Notes on Economics in the Nut House:
GOP As Party of Budget Restraint; Efficient Markets; Privatization

by Edward S. Herman
December, 2007

GOP as the Party of  Budget Restraint

In her August 4th piece in the Huffington Post,  on “Rove Exits With His Usual M.O.’s: Delusional and Deceptive,”  Arianna Huffington offers as a major Rove delusion his notion that “by Bush wielding his veto pen in the upcoming budget fight, the GOP will restore its reputation on spending restraint.”  Huffington asks how this can be when Bush has bloated the budget by 50 percent and has promoted a war that will cost over a trillion dollars? Huffington is wrong on this. She fails to recognize that in this militarized society that specializes in wars of choice, and with the establishment, including the media, highly protective of  the military budget, the military budget is put into an entirely separate class whose expenses are acceptably open-ended and concern over waste and literal theft is muted. So the word “restraint” jars when talking about the military budget, and conveys intimations of  disregard for “national security,” which is being protected as our armed forces fight pacification wars in Iraq and Afghanistan, threaten Iran, and stand guard in scores of bases across the globe.

The Democrats understand this and have internalized this double standard and regularly strive to show their mettle by urging more funding for the military establishment. And worried over the allegations of  their spendthrift proclivities the Dems are reluctant to spend on civil society, with Bill Clinton notoriously using most of the small “peace dividend” after the fall of the Soviet Union to reduce the debt rather than “putting people first.” Reagan more than doubled the national debt in his terms of office, and Clinton actually succeeded in balancing the budget and reducing the debt. But this has not made any difference as there remains the important difference: the Democrats still have a modest tendency to serve their mass voting constituency, whereas the Republicans are pretty reliable about screwing the general public while blowing wads on wars, tax cuts and corporate welfare.  But they show real restraint in serving the general community. The Dems are competing hard on this, but so far the Republicans retain the edge in “restraint.”

The business community was thrilled when the Gingrich Republicans won the 1994 election, because they recognized that this new gang would unreservedly serve their interests and run roughshod over the general public. Some of the corporate community representatives were quite open in explaining that however well Clinton had been doing on their behalf, Gingrich and company would do better on things like taxes, weakening of  labor,  corporate access to public property, and a halt to and rollback of environmental impediments to business. (Clinton’s subsidy programs to high tech were nice “ but don’t compare with the GOP plans to slash taxes and regulation and to put restrictions on law suits.” “Big Business Striking It Rich in GOP ‘Contract,’” Wall Street Journal, March 7, 1995).  For these benefits, the business community will tolerate Republican deficits in a way they won’t with the Democrats. George W. Bush has of course done wonders for the business community,  which is why deficits of staggering size that would have produced continuous business and corporate media indignation if produced by Democrats, and vast waste in military spending on wars and boondoggles, are tolerated (and why Bush gets away with steady evisceration of the Constitution and a pre-9/11 security failure that would have led to Clinton being impeached and driven out of office).  This is an illustration of  the higher irresponsibility of  business as their short planning horizon and completely self-interested objectives make them into grab-and-run operatives.

Efficient Markets

Market ideology has taken some heavy blows in the last several decades. In Chicago School theory, corporate executives would be driven to support stockholder interests rather than their own narrow interests because executive looting would cause earnings and therefore stock prices to fall, which would activate the directors, stockholders, and the “market for corporate control.”  That is, bad managers would be ousted by directors who were “agents” of the stockholders, or by stockholders selling out to outside buyers who would come in and provide more efficient and non-looting management (the market for corporate control). Stock options would link managerial  to stockholder interests as they would make stock price gains beneficial to both.

But in the critical theory of corporate control, dating back to A. A. Berle and Gardiner Means’ The Modern Corporation and Private Property (1932), and even earlier, Thorstein Veblen’s Theory of Business Enterprise (1904), wide dispersion of  the stock and management domination of the proxy machinery gave managers effective control of the board and hence of  policy;  management was self-perpetuating and had a fair amount of discretion in nest-feathering. Veblen stressed how strategic position allowed the control group and bankers to manipulate and take advantage of  “conjunctures”--economic disturbances, “excessive competition,”  speculative booms, merger deals, and opportunities for “an alert redistribution of investments from less to more gainful ventures”--to loot.

History has vindicated the critical perspectives. The spectacular rise in executive pay,  very often quite unrelated (and sometimes inversely related) to corporate performance, the numerous scandals involving managerial looting via perks and excessive options with moveable or post-dated prices, merger activity that has once again been geared to ability to sell securities and reap large commissions, bought-out managers exiting with huge “golden parachutes,” with the taken-over company not better managed but asset stripped, all show market forces failing to serve stockholders, let alone the larger community.  Somehow, boards of directors rarely become independent of the management and serve as effective agents of the shareholders, and the shareholders remain inactive or, if truly unhappy, follow the “Wall Street Rule” (i.e., sell the stock), as recognized by Berle and Means, Veblen and  my own updating analysis of Berle and Means (Corporate Control, Corporate Power [New York: Cambridge University Press, 1981]l). Scandals continue to produce weak reforms with loopholes and dependency on vigorous enforcement that fades quickly as memory recedes, market power grows, and in recent years business domination and deregulation ideology make regulation a do-nothing or corporate protective facade.

The dot-com and housing bubbles have also shown that markets continue to move out of control and produce serious macro-instability.  Globalization of finance, greater complexity in financial instruments and structures beyond the comprehension of  a  stripped down regulatory authority, and the continued force of competition pushing risk-taking to extremes poses problems for the future that could be ultra-destabilizing. The great expansion of  securitization, which supposedly spreads risks beyond the original lender, has proven in the ongoing mortgage market crisis to have encouraged new levels of risk-taking that are coming back to haunt the original lenders as well as those who bought mortgage-based packages from “responsible” lenders on trust.

These serious market inefficiencies have so far not produced a global disaster, but this has been because governments have stepped in with easy money and bailouts that so far have done their job. But with the new unknown levels of  risk hidden in the market, the  great likelihood of  a near-term end to the unsustainable rise in the U.S. foreign debt and dollar accumulation abroad, and the possibility of  a still larger war in the Middle East, financial market trouble lies ahead.


One of the central features of neoliberalism and the class war being waged by capital against labor and the general welfare, has been the importance of  privatizing everything in sight in the alleged interest of  “efficiency.”  An important half-hidden motivation, made explicit by Margaret Thatcher, was to weaken government, which in semi-democratic societies is potentially responsive to the public interest, in favor of  an enlarged private sector, which is not responsive. (For Thatcher, privatization was “one of the central means of reversing the corrosive and corrupting influences of socialism… [and] is at the centre of any programme of reclaiming territory for freedom [sic].”) Privatization has been a central objective of the IMF and World Bank in their operations, demonstrating well their role as servants of  global capital.

The case for privatization is seriously flawed, although rarely contested. One flaw is its neglect of  the fact that for many services there are positive externalities that a private operator will ignore because by definition these benefits can’t be captured in revenue—for example, the benefits to the environment of public transportation; the benefits to society of preventive medical care; the benefits to both overall efficiency and a  democratic order of a public education system that educates everyone and gives some emphasis to knowledge essential for democratic citizenship; and the citizenship benefits of  a public radio and TV system that features intelligent debate and the provision of  essential information.

A second flaw is that privatization may also increase negative externalities. It has often been grounded in the ability of  the privatizers to shift to non-union labor and cut wages and benefits, to more readily  dump older and injured workers and abandon communities without regard to social costs, and to pass off wastes on the larger community.

A third flaw is that for public services that are contracted out the state has to monitor the privatized operations to see that the promised services are rendered  as stipulated in contracts. This means an extra administrative operation added to the real costs of privatization, a built-in source of inefficiency that the privatized operation may be hard put to overcome. (For a good analysis of this, and other privatization issues, see Elliott D. Sklar, You Don’t Always Get What You Pay For: The Economics of Privatization [Ithaca: Cornell University Press, 2000]).

A fourth flaw is that privatization puts a premium on political influence that will allow the privatizers to get contracts that will allow them to inflate costs (and profits) and skimp on services. Where the privatization involves the buying and taking over of public property (as opposed to contracts for services), political influence can allow the buyers to buy at low prices and effectively loot. This  means that “competition” in the privatization process is more importantly a matter of  trying to gain political favors than of getting the costs of services down. Once the contract is won, the government often becomes locked in to dealing with the private owner, who cultivates his political friends while his former rivals are bought up or disappear. This is the basis of the classic phrases descriptive of military contractors: the contracts are “golden handshakes” between governments and contractors, who “buy in, get well later.” Instead of  greater efficiency we get inflated costs as the contractor gets well later.

Politicians who favor privatization will get well funded in the election process, and when they attain power will be inclined to treat generously those to whom they owe office. A Thatcher or Bush are also ideologically inclined  to be lavish toward privatizers, to load their administrations with conflict-of-interest appointees, and to look the other way as public property  is effectively stolen. In the Thatcher years, according to one estimate, the  public property disposed of was undervalued by 33 percent just based on the difference between the sale price and market price of the privatized property one week after the sale. This didn’t include the huge sales costs, debt write-offs, and other expenses that made privatization “the greatest ever public finance fraud” (Dexter Whitfield). In even less democratic political environments like Mexico and Russia, privatization looting was vastly greater.  

Privatization has taken an especially heavy blow during the George W. Bush years, where everything in sight has been privatized, extending not only  to military supply but intelligence and wide-ranging “security” services, and where the third and fourth flaws noted above have been dramatically evident. Political influence has shaped the process decisively, with conflict-of-interest appointments a matter of course, sweet-heart contracts and non-competitive bidding across-the-board, minimal auditing and penalties for outright robbery, and looting built-in.  The Democrats have moved slowly into this area of  immense abuse at taxpayer expense, just as they have moved at a glacial pace in extricating this country from the Iraq war. Perhaps they are too dependent on the contractor-financial community to be very aggressive here. After all, it is a different matter going after Halliburton, Bechtel, GE, Lockheed and scores of others of similar power than it would be going after welfare mothers getting more than their just desserts.

But the big lesson is clear: privatization may not only greatly reduce efficiency, it can become a run-away looting operation in hands truly friendly to privatizing interests and responding fully to their demands.

First published in Z Magazine

Edward S. Herman is Professor Emeritus of Finance at the Wharton School, University of Pennsylvania, and has written extensively on economics, political economy and the media. Among his books are The Real Terror Network, Triumph of the Market, and Manufacturing Consent(with Noam Chomsky).

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