Efficiency Criteria for Nationalised Industries (Routledge Revivals)

Alec Nove

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136629198
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

First published in 1973, Efficiency Criteria for Nationalised Industries asks by what criteria we should judge the efficiency of nationalised industries, what we mean by saying they should be run commercially and where the public interest should lie. In this work, Professor Nove believes we answer these questions incorrectly due to a lack of understanding of economic theory and a desire to relate real world economics to that of the text book. The author says many economists, in a world of indivisibilities, complementarities and systems, persist in thinking in terms of one-dimensional, fragmented marginalism. Professor Nove, who is known for his writings on the Soviet economy, raises many points relevant to the East as well as the West. His work contributes to the economics of socialism, while also making the case for greater realism in economic theory in general.

Chapter 1
Diagnosis

Why should anything be nationalised?

There could be two types ol answer: one concerns ideology and the class war, and the other economic and/or social efficiency. In this work I shall concentrate on efficiency, i.e. on the proposition that things which are nationalised are so because in some way they can be better run than by private enterprise. This is not to dispute the validity or otherwise of the value judgment that capitalists or landlords ought to be expropriated, or that the given distribution of income or of property is wrong. Those who hold such views are entitled to hold them. (These same people may also argue that, in certain cases, private ownership of property stands in the way of efficiency.) Be all this as it may, I am assuming that the main, or a main, reason for nationalisation is the conviction that the post, transport, mines, electricity, television and gas industries are operated more efficiently, in something which could be called the public interest, under nationalisation.¹ Indeed, it is obviously in the public interest that they be operated efficiently, for otherwise the resultant waste of resources deprives the community of additional goods or services, or leisure, which it otherwise would enjoy. The problem, as we shall see, is how to identify just what efficient operation is and what criteria are applicable. However, we must forget naive 'pseudo-socialist' notions that accounting and economic operation are somehow unimportant. Nonetheless, the words 'in the public interest' were not used idly earlier in this paragraph. Unless they do have some meaning, there really is little point in public ownership of anything, and the meaning, if any, surely relates to possible conflict between private profitability and some apparently desirable act or omission. For if the question were purely one of private profitability, any individual or firm, Joe Bloggs or Bloggs Ltd, could produce the goods or perform the service, and there would be no problem and no economic case for public ownership.

In the formal world of micro-economics there is some recognition of this. Public ownership, or public regulation of private business, even quite orthodox textbooks will tell you, can be justified where there is a natural monopoly, or where the existence of economic or social external effects is sufficiently important to make micro-profitability a misleading criterion. A familiar example, which appeared in textbooks already fifty years ago, is the smoking factory chimney. To abate the nuisance may reduce profits, but the smoke imposes costs on individuals who are not engaged in economic transactions with the firm which owns the factory, but who are entitled to protection. Or society as a whole gains, economically and socially, from the delivery of correspondence to all the inhabitants of the given country; members of society wish to be able to write to anyone, and have these letters delivered; but delivery of letters to remote destinations would not 'pay', save at prohibitive rates, and so in all countries the postal service has been nin by the state.

Economists will generally admit that there are many instances of external economies and diseconomies, and historians will certainly recall that the economic effects of the Union Pacific Railroad, or of the railway which linked the Ukrainian wheat-fields with Odessa, were by no means limited to the profit and loss account of the respective railways and of their immediate customers.

However, some economists have the regrettable habit of forgetting the assumptions upon which their own generalisations rest, A recent example in another connection is E. J. Mishan. An original and challenging thinker, he very properly reminds us of the external diseconomies of growth, such as congestion and pollution. Yet he proves that he can wear blinkers as well as anyone. Thus in his Twenty-one popular economic fallacies² Mishan tells us that immigration cannot help our economy, nor the brain drain harm it, because men are paid the value of their contribution to the economy! If this were indeed so, an immigrant would be paid what he produces, and then, assuming he remits some of his earnings abroad and has above-average calls on social services, his net contribution is a minus. A skilled engineer who leaves Britain for Australia was paid what he produced, and so no net loss follows from his departure. QED.

Now this is, or can be, nonsense. One reason is that formal theory only asserts that the marginal labourer or engineer is paid the value of his product, or gets 'the rate for the job', and there is no particular reason to assume, in real-world conditions, that the individual who arrives or departs is the marginal labourer in this sense. (Not everyone who gets 'the rate for the job' is of equal skill.) However this would hold true only in equilibrium, a condition without bottlenecks of labour or of anything else, in which supply and demand for all things are equal, and where there is perfect mobility and substitutability of all factors. Furthermore, even in pure theory no one would employ the marginal labourer or engineer unless, by so doing, he obtained an income equal to the going rate of interest; otherwise it would pay him to let the money earn that interest. However, the essential point, which makes this instance of economists' blindness relevant to our theme, is that Mishan of all people forgets about external effects. By this, in the context of labour, I mean the effect of one man's work on that of others.

A simple example: a centre-half of a professional football team is paid a wage. However, apart from the contract between his club and himself, he has an effect on the performance of other players in his team. To some extent this would be reflected in his wage, but it is unlikely to be so in its entirety, because football is a team game and the separate contribution of each player cannot be readily disentangled and identified. So much so that some football teams pay the same wage to ah regular first team members. It is intuitively obvious that the loss (or gain) due to the departure (or arrival) of a centre-half will not necessarily be measured by the wage of the individual in question. It will have some 'external' effects on the performance of the team.

Workers, engineers, research laboratories, are also engaged in varying degrees of teamwork. The same argument applies.

There are specificities, complementarities and the like. Trades are not interchangeable; one man's speciality affects the performance of fellow-workers. An employee performing task A requires the co-operation of someone else who can perform task B, which requires a different skill. If the man who is able to perform task B leaves, it may be difficult to replace him, and this would affect the productivity of the first employee. So clearly the departure or arrival of an employee can have effects which cannot be ignored. Therefore, pace Mishan, we are not wrong if we surmise that Germany has gained something from importing 2½ million workers from abroad, something greater than their earnings, and that skilled engineers who leave Britain for Australia could represent a net loss for the one, a net gain for the other.³

Mishan's error is an interesting one, because it is logically on a par with the kind of error we will again and again be encountering. Because micro-economic theory is usually presented so that external effects, complementarities, indivisi bilities and the like, are inconvenient (they mar the beauty of the theory), they are relegated to footnotes and all too often forgotten. The theory, and the concept of optimum with which it is associated, operates elegantly and rigorously when there is infinite divisibility, and when each transaction is, so to speak, sufficient unto itself and affects no other individual, or firm, or transaction. Then what 'pays' is, almost by definition, the right and efficient thing to do. We shall be examining the theory and its assumptions in detail in due course. It is enough to stress at this stage that this theory fragments. It neglects systems of inter-relationships. We have seen how Mishan misapplied micro-theory to labour. His colleagues all too readily misapply it to nationalised industries, and the cause of the error is the same: the almost instinctive search for unrelated marginal fragments out of which they build a concept of efficiency and rationality. (Strictly speaking, these are not unrelated; they are related only through market and price.) To say this is not to attack the marginal principle as such, for decisions do in fact very often concern increments of an output or a process, and thus are marginal. 'Marginal' need not imply 'fragmented'. However, as we shall be arguing later, there are logical and indeed mathematical reasons why it in fact often does so.

Where do nationalised industries come in? How can the Mishan error analysed above apply to them? It can do so all too easily. Just as the relationship between the productivity and pay of the marginal labourer can be seen through blinkers, which do not permit even the intelligent observer to consider the elfect of one labourer's work upon that of others, so a nationalised ship or bus can be deemed to be operating economically only if it makes a profit at least equal to some defined rate of return on the capital which it represents. Therefore, to cite but one example at this stage, the nationalised Scottish Transport Group removes cruise ships from the Firth of Clyde or buses from rural routes, without considering the effect this might have on the economics of tourism in Scotland, or indeed the costs which its decision might impose on other public authorities (for example, posts, education and the like). In ignoring such matters, the Transport Group can refer to the Transport Act of 1968, passed by a Labour government! Admittedly, as we shall see, the Act did make provision for subsidies, but it lends itself all too easily to a 'commercial' interpretation.

One is entitled to ask: if a public authority operating transport services does not take into account the economic (not to say social) effects of its actions, but confines its attention to its own profit and loss account (and fragments even there, as we shall see), what conceivable reason can there be for putting transport under public ownership? Who has ever doubted that transport, of all things, has external effects?

It is even said (and it could be true) that the profits of the bar on cruise ships are paid into a separate account, and are not allowed to 'count' in computing the profitability of a shipping service. It is supposed to make a profit on its purely shipping role, while drinks are a matter for the catering department. This could be so, because it is entirely consistent with the advice the 'marginal-fragmentation' economists would give. Transport is transport and drinks are drinks. The latter could be 'hived off' to private enterprise, were it not for the bar's physical location in a nationalised ship, but analytically the bar is 'hived off'. To use its profits to offset operational losses is 'cross-subsidisation', i.e. unsound economically. Now a bar on a ship (or in a cabaret, for that matter) is not really an externality, since it is part of the same undertaking as well as being physically located there. So this is an example not of external effects but of internal effects.

Economic theory is, of course, aware of the existence of external effects. External economies confer benefits on persons or firms who are not the subject of the given decision, or parties to the given transaction. External diseconomies harm such individuals or firms. We will have many occasions to quote examples in the pages that follow. Actions by some individuals (or groups) can affect the productive potential or welfare of other individuals (or groups). Sometimes it is possible to reconcile these 'contradictions' through the market. Thus, to take an example, if a building operation makes a loud noise, which could be abated at a cost of £x, the residents of the area could pay the construction company this sum to reduce the nuisance. Alternatively, if the residents had legal means of redress (by suing the company for the nuisance created), it might pay the company to incur this cost. Theory also knows of complementarities, both in productive processes and in consumption. Thus Lancaster⁴ has pointed out that goods are bundles of characteristics which cannot always be separately priced. Yet it is still true that students can take good honours degrees, read all the best textbooks, and still neglect these aspects of economic reality, for reasons to be discussed later on.

Indeed, the term 'externality' is of its nature ambiguous. It depends on what one is considering. If two individuals make a deal, any other individual affected by it is external to that transaction. If a factory pollutes a river, that is an external diseconomy. But if the factory itself owns fishing rights in the river, it is an internal diseconomy, for now we are considering an economic unit which could be defined as Factory-and-fishing. We can say that such a unit 'internalises' what would otherwise be the external effects of industrial waste on fish. Similarly, a shipping service to a holiday island, if its operators have no financial interest in the island's hotels, is financially indifferent as to the effects of its services on these hotel's profits. They are external to its operations (though of course the hotels' existence does contribute to demand for shipping services). But it is perfectly possible for the hotels to be owned by the shipping concern, or for the hotels consortium to own and operate the ship. In either event, there is a ship-and-hotel firm, and the externality will have been internalised. This could be rational, because of the indivisibility-interdependency: people attracted to the hotels use the ships, and the hotels could not make money unless the ships took the customers to the island. In this situation, it would be hard to identify the profits attributable solely to ships or solely to hotels. (In practice we might have a third of the hotels' customers travelling in their own yachts, and half of the users of the ships will not be staying at the hotels; in real life there are usually degrees of complementarity.)

In many countries a local authority runs ships in just the situation here described. For example, the prosperity of the holiday island, lie de Re, in the Bay of Biscay justified the maintenance of large car ferries, fully used only at peak holiday periods and certainly not 'paying their way' qua car ferries. They are operated by the Charente Maritime departement. It is probable that, seen as an economic unit, the island-tourism-and-car-ferries complex pays handsomely, though the ferries' accounts do not show it.

Why do I dwell at such length on externalities? Because one of the principal arguments for public operation and control of any sector of the economy is that it permits the internalisation of externalities. Indeed, this is what 'taking the public interest into account' means. Thus the Scottish Transport Group's raison d'être should be that it can take these things into account, whereas separate private bus and shipping companies cannot. Instead we have fragmentation even of the Transport Group's own decision-making. Not just the bar, either. I well remember the voice on the telephone coming to me from the Glasgow office of a transport undertaking under the Group: 'Yes, this [shipping] service is now withdrawn. It is a pity. It messes up one of our own most popular tours. But you see, it is the new accountancy.' A classic example of the externalising of inlernalities, a wilful refusal to see the wood for the trees, a marginalist fragmentation of which no intelligent businessman would be guilty, committed in the name of a misunderstood economic 'rationality'.

It is important here to avoid confusing three points, all of importance in the present context but different analytically. One relates to the negative consequences of the excessively fragmented view of profitability, consequences negative from the standpoint of economic profitability. The second concerns the question of goods and services which do not pay on any economically reasonable definition of 'pay', but which should nonetheless be provided on social grounds (e.g. a boat service to the Outer Hebrides); this raises the question of subsidisation. Finally, there is the question of how far a monopoly should be compelled, as a condition for its existence, to undertake activities, which, given its monopoly position, would not pay. All these questions, which will be gone into at length in subsequent pages, are begged by the doctrine of 'commercial operation'.

So one part of the disease is failure to see those interrelationships and complementarities which constitute a principal justification of large-scale operation under private as well as public ownership. The other is an inability to comprehend the logic of monopoly.

Let us make an elementary observation. A public monopoly, if told to operate 'commercially', will tend to behave in exactly the same way as a private monopoly.

Indeed, it can be argued that it would be worse. The reason is this. A private monopoly is generally supervised by some sort of regulating body, to prevent abuse of its position. Thus in Britain we had the Railway and Canal Commission; in America, they still have the interstate Commerce Commission and similar organisations. There are imposed statutory duties in some instances. If the monopoly is based on legal enactment, it was considered normal, even at the height of laissez-faire, to bind it with various conditions. Thus in 1844 it was laid down that a 'Parliamentary train' should travel along every railway, calling at every station and charging no more than a penny a mile third class. Private monopolies, which are not based on law or franchise, are always conscious of being monopolists on sufferance, since failure to give some minimum satisfaction to customers could lead to the invasion of their 'territory' by a competitor.

By contrast, a public commercial monopoly is subjected to few constraints, at least in Great Britain. It is told to make money, and the ministry deliberately refrains from interfering with its day-to-day operations. It must therefore be expected to behave as a private unsupervised monopolist would, if in addition he was protected by law from competition.⁵ Indeed, many large private corporations are concerned with public goodwill, if only because they do not want to give politicians a justification for interference. Some of them therefore are prepared to spend a lot in order to establish a public-spirited image. Nationalised industries cannot fear nationalisation, and in addition may be barred by their own rules from spending money other than for their own business needs. This is surely a deplorable distortion of any conceivable principles of nationalisation. It should be welcomed by Conservative ideologists anxious to prove the inefficiency of 'socialism', but it is more difficult to explain the adoption of such principles by the Labour party.

Perhaps the dangers are hidden from their economic advisers by the deficiencies of monopoly theory of the conventional kind. Generations of students are taught that a monopolist would try to equate marginal revenue with marginal cost, while under competition marginal revenue would tend to equal price (we shall see later how totally ambiguous these apparently simple phrases are). The monopolist's output would therefore tend to be somewhat smaller, the price somewhat higher, than would obtain under competition, the size of the difference being dependent on demand and supply elasticities.⁶

However, like so much of micro-ec...

Table of contents

• Cover
• Title
• Copyright
• Preface
• Contents
• 1. Diagnosis
• 2. Micro-economics and the Real World
• 3. The Argument applied to Eastern Europe
• 4. The Relation of Theory to Practice
• 5. Pricing and Investment Criteria
• 6. Duty, Purpose, Supervision
• 7. Theory, Nationalised Industries and Socialism
• Reference Notes
• Index