In every election cycle, some of the candidates running for national office claim they are running against Washington. They claim that only people with their particular life experiences have the transferable skills to free the country from an alleged mess created by career politicians. Consider the Republican primary race to succeed retiring Senator Rob Portman of Ohio. Josh Mandel, who served as Ohio Treasurer and served honorably in Afghanistan, assures us that when he gets to Washington he will not only "drain the swamp" but also "blow up the swamp." Another contender for that Senate office is prominent businessman Mike Gibbons who asserts his comparative advantage is great business acumen honed in the private sector. Consider, too, Wisconsin's Senator Johnson, currently running for a third term, who often touts his business experience and his accounting training as giving him essential insights into the importance of shrinking the government.
Should Government Be Run Like a Business?
The frequently-heard assertion from office-seekers who lack public-sector experience is that government should be run like a business; if it were, the U.S. would be solvent, more efficient, and more prosperous. Along with this misconception goes its corollary: private sector CEOs are “job creators” and government is a job killer. As with many trivializations in economics, this one resonates well with the public but it is dangerously wrong.
The reason this is wrong is derived directly from the free-market model, a concept initially proposed by Adam Smith and rigorously developed since. The model is routinely taught in economics classes and business school prerequisite classes and shows that the public interest is served best by competition among firms and their investors, even though the public interest is not part of the decision maker's motivation. But it also shows that when the pre-conditions for competition do not exist, market efficiency requires intervention by government. Economic activity, including job creation, requires a great confluence of inputs as well as coordination of the public and private sectors. The private sector firm is necessary for most of the jobs created, but it is not sufficient. Public goods (roads, schools, universities, courts, and law enforcement), paid for with taxes, are essential components of successful job creation efforts. Moreover, government often has to promote the process of competition, as well as ward off recession and high unemployment.
The Private and Public Sectors are Complements
The economy is not a large version of a business firm. Managing an economy requires a more comprehensive economic model than the one followed in managing a firm. A firm is a small piece of a very large puzzle. To manage a firm, CEOs employ "microeconomic" reasoning to guide all aspects of their puzzle piece: e.g., financing, marketing, and operating decisions. By contrast, managing an economy requires an understanding of macroeconomics, which focuses on the aggregate behavior of firms in the economy, i.e., how all the puzzle pieces fit together. For example, a properly-run government will counter the business cycle by dampening an expansion to control inflation and softening a downturn to limit unemployment. A properly run business firm, even a very large one, cannot hope to modulate economy-wide swings and instead must accept its limited role within the economy.
Consider the different strategies pursued by firms and governments during recessions. Firms suffer reduced demand for their products and services. Consequently, to survive a recession and prepare for better times, a firm has a strong incentive to contract. But business leaders who "tighten their belts" during recessions often have a hard time understanding why the government orders a bigger belt. Economic activity encompasses four categories of spending: consumption, private sector investment, net exports, and government. In the disastrous recession of 2008, the first three of these categories declined. Mark Zandi, chief economist at Moody's Analytics, estimated that, if the government had also tightened its belt, unemployment would have risen to 15 percent. Instead, it peaked at the still-terrible rate of 9.5 percent. In other words, the recession would have been much worse had it not been for government intervention.
Similarly, in 2020, during the pandemic and prior to the successful distribution of a vaccine, many businesses were shutting down due to collapsing demand and, in many cases, were forced to shut down by government order. As the economy lost 21 million jobs in a month and a half, the federal government frantically borrowed and spent $3.1 trillion in just one year. This counter-cyclical spending shored up businesses and households which otherwise would have been lost.
William L. Holahan is Emeritus Professor and former Chair of Economics at the University of Wisconsin-Milwaukee.