The Folly that is Nationalisation

There are a host of groups in South Africa these days calling for ‘nationalisation’.  Nowhere have we seen these calls more passionately directed of late than to the area of minerals and mining.  Mining is big business in South Africa.  Mines built this country.  For well over a century now South Africa has been able to sell minerals that existed beneath the ground to foreigners in return for technology, goods, services, cars, planes, trains and just about everything else.

Selling minerals to the world has, quite simply, enabled South Africa to experience hundreds if not thousands of years of economic development in a few short decades.

Those who wish mining operations to be nationalised claim to want a world in which all men and women of South Africa, but especially the poor and marginalised, benefit financially from what they deem to be the property of all this country’s people: the minerals we are blessed with through no effort of our own.

Unfortunately, good intentions don’t always equal good sense.  If they did we would scarcely have many troubles on our planet as there are more than enough people earnestly beavering away at our myriad of problems with the best of intentions.

I will briefly show below why the desire to nationalise commercial assets, no matter how well-intentioned it may be (even this is debatable) is nothing short of folly and how, if nationalisation is followed, it will make this country and, crucially, its poorest members, unambiguously worse off.

The Shareholder Problem

When all is said and done, nationalisation is simply this: Exchanging, either by force or voluntary transaction, majority shareholding from one or many private individuals or firms who have invested their own funds, to a public entity called the state who invests other people’s funds (taxes).

This shift in shareholding is profound.

The first set of shareholders demand to see the minerals extracted and taken to market at the lowest possible cost, to see the best price fetched at market, and therefore to generate a surplus (profit) which will enable them to earn an income stream that rewards them sufficiently for foregoing personal funds (capital) that could have been used to fund immediate consumption.

The second shareholder, being wholly political in motivation and incentive, demands to see minerals extracted using the most amount of labour possible, and to see as much profit generated as possible so as to distribute as much income as possible to the poor and marginalised. 

The incentive to receive a personal income stream as compensation for foregoing the use of funds for immediate consumption does not exist for the State as it does for private shareholders.  Members of the State managing the investment did not themselves have to forgo immediate consumption in order to invest but instead simply invested other people’s tax money which they extracted with very little effort.  The ability of taxpayers to monitor the income return received for giving up tax funds is almost non-existent as they cannot be sure how much of their personal funds went to the investment and how much income return would be acceptable.  Moreover, with so many taxpayers it is likely that each individual taxpayer only has a very tiny proportion of his tax income invested, meaning the individual incentive and ability to hold the State shareholder accountable diminishes to close to zero. 

Aligning Our Goals And Incentives

We can see immediately that the private shareholders’ goals are completely in harmony with one another.  It does not undermine the goal of fetching the best price on the market to also extract minerals at the cheapest possible cost, nor do these production and sale incentives hinder the goal of earning an acceptable income stream.  Indeed, they enable the acceptable income stream.  In this quest these shareholders, with their treasure on the line, have strong incentives to hold the board of directors accountable for performance.  The board in turn will transmit the message from the shareholders to management, and management to employees.

By contrast we can see that the State shareholder has a web of conflicting goals and incentives, and a weak chain of accountability.  The goal of jobs maximisation is patently at odds with the goal of maximising profits for distribution to the poor.  Maximising profits to help the poor is misaligned with the lack of incentive to receive compensatory income.  The ultimate funders, the taxpayers, have too little individually on the line to hold the State adequately accountable.  The State meanwhile, in its conflicting goals of maximising employment and redistributing income to the poor, is very likely to find the rewards for appeasing employees higher than the penalties incurred for not aiding the poor and marginalised.  The poor and marginalised are great in number and disorganised, while the workers are fewer but far better organised and able to bring strong political pressure to bear on the State shareholder.  Job losses make headlines.  Another unfed homeless orphan doesn’t.

The result is that the profit motive starts to die.  The state finds it easier to whittle down surpluses by keeping on more employees than are needed.  Projects are chosen for their employment benefits not whether they deliver the best product at the cheapest possible price to people who need it.  With the death of the profit motive comes the death of accountability throughout the organisation.

In short, when the state becomes the majority shareholder, corporate incentives become fatally incongruous to the detriment of profit, and this, at its core, is the fatal flaw of nationalisation.

What’s So Good About Profit?

I have pin-pointed what I think is the fundamental problem with an industrial strategy of nationalisation.  The problem is not, as often asserted, that “government doesn’t know how to run a mine.”  Few of us know how to run a mine, and private shareholders certainly do not know how to run a mine, which is why they have entrusted their capital to those who do.

No, to say that the problem is one of know-how is to miss the whole problem.  After all, the State can simply keep employing the same technicians who worked at the mine under the private shareholders.  There need be no loss of technical expertise in running the enterprise.  Managers, truck drivers, miners, and engineers may all work for the State for the same pay as before.

The problem is incompatible incentives: maximising employment and maximising profits.  These two cannot go together.  The State has to choose one or the other.  If it chose profits and was deeply committed to achieving a highly profitable enterprise, there is every chance that it can bring sufficient pressure to bear on directors, management and staff to perform and create success.  On the other hand, if it chooses employment, then the enterprise will quickly become unprofitable, which is the number one hallmark of nationalised entities.

The question might now arise: So what?  What’s so good about profits?

I’ll let Henry Hazlitt answer this one from the chapter The Function of Profits in his great book, Economics in One Lesson [Own emphasis]. 

“When the economy is free, demand so acts that some branches of production make what some government officials regard as “excessive,” “unreasonable,” or even “obscene” profits. But that very fact not only causes every firm in that line to expand its production to the utmost, and to reinvest its profits in more machinery and more employment; it also attracts new investors and producers from everywhere, until production in that line is great enough to meet demand, and the profits in it again fall to (or below) the general average level.

In a free economy, in which wages, costs and prices are left to the free play of the competitive market, the prospect of profits decides what articles will be made, and in what quantities—and what articles will not be made at all. If there is no profit in making an article, it is a sign that the labor and capital devoted to its production are misdirected: the value of the resources that must be used up in making the article is greater than the value of the article itself.

One function of profits, in brief, is to guide and channel the factors of production so as to apportion the relative output of thousands of different commodities in accordance with demand. No bureaucrat, no matter how brilliant, can solve this problem arbitrarily. Free prices and free profits will maximize production and relieve shortages quicker than any other system. Arbitrarily fixed prices and arbitrarily limited profits can only prolong shortages and reduce production and employment.

The function of profits, finally, is to put constant and unremitting pressure on the head of every competitive business to introduce further economies and efficiencies, no matter to what stage these may already have been brought. In good times he does this to increase his profits further, in normal times he does it to keep ahead of his competitors, in bad times he may have to do it to survive at all. For profits may not only go to zero, they may quickly turn into losses; and a man will put forth greater efforts to save himself from ruin than he will merely to improve his position.

Contrary to a popular impression, profits are achieved not by raising prices, but by introducing economies and efficiencies that cut costs of production. It seldom happens (and unless there is a monopoly it never happens over a long period) that every firm in an industry makes a profit. The price charged by all firms for the same commodity or service must be the same; those who try to charge a higher price do not find buyers. Therefore the largest profits go to the firms that have achieved the lowest costs of production. These expand at the expense of the inefficient firms with higher costs. It is thus that the consumer and the public are served.

Profits, in short, resulting from the relationships of costs to prices, not only tell us which goods it is most economical to make, but which are the most economical ways to make them. These questions must be answered by a socialist system no less than by a capitalist one; they must be answered by any conceivable economic system; and for the overwhelming bulk of the commodities and services that are produced, the answers supplied by profit and loss under competitive free enterprise are incomparably superior to those that could be obtained by any other method.

I have been putting my emphasis on the tendency to reduce costs of production because this is the function of profit-and-loss that seems to be least appreciated. Greater profit goes, of course, to the man who makes a better mousetrap than his neighbor as well as to the man who makes one more efficiently. But the function of profit in rewarding and stimulating superior quality and innovation has always been recognized.”

I would add here that without profit there is no income for investors and without income there is no reward for giving up immediate consumption in the form of savings and investment.  Without investment we will not be able to replenish the capital stock and eventually our production will become inefficient and ultimately cease altogether.  Profits in this sense are one of the great cogs in the wheel of economic progress.  Without profit or surplus there can be no capital accumulation and without capital accumulation we are all further away from consuming that which we want and need to consume.

Without capital accumulation our standards of living plummet, our wages fall, our productivity is destroyed.  We become basic subsistence folk.  To the extent therefore that policies of nationalisation tend to erradicate profits, we can say that nationalisation policies will lead to falling rates of new capital accumulation and therefore lower standards of living, lower wages and employment, and declining productivity.  Guaranteed.

The tragic irony of this is that these negative effects are felt more by the poorest of the poor and the marginalised than by any other group in society.  It is these that remain mired in their poverty with no work and no opportunities.

Nationalisation of industry is not just a bad idea, it is an economic death-sentence.

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