Moving Past the Public vs. Private Debate

Public choice economics teaches us that governments can leverage the power of markets too.

Public Choice 101: People Stay the Same, But the Rules Change

The founding insight of Public Choice economics is simple. A human being who steps across the threshold of city hall does not mutate from a profit-maximizer into a saint. Incentives and information are what drive human behavior. Change the rules of the game and you get different outcomes, even though the players are still the same old Homo sapiens. Economist James Buchanan captured this economic view of politics with his famous phrase, “politics without romance.” Public Choice provides a realistic antidote to textbook portrayals of benevolent planners.

Libertarians understandably latched onto the ideas behind Public Choice Theory because it punctures naive faith in government benevolence. But stopping there sells the theory short. If people remain people across institutions, then there is a corollary that is just as important. Public organizations can succeed when they import the knowledge-generating and incentive-shaping devices that work so well in markets. The public-versus-private dichotomy shouldn’t be the decisive fault line in our thinking. The market-versus-non-market one should be.

Markets as Knowledge and Incentive Engines

Prices, profits, and losses are the market’s guiding signals. They tell producers and consumers what is scarce, where demand is rising, and whether yesterday’s plans were mistakes. Pay structures inside firms perform a similar function. They incentivize work effort and align motivation around a common goal, usually earning the company a profit.

Governments can, and sometimes do, harness these same tools. With sovereign wealth funds, the state inserts itself into capital markets on essentially the same terms as any private investment fund. Norway’s Government Pension Fund Global, Singapore’s Temasek, and Alaska’s Permanent Fund all invest in diversified equity and bond portfolios, earning market-rate returns.

Governments participate in markets in other ways too. School districts bid for tablets and textbooks. Cities issue bonds to finance infrastructure. And agencies across the government compete for scarce labor by offering competitive salaries. Each transaction involves a price, and each price confers information back to decision makers about relative scarcity and popular demand.

Where this kind of market feedback is muted, performance predictably sags. Where it is amplified, the public sector begins to mirror the efficiency we expect from private enterprise. The takeaway for reformers is that the more we can route public goals through market-like channels, the more likely we are to get good results out of bureaucrats who, after all, are the same human beings who rely on market signals to guide every grocery store visit and Amazon purchase after they get off work.

The Myth of Private Sector Perfection

If you’ve ever circled the office looking for that one working stapler, you know private firms are not paragons of efficiency either. Tragedies of the commons are rampant in private organizations, afflicting everything from the shared office printer to the communal refrigerator. Knowledge silos pop up across teams. Promotion contests reward political acumen and status signaling rather than productivity.

In short, all the foibles we bemoan about bureaucracies related to slack, turf wars, principal agent problems, and asymmetric information are alive and well on the private sector side too. The disciplining difference is that an under-performing company eventually goes out of business. Governments face a much softer budget constraint, but even they occasionally slam into it when deficits or bad policy drive voters or bond markets to revolt.

The key point is that inefficiency thrives wherever price and profit feedback mechanisms run thin. Inside a corporation, most day-to-day tasks happen in an internal command economy. That is why the same pathologies we ridicule in public agencies appear behind closed office doors too. Government simply operates with a larger share of its decisions in that non-market zone. Move more choices into the realm where prices operate, and both sectors sharpen up. Slide the dial the other way, and even the slickest startups start to look like the DMV.

Recognizing this symmetry inoculates us against two extremes—romanticizing the state or romanticizing the firm. Both are human enterprises wrestling with the same cognitive limits.

Economists Used to Let Prices Lead

During the 1980s and 1990s the economics profession was brimming with applied public choice optimism. If perverse incentives and knowledge problems were the illness, then market signals were the cure. That mindset birthed a string of reforms that harnessed the power of markets to advance the public good. These include:

• Cap-and-trade for sulfur dioxide. The 1990 Clean Air Act created tradable SO₂ allowances that cut acid rain emissions by more than half and likely saved utilities (and therefore rate-payers) billions compared with traditional command-and-control standards.

• FCC spectrum auctions. Beginning in 1994, the Federal Communications Commission used an economist-designed simultaneous ascending auction system to sell wireless spectrum. Since then, the FCC has conducted more than 100 spectrum auctions, collectively raising over $230 billion.

• Congestion pricing. London’s 2003 cordon toll and Stockholm’s 2006 congestion charge slashed peak-hour traffic while cutting local air pollution and childhood asthma attacks.

• School choice vouchers. Building on Milton Friedman’s famous proposal, voucher and education savings account programs let education dollars follow students, injecting consumer choice into classrooms and spurring competition among providers.

In each case, policymakers used the same insights that animate successful marketplaces to design innovative public policies. Yet somewhere in the early 2000s that reformist energy fizzled. Cap-and-trade was replaced by technology mandates and command and control regulation. Spectrum auctions soldier on, but many other public assets, from public lands to highway lanes to airport slots, are still rationed administratively. Congestion fees remain political third rails (with New York City’s long-delayed plan being Exhibit A), and voucher experiments are still controversial. The result is that the entire toolkit of market-based policy designs has gradually drifted out of fashion.

Public Choice 2.0: Shrink Non-Market Spaces Everywhere

The mission for the next generation of public choice economists isn’t to sneer at government. It’s to design institutions that push more decisions through market channels. Public Choice 2.0 is a plea to put the old debates about public sector vs private sector aside and focus on the divisions that really matter.

Think of the economy as divided into two zones. In one zone, transactions take place through markets. Buyers reveal their willingness to pay, sellers produce based on cost constraints, with profits and losses encouraging producers to “do more” or “do less.” In the other zone, decisions flow through hierarchy and politics. In that non-market zone, scarce resources are allocated not by prices but by political factors like seniority, charisma, departmental fiefdoms, and the art of strategic flattery. Office cubes go to those who curry favor with the boss, and budget increases gravitate toward those teams with the most political clout or status.

Where non-market zones thrive, information decays and accountability lapses. Where market zones flourish, feedback loops sharpen and resources move toward higher-valued uses. Both zones will always exist, so the question is one of degree. By steadily enlarging the market sphere and paring back the non-market one, we can cultivate systems that produce more, waste less, and raise the quality of provided goods and services.

Escaping Cynicism

Public choice’s great achievement was to puncture the myth of angelic politicians. But the field has rightly been criticized for being too cynical about the potential for government to promote social welfare. Its next act should be more constructive, showing how the same self-interest that leads to successful outcomes in markets can be leveraged to serve the general interest too. Adam Smith’s invisible hand knows no political boundaries.

Investment bankers who join the Treasury Department do not suddenly lose their spreadsheet skills on day one of their new job. Tie a share of any deficit savings they find to performance bonuses, and you’ll start to see their Wall Street-honed creativity redirected toward protecting the taxpayer’s bottom line. Strip away price and profit signals, however, and even the brightest MBA will end up stuck in the same administrative quicksand that stalls the most dysfunctional government agencies.

Ironically, just as public choice economists are too cynical about the potential for government reform, they aren’t cynical enough about the challenges that firms struggle with internally. Most corporate units operate like mini-command economies rife with empire-building and incentive misalignment. Decision rights concentrate at the top, information bottlenecks emerge across teams and in middle management, and the absence of hard pricing for internal services breeds its own brand of private sector waste.

Why So Little Rent Seeking?

Public choice economist Gordon Tullock once posed a puzzling question, which is why is spending on lobbying and other forms of rent seeking so modest compared to the enormous potential gains at stake? One explanation is that similarly wasteful competitive dynamics exist within the private sector as well.

Whether the goal is a promotion, capturing market share, or securing investor funding, the competitive process can sometimes mirror the pursuit of government favors. A benefit is gained at someone else’s expense. In many cases, no new value is created; the victor simply receives a transfer that might have gone to someone else of similar ability. From a societal standpoint, any resources expended in this zero-sum contest are wasted unless the competition produces meaningful innovation or improvement.

To be clear, competition does drive productivity improvements and lead to better outcomes in numerous cases. Stronger performers rise and superior products emerge. But this isn’t guaranteed. When differences between competitors are negligible—as with indistinguishable soda brands or entry-level job applicants with minimal training—competition can become largely unproductive, serving only to exhaust resources.

Public choice economists have often been fixated on inefficiencies in government, overlooking the significant rent seeking that occurs in the private sector. Rent seekers, unconcerned with the source of the gains, pursue opportunities across the entire economy, not just through government channels. The mystery of “too little” rent seeking may remain unsolved only because economists have been looking in too few places.

Conclusion

The implications of public choice economics are obvious and intuitive to almost anyone. Politicians are out for themselves as opposed to their constituents. Yet, strangely, the fields has failed to find many adherents. No doubt this is partly because of its enduring cynicism about government.

The time has come for that to change. Public choice should become simultaneously more optimistic about the potential of government, while growing more realistic about the realities of markets. Harnessing the incentive and information powers of the price system can indeed serve the general interest, but within the market sphere, economists must also be careful to identify rent seeking where it exists and root it out.

The distinction that matters is not public versus private, but market versus non-market. A task for public choice economists is therefore to help move that boundary steadily in a more market-oriented direction, narrowing the zones of the inefficient and rudderless command-and-control economy and expanding the zones of price-guided feedback and learning, while working to improve the functioning of markets at the same time.

For too long, public choice has over-emphasized the deficiencies of human beings in government settings, leading to a culture of pessimism that turns many off. By emphasizing the positive attributes of markets, and how they can be harnessed for public purposes to promote the greater good, this pessimism can be transformed into an optimistic outlook—one that may cause those who dismissed public choice to give the field a second look.