Britain isn’t a business (but thankfully businesses aren’t like Britain)

stephen clarke, 13 January 2012

Yesterday on The New York Times online and today in the print edition, economist Paul Krugman discussed why ‘America Isn’t a Corporation’. Krugman makes a number of interesting points that all politicians would do well to remember, however, he perhaps fails to explain one of the most important reasons that a state is not a corporation: that it is not exposed to competitive pressures.

Krugman rightly points out that one of the most important ways in which a national economy is not like a corporation is because corporations sell the bulk of what they produce to other people while the vast majority of what America and all big countries produce they themselves consume. Turn this on its head and one can appreciate the importance of this distinction:

If corporations sold the vast majority of what they produced to their own employees they would need their employees to be able to buy their product(s). The only way that the company could guarantee the biggest market for its products would be to ensure that all employees had enough income to afford them. The company would have an incentive to take steps to redistribute wealth or, perhaps more effectively, pay its employees a similar amount. Therefore it would not be beneficial for a company to pay its CEO vast multiples of what the other employees earn if as a result these employees could not afford to buy its product(s).

This counterexample explains why (economically, because clearly redistribution is justified on other grounds as well) states engage in redistribution: prosperous economies are those where people can afford to sustain merchants by buying their wares (if anyone doubts this then take a look at the interest swirling around the Christmas retailing figures).

Countries are not companies, but they do share some of the same characteristics. One of the simplest ways in which the two entities are similar is the way in which both have outgoings and income. For the state income comes in the form of tax and outgoings take the form of services. In essence tax is a payment for a service, the state is sometimes in a better position to provide a service (perhaps because of economies of scale or because they can prevent free-riding) than an individual, group or business. In return all individuals are forced (preventing free-riding) to contribute. Although some will balk at this description, perhaps because they pay taxes and have private health care, it is fair (if simplistic).

In this sense a state, like a business, needs to make sure that its outgoings do not exceed its income, otherwise it will need to take on debt and this could threaten the solvency of the state. Krugman perhaps treats this issue too lightly when he discusses the problems of Greece, Ireland and Spain. More importantly though he does not go further and neglects to explain that one of the main reasons that the state is not a corporation is that in many respects it is not exposed to competition and so should be incredibly wary of spending money. It should be wary of spending money because unless it does it in a competitive market environment it is difficult to assess whether it has spent money wisely.

The ramifications of this are important. The Government should ensure that all citizens have access to good quality health care and education but does it need to directly provide these services? No – it might be better that private providers serve customers, while the state pays people so that they can choose these services themselves. The exertion of choice and the market can help improve outcomes (although one does need to ensure that information asymmetries and other market failures are addressed).

It can be damaging to run the state like a corporation, but it can be equally damaging for the state to take on activities best left to corporations or the private sector.