Note: this is a cross-post fromThe Realignment Project.

“A term like capitalism is incredibly slippery, because there’s such a range of different kinds of market economies. Essentially, what we’ve been debating over—certainly since the Great Depression—is what percentage of a society should be left in the hands of a deregulated market system. And absolutely there are people that are at the far other end of the spectrum that want to communalize all property and abolish private property, but in general the debate is not between capitalism and not capitalism, it’s between what parts of the economy are not suitable to being decided by the profit motive. And I guess that comes from being Canadian, in a way, because we have more parts of our society that we’ve made a social contract to say, ‘That’s not a good place to have the profit motive govern.’ Whereas in the United States, that idea is kind of absent from the discussion. So even something like firefighting—it seems hard for people make an argument that maybe the profit motive isn’t something we want in the firefighting sector, because you don’t want a market for fire. “
— Naomi Klein

Introduction:

As I discussed in part 1 of this series, “Public Virtues” will examine those areas in which the public sector has an economic advantage, and compare and contrast those where the private sector is supposed to have an advantage. And where better to start than the profit motive, the first principle of capitalism that’s been held up, not just as an explanation of why corporations get better and better at making widgets if people give them money, but why the public sector is inherently and unalterably inefficient, technologically stagnant, and uncompetitive. The profit motive, as everyone knows who’s lived in the capitalist world, basically holds that because people want to make a profit, they are pushed towards the maximization of their resources, and thus seeking to make profits, they make the system as a whole more efficient and productive.

However, most honest thinkers, i.e those not professionally involved in proving that capitalism is infallible, admit that the profit motive only spurs innovation and efficiency where it actually exists. Where it doesn’t, you wind up with market failures.  And where the market fails, that’s the natural place for the public sector. The debate, however is how often and where this happens.

Background:

Perhaps the best example of a market failure and public sector success is the example of the electricity industry in the Tennessee Valley and rural America more broadly in the 1930s, and the creation of the Tennessee Valley Authority (TVA). In order to really understand the history of this, however, you have to understand the history of the electricity industry. In the 1920s, electricity companies occupied roughly the same place as telecommunications companies did during the late 1990s;: they were high-tech, associated with progress and the future, and they had positive knock-on effects to other industries (industrial electrification aided mechanization, consumer electrification opened up markets for appliances like radios and refrigerators, and so on).

However, the electricity utilities were also vaguely reminiscent of the railroad companies of the late 19th century: they tended to focus on population centers where they knew there would be large numbers of customers with ready cash, they tended to build power lines competitively, trying to “cordon” off market share physically by blocking the extensions of their competitors’ lines into territories they were serving, and they tended to develop regionally, moving from one population and profit center in an area to nearby centers, in order to keep their construction costs down. What all of this meant was that huge areas of rural America, especially in the South, were largely cut off from electrification, even as the rest of America embraced the technology and especially the new appliances it powered.

And this essentially became a self-fulfilling prophecy. Rural America was cut off because electricity companies considered it to be ta part of conventional wisdom that there wasn’t a market out there: rural folk had no appliances to run electricity on, population centers were too spread out to make extending electricity lines and constructing new plants profitable, and there just wasn’t the demand. Of course, a huge part of the problem was that there wasn’t any demand because there was no way for rural consumers to express their demand – Rural consumers wouldn’t buy the new appliances because they didn’t have electricity to run on, and they couldn’t get electricity because no one was available to sell to them – and there wasn’t sufficient capital in rural areas to create local utilities that might signal potential demand.

What made the Tennessee Valley Authority and the Rural Electrification programs of the New Deal so revolutionary for their time was that they worked precisely because the government didn’t have to abide by the profit motive.  The New Deal spent huge amounts of money constructing dams in the Tennessee Valley (the Muscle Shoals Dam alone cost $46 million to build) and other rural areas, which was considered a total wild goose chase by private utility companies. And because they could afford to operate without a profit for several years, the TVA was able to build 20 dams and essentially created a consumer base from nothing. Within the seven-state area of the TVA, the number of electrified households rose from 6,000 to half a million in the first eight years.  And just as happened in urbanized areas, there was a huge knock-on effects – the TVA created 200,000 jobs, and those 200,000 workers could then afford to buy electricity; once electricity was available, industry moved in to take advantage of cheap land and labor, creating a further 500,000 jobs and changing the balance of agriculture and industry from 4:1 to 1:2. (hat tip to Marsha Freeman)

One of the things this shows is that, not only is there a huge space for market failures in basic consumer industries (as opposed to rare, isolated cases), but that public intervention into market failures is a boon for the private sector, rather than a hardship.

Principle:

In the modern corporate world, Wall Street has created expectations of 5% quarterly earnings growth as essentially normal – should a publicly-traded company fall below this mark, ratings agencies will downgrade your stock and investors will start to flee; even in privately-held companies will find their access to credit threatened if your bankers feel you’re not a solid risk anymore. Now, in many areas, this modern, high-octane version of the profit motive produces amazing results in terms of increasing productivity of widget production.

However, it also has distorting effects that I think exacerbates the extent of market failures in the current economy. To give a good example, let’s look at newspapers. The problem with newspapers is that their product doesn’t really change from quarter to quarter, and their consumer base (i.e, the total universe of potential buyers) doesn’t really change from quarter to quarter either. So how do you generate 5% quarterly earnings growth, when advertising revenue is declining? The answer is you lay off reporters and save on labor costs. But this means a weaker product, which further exacerbates your consumer base problem.

So, if we think about how the public stacks up against the private, we have to conclude that, even if given public sector inefficiency (which is not conceded except for the sake of argument), wherever the profit margin (especially if we’re talking about 5% quarterly earnings growth) is equal to or more than the inefficiency of the public sector, then government should prevail in the face of the private sector.

Conclusion:

Now, a neoclassical economist will tell you that that’s almost never the case and that public institutions will never approach the productivity of private corporations. Yet, in many empirical case, if you look at the privatization of utilities or the charter school movement, the case for superior private sector falls flat.

So what if the scope of the public sector is much larger than we’ve thought?