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Incentives and Consequences

John Yochelson’s 10-year strategic overview and outlook on U.S. competitiveness is the first in what we expect to be an …

John Yochelson’s 10-year strategic overview and outlook on U.S. competitiveness is the first in what we expect to be an annual feature in these pages examining key international issues facing CEOs. A systematic look at how the U.S. economy has fared over the past decade both in comparison to other economies and to its own historical performance is long overdue.

Yochelson is president of the Washington-based Council on Competitiveness, a non-partisan, non-profit forum of CEOs and leaders from labor and academia that seeks to set a national agenda to strengthen U.S. competitiveness. CEO council members contributing to the report include Rockwell’s Don Beall, Boeing’s Phil Condit, Pfizer’s Bill Steere, Eastman Kodak’s George Fisher, and Xerox’s Paul Allaire, the executive committee’s former chairman.

Nine out of 10 council members polled by the organization reckon the U.S. has strengthened its overall position and attribute most of the gain to the private sector. Although trade stands out as an area in which federal policy has contributed positively, three out of four rate the overall federal role since 1985 as neutral to negative.

This will not surprise those familiar with public choice theory. Last year, two reports from the Joint Economic Committee (JEC) demonstrated why government tends to diminish economic well-being. Politicians and civil servants respond to incentives-the problem is they face different incentives than most. In the private sector, competition ensures that businesses minimize costs. In an open market, offering additional benefits, such as higher quality goods, while maintaining or reducing costs, will boost profits. Others must then match such benefits or compensate to survive. As a result, there is a relentless search for additional benefits, which in turn spurs economic growth.

This incentive is completely absent in the public sector. Politicians do have incentives, such as job security, power, or prestige, but the structure is murky at best. And even those with the best of intentions naturally assume that the size of their bureaus, budget, and staff ensures their agency’s effectiveness.

Public-sector incentives also obscure information. In a socialist economy, for example, there is no way for a manufacturer to gauge the value of a service or to determine which mistakes are costly and which are trivial-without profits as an indicator.

To ensure that taxpayers’ resources are not wasted, public officials must develop rules and procedures that define appropriate behavior. However, rigid rules have a cost. They can stifle innovation and initiative. They drive up costs and force public servants to make poor economic decisions, such as the IRS spending $4 billion on a computer system it later admitted it could not use. Without prices to provide signals and profits to guide behavior, grave mistakes are avoided by setting more elaborate rules, which invariably impede creativity and flexibility, adding further to cost.

The different incentive structure of the public sector partly explains the expanding size of the government and its tendency to slow economic growth and reduce economic well-being. A sobering statistic not found in Yochelson’s report is the real government outlay per household in 1987 dollars. According to Steve Moore of the Institute for Policy Innovation and author of “Government: America‘s #1 Growth Industry,” in 1900 total outlays per household were $1,650. By 1960 it had jumped to $12,800 by 1990 the figure was $23,140.

An understanding of the effects of public-sector incentives clearly suggests that re-engineering government is critical to improving the health of the economy. The U.S. is by no means the worst offender in this respect. In the Heritage Foundation’s annual index of economic freedom the U.S. is tied with Switzerland for fifth place. Yet last year it ranked fourth. (New Zealand knocked it out of that spot in 1997.) The trend is not in the desired direction.

About J.P. Donlon

J.P. Donlon
J.P. Donlon is Editor Emeritus of Chief Executive magazine.