a modern economy is to commit a fatal conceptual error.

The distinguishing characteristic of a division-of-labor economic system is the structure of its economic interdependencies, a structure that decidedly influences, shapes, and conditions the economic actions of all of its members.

In order to gain a correct understanding of the nature of life in a division-of-labor economy we have to understand the necessary and unique conditions that define and characterize the motivations of its participants, namely, the role of moneymaking and productive expenditure in the production process.

First, as Professor Reisman explains, "[W]ithout the earning of money, one must attempt to produce and to live at a level somewhere between that of Robinson Crusoe and the inhabitants of Tobacco Road".2 The incredible complexity of the division-of-labor economic system is held together by the price system, which in turn depends vitally on money and monetary calculation, as shown by Ludwig von Mises and the Austrian school.3 None of these things enter the consciousness and motivations of Robinson Crusoe: neither the necessity of making money nor the need for monetary calculation to appraise the outcomes and expectations that result from his own actions.

Second, under the division of labor in a monetary economy, all expenditures are to be classified as either productive or unproductive. (Unproductive expenditure is also called consumption.) That is, a given quantity of money and volume of spending can ultimately be divided according to the purpose of the spending — either consumption or production. There are no other alternatives.

From the point of view of an individual consumer, once money has been spent on consumers' goods, he must find ways to obtain fresh funds in order to be able to consume in the future. That the money is spent and gone is most clearly present in the fact that an act of consumption does not provide any means, either physical or monetary, to obtain goods next time. It is literally an act of destruction of the goods which had been previously produced.

On the other hand, productive expenditure, according to Professor Reisman,

"is synonymous with reproductive expenditure, for it is money which is both laid out and brought back by virtue of productive expenditure…. This is because, in the context of the whole process of which it is a part, productive expenditure does not constitute a using up of money. Funds that are productively expended subsequently return, usually with the addition of a profit. Funds that are unproductively expended, as a rule, either do not return at all or return only in a smaller amount, and thus are simply consumed…. In the one case, there is replacement and increase. In the other, simply decrease."4

Now, the productive expenditures are made only by business enterprises in order to produce goods and services that can subsequently be exchanged for money on the market. Bringing in money revenues constitutes, of course, the very purpose of organizing business enterprises in the first place. And since the quantity of money and volume of spending are in some sense always fixed, there is a constant competition for the scarce money funds among the business firms.

It is entirely irrelevant to what extent an activity in question is physically productive. An activity is to be classified as productive if it is carried out with the purpose of bringing in or helping to bring in money either in the form of sales revenues, rental revenue, or interest revenue.

For example, a laundry service and a housewife both use washing machines. Both parties make dirty clothes clean again, i.e., they both "produce" clean clothes. In both cases the washing machines undergo wear and tear and natural deterioration. Yet, despite all their similarities concerning the physical aspects of cleaning, they represent two fundamentally different activities in respect to their economic significance.

In the first case, the housewife does not receive for her domestic "services" any payment that she can use to purchase a new washing machine once the old one wears out. She must turn to other sources in order to receive the necessary funds to buy a new machine. On the other hand, the laundromat receives payments precisely for the cleaning services it provides. The revenue thus received can be used to replace the washing machines it operates. The actual utility derived from home-cleaned clothes might indeed be very high; the clothes might be cleaner and smell better if a housewife does the laundry, but this fact is entirely irrelevant with respect to the nature of economic relationships within the division-of-labor economy.

If we push matters further back, we are, of course, confronted with the question of what the housewife or her husband does to afford the washing machine in the first place. And as I explained in some detail in yet another article, the source of wages cannot be consumption expenditure but only productive expenditure made by business firms.5

Economic Status of Government in a Division-of-Labor Economic System

Now, in order to answer the question of whether or not the government can be a producer — whether at least some of its projects may fall under the category of (productive) investment — we need to observe the following facts about the government in its capacity as economic entity.

First, the very fact that the government must resort to the collection of taxes (or the printing press) to finance its activities and projects, is a prima facie case against equating its activities with production and exchange.

Second, the manner in which government collects and spends its funds — in short, how it manages its economic resources — is not at all akin to the nature of the operations of business firms whose existence is subject to the forces of economic competition on the basis of profit and loss. Indeed, the modus operandi of the government is precisely the bureaucratic principle, which is the opposite of the principle of profit and loss. It is precisely because the government collects, not earns, the money to finance its projects that the status of government must be understood to be akin to that of the consumer.

It is best to quote Ludwig von Mises on this subject from his 1962 book Bureaucracyat length:

The objectives of public administration cannot be measured in money terms and cannot be checked by accountancy methods… In public administration there is no connection between revenue and expenditure. The public services are spending money only; the insignificant income derived from special sources (for example, the sale of printed matter by the Government Printing Office) is more or less accidental. The revenue derived from customs and taxes is not "produced" by the administrative apparatus. Its source is the law, not the activities of customs officers and tax collectors. It is not the merit of a collector of internal revenue that the residents of his district are richer and pay higher taxes than those of another district. (pp. 48–50)

A [government] bureau is not a profit seeking enterprise; it cannot make use of any economic calculation; it has to solve problems which are unknown to business management. (p. 51)

The conduct of government affairs is as different from the industrial processes as is prosecuting, convicting, and sentencing a murderer from the growing of corn or the manufacturing of shoes. Government efficiency and industrial efficiency are entirely different things. A factory's management cannot be improved by taking a police department for its model, and a tax collector's office cannot become more efficient by adopting the methods of a motor-car plant… [N]o reform could transform a public office into a sort of private enterprise. A government is not a profit-seeking enterprise. The conduct of its affairs cannot be checked by profit-and-loss statements. Its achievement cannot be valued in terms of money. (p. 55)

Government is a consumer, albeit a consumer of a special kind. Hence, all of its activities and programs, whether to finance various welfare projects, public education, or construction of roads, dams, and infrastructure are consumptive by their very nature. Like any other consumer, the government must turn to the production process — that is, to producers — for its funds. But unlike ordinary consumers, who obtain their incomes through voluntary exchange, the government obtains its income by means of forcible taxation.

  • 1. It is easy to see why people would assume bridges and harbors have productive potential, but when such projects are worth undertaking, the free market will undertake them.
  • 2. Cf. George Reisman, Capitalism: A Treatise on Economics, p. 443.
  • 3. See Ludwig von Mises (1922): Economic Calculation in the Socialist Commonwealth.
  • 4. Cf. Reisman, Capitalism, p. 444.
  • 5.
    Professor George Reisman originated the enormously fruitful ideas in connection with the distinction between productive and consumptive expenditures as applied to the case of a division-of-labor economic system. For a detailed discussion of the principles underlying the distinction and a number of important implications for economic theory, see his book Capitalism: A Treatise on Economics, chapter 11: "The Division of Labor and Productive Activity."

Vladimir Menshikov

Vladimir Menshikov is a PhD student at the University of Turin.

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