The Economic Irrationality of the State

by Eric Englund

"The truth is that the State is a conspiracy designed not only to exploit, but above all to corrupt its citizens." – Leo Tolstoy

"None are more hopelessly enslaved than those who falsely believe they are free." – Johann Wolfgang von Goethe

In 1912, Ludwig von Mises's masterwork The Theory of Money and Credit was published; and to this day, this book is underappreciated. How can this be? After all, in this book, Mises unveiled his regression theorem demonstrating commodity money, such as gold, can have its purchasing power traced back in time to the point where gold was not a medium of exchange. Mises, accordingly, eliminated the conundrum in which the marginal-utility explanation of money demand would merely be a case of circular reasoning; money emerged out of barter and his logic is irrefutable. Mises also laid the foundation for the Austrian theory of the trade cycle, which correctly deduces that economic boom-bust cycles are caused by inflationary bank-credit expansion as enabled by central banks and their governments. While writing The Theory of Money and Credit, Mises was pondering the issue of economic calculation in a socialist state. Per Murray Rothbard,

Mises writes that he was led to consider the socialist calculation problem by his work on The Theory of Money and Credit. Here Mises realized for the first time with keen clarity that the money economy does not and cannot calculate or measure values directly: that it only calculates with money prices, the resultants of such individual valuations. Hence, Mises realized that only a market with money prices based on the evaluations and exchanges of private owners can rationally allocate resources, since there is no way by which a government could calculate values directly. Hence, for Mises his article and book on socialism was part and parcel of the development of his expanded integration of micro and macro, of direct monetary exchange, that he had begun but not completed in The Theory of Money and Credit.[1]

Without private ownership in the means of production, economic calculation is impossible. Per Joseph T. Salerno, "a single human mind ... would be utterly incapable of determining the optimal pattern of resource allocation or even if a particular plan were ludicrously and destructively uneconomic."[2] To be sure, the collapse of the USSR demonstrated the harmful, resource-misallocating, and uneconomic nature of the socialist state.

Ludwig von Mises, indisputably, was correct about the inherent irrationality of the socialist state. Because Mises, however, grudgingly believed in the necessity of the state, he did not extend his critique to the irrational essence of the state itself – after all, he believed that government was necessary for providing national defense, courts, prisons, and police protection/security.[3] He did not see free-market solutions emerging in lieu of these state-provided services.

Given the nature of all states, is it not true that government entities are incapable of rationally allocating resources? In a socialist state, an economy cannot emerge due to the impossibility of economic calculation under collective ownership of the means of production, as prices for production goods cannot materialize. Owing to the character of all states, however, it is impossible for bureaucratic operatives to rationally allocate resources, which is due to the impossibility of applying a profit-and-loss test to the operations of the state. Such impossibility arises as a state's revenues are based not on voluntary market exchanges but are based on coercion mostly via taxation. In a world of scarcity, it stands to reason that entities which misallocate resources and destroy capital are fundamentally irrational and undesirable. Any entity that comes into existence based on coercion and theft and then is incapable of rationally allocating resources under its control is criminal in nature and harmful to mankind. This entity is the state.

The State Is Anticapital

Capital is wealth, in whatever form, and is used or is capable of being used to produce additional wealth. Farmland, seeds, tools, buildings, and draft animals are examples of capital that predate the emergence of the state. Just as there was a day when gold emerged as money, there was a day where the state was born. It is axiomatic, however, that capital existed prior to the emergence of the state. As Linda and Morris Tannehill wrote,

Wealth does not exist in nature but must be created. The only means of creating wealth is value-production and free exchange – the manufacture and trade of some desired good or service. One may obtain wealth directly, by productive work, or one may obtain it indirectly, by looting it from a producer, but the wealth must be created by production in the first place in order to exist at all.[4]

For man to satisfy his needs and desires, there are the economic means and the political means.[5] Correspondingly, the "state is an organization of the political means. No state, therefore, can come into being until the economic means has created a definite number of objects for satisfaction of needs, which objects may be taken away or appropriated by warlike robbery."[6] The state, consequently, was born on coercion, expropriation, theft, and violence.

The most aggressive expropriator of wealth is the socialist state. Under socialism, the state takes ownership of all means of production, including land. Prior to the emergence of the socialist state, for example in the USSR, much of the means of production and land were privately owned. On the formation of the USSR, all means of production and land were collectivized and, therefore, brought under control of the Soviet Union's central planners. A more accurate way to describe this collectivization process is to call it for what it is: state-sponsored coercion and theft on the grandest scale known to mankind.

After 74 years of existence, the Soviet Union collapsed, thereby exposing socialism's devastation to its people, resources, and capital. "As the Soviet Union came to an end, the public had been reduced to a collective of hunter gatherers, barely existing at a subsistence level."[7] The total state, as exemplified by the Soviet Union, led to the total impoverishment of its people – not to mention that it murdered approximately 20 million of its own citizens.[8]

Although states openly steal property, there are varying degrees of "respect" states concede with regard to private-property ownership. People in the United States, for instance, feel relatively secure in their ownership of private property. It is, nonetheless, a grey area as to who owns land and houses in the United States. For if someone fails to pay property taxes, then the taxing authority can legally confiscate the house or tract of land. Moreover, the 16th Amendment to the US Constitution allows for direct taxation – and, therefore, Uncle Sam has claimed prior ownership to the fruits of everyone's labor in the United States. Money is property, just as much as real estate is, and both are subject to confiscation in the United States.

The More Power a State Has, the More Its Criminal Nature Is Exposed

The very existence of the state puts humanity on a slippery slope toward state servitude, grinding poverty, and premature death:

Just as "the power to tax involves the power to destroy," the sanctioning of state authority to regulate even one percent of our conduct is to admit its authority as to the rest.[9]

Ludwig and Margit von Mises escaped the clutches of the epitome of totalitarianism: Nazi Germany. It is widely known how murderous this totalitarian state was. During Ludwig von Mises's lifetime, the extent of the Communist bloc's criminality and destructiveness was not known. When The Black Book of Communism: Crimes, Terror, Repression was published in 1999, the evil and criminal nature of the total state, as laid bare by Communism, was exposed for the whole world to see.

There is an erroneous mindset that Nazism represents the extreme right of the political spectrum while Communism represents the extreme left. This is a mistake, as private-property ownership and liberty are demolished under the totalitarian state, regardless of its label. In other words, totalitarianism is totalitarianism. The authors of The Black Book of Communism drew this exact conclusion:

One thing is certain: Crimes against humanity are the product of an ideology that reduces people not to a universal but to a particular condition, be it biological, racial, or sociohistorical. By means of propaganda, the Communists succeeded in making people believe that their conduct had universal implications, relevant to humanity as a whole. Critics have often tried to make a distinction between Nazism and Communism by arguing that the Nazi project had a particular aim, which was nationalist and racist in the extreme, whereas Lenin's project was universal. This is entirely wrong. In both theory and practice, Lenin and his successors excluded from humanity all capitalists, the bourgeoisie, counterrevolutionaries, and others, turning them into absolute enemies in their sociological and political discourse. Kautsky noted as early as 1918 that these terms were entirely elastic, allowing those in power to exclude from humanity whenever they so wished. These were the terms that led directly to crimes against humanity.[10]

Under the total state, there is no private property including ownership of one's own body. Those exercising power under a totalitarian regime see nothing wrong with killing people for the sake of the state. It is no wonder that Communist regimes killed nearly 100 million people during the 20th century.[11]

The 20th century, overall, was a bloody one. Dr. R.J. Rummel has coined the term democide, which means "the murder of any person or people by a government, including genocide, politicide, and mass murder."[12] These deaths do not count combat deaths attributed to war. In the 20th century, according to Dr. Rummel, democide accounted for 262 million deaths.[13]

As states gain power and liberty recedes, the evil, criminal, and murderous nature of the state becomes self-evident.

All States Subsist on Coercion and Theft and Are Uneconomic

There is an assertion that a social contract exists in which individuals tacitly consent to give up some of their freedoms in exchange for the benefits of a political order and security as provided by the state. In reality, who consents to being murdered by a state in the name of political order? Who consents to being taxed? Whether an individual is more likely to be murdered by a state or is merely taxed and bossed around by a state has everything to do with where someone is born and has nothing to do with consenting to the dictates of the state.

Taxes are not voluntary contributions made to the state. Figuratively speaking, taxes are collected at gunpoint and failure to pay may land one in prison or worse. Per Lysander Spooner,

If the government can take a man's money without his consent, there is no limit to the additional tyranny it may practise upon him; for, with his money, it can hire soldiers to stand over him, keep him in subjection, plunder him at discretion, and kill him if he resists.[14]

What Spooner described is the unvarnished reality that the state represents the negation of liberty. For if an individual does not fully own the fruit of his labor (i.e., money income), then he lives in a condition of tax slavery.

Taxation also depresses production. It is a natural response to prevent a thief from stealing one's belongings. Yet if the thief is the state, mankind has the inclination to keep as much as possible away from the government and the economic impact is deleterious. On this matter, let's turn to Frank Chodorov:

Taxes of all kinds discourage production. Man works to satisfy his desires, not to support the state. When the results of his labor are taken from him, whether by brigands or organized society, his inclination is to limit his production to the amount he can keep and enjoy.[15]

Chodorov further comments,

While we are on the subject of discouragement of production by taxation, we should not overlook the greater weight of indirect taxes, even though it is not so obvious. The production level of a nation is determined by the purchasing power of its citizens, and to the extent that this power is sapped by levies, to that extent is the production level lowered. It is a silly sophism, and thoroughly indecent, to maintain that what the state collects it spends, and that therefore there is no lowering of total purchasing power. Thieves also spend their loot, with much more abandon than the rightful owners would have spent it, and on the basis of spending one could make out a case for the social value of thievery. It is production, not spending, that begets production. It is only by the feeding of marketable contributions into the general fund of wealth that the wheels of industry are speeded up. Contrariwise, every deduction from this general fund of wealth slows down industry, and every levy on savings discourages the accumulation of capital. Why work when there is nothing to it? Why go into business to support politicians?[16]

A private company's revenues are derived from spontaneously emergent, market-based demand (in other words "organic" demand), whereas a state's revenues arise from theft. States are anticapital, irrational, and uneconomic in and of themselves.

If there is any contract that must be broken, it is the alleged social contract between individuals and the state. Living standards would rise, due to increased capital accumulation and savings, which in turn would result in more goods and services being brought to the market.

Economic Calculation

What is economic calculation and why is it important? In Human Action, Ludwig von Mises succinctly answers these questions:

The task which acting man wants to achieve by economic calculation is to establish the outcome of acting by contrasting input and output. Economic calculation is either an estimate of the expected outcome of future action or the establishment of the outcome of past action. But the latter does not serve merely historical and didactic aims. Its practical meaning is to show how much one is free to consume without impairing the future capacity to produce. It is with regard to this problem that the fundamental notions of economic calculation – capital and income, profit and loss, spending and saving, cost and yield – are developed. The practical employment of these notions and of all notions derived from them is inseparably linked with the operation of a market in which goods and services of all orders are exchanged against a universally used medium of exchange, viz., money. They would be merely academic, without any relevance for acting within a world with a different structure of action.[17]

In a territory where the institutions of private property and sound money are honored, all goods and services can be coherently exchanged on the free market. Under these conditions, money prices emerge for both consumer goods and producer goods. Prices for producer goods are a derivative of the prices of consumer goods, with the prices of producer goods emerging through price imputation.[18]

With private ownership in the means of production, an economy can flourish. Entrepreneurs can make rational business decisions and subject such decisions to the profit-and-loss test:

Monetary calculation is the guiding star of action under the social system of division of labor. It is the compass of the man embarking upon production. He calculates in order to distinguish the remunerative lines of production from the unprofitable ones, those of which the sovereign consumers are likely to approve from those which they are likely to disapprove. Every single step of entrepreneurial activities is subject to scrutiny by monetary calculation. The premeditation of planned action becomes commercial precalculation of expected costs and expected proceeds. The retrospective establishment of the outcome of past action becomes accounting of profit and loss.[19]

A tool businessmen use to determine the success or failure of past actions is a financial statement, which includes a balance sheet and an income statement. It is important to understand that all entries in the balance sheet and income statement are expressed in terms of money. A businessman can directly correlate whether his company's capital base (i.e., the company's net worth as reflected in the balance sheet) is expanding or contracting depending on if the company turned a profit or made a loss. Such monetary calculation assists a businessman in deciding to maintain or change a business plan based on satisfying the ever-sovereign consumer.

In business, a private company can gauge the demand for its products through its sales volume. Using generally accepted accounting principles (GAAP), sales are recorded as the very top entry of an income statement (also known as a profit-and-loss statement) using the term "revenues." Revenues are generated through the voluntary exchanges of money, from customers, in return for the products sold to customers. A company will know quickly if there is a demand for its product – for if sales do not materialize or are significantly below expectations, then the company's revenues will reflect this lack of customer demand. A revenue shortfall, in turn, most likely will reveal a company with an unprofitable business model in which revenues fall short of covering production and overhead costs. Hence, the income statement will reveal a net loss. The company's capital base will shrink as a result of this loss.

A GAAP income statement, for a private company, would look like the following:

• Revenues
• Cost of Revenues Earned
• Gross Profit
• General and Administrative Expenses
• Net Income from Operations
• Other Income (Expenses)
• Net Income (Loss)
• Retained Earnings, Beginning of Year
• Retained Earnings, End of Year

If the company turns a net income, its retained earnings will increase, thus resulting in an increase of the company's capital base. If the company turns a net loss, then retained earnings will shrink and this results in the diminution of its capital base. This is the elegance of economic calculation.

The State Cannot Calculate

All states are extramarket constructs and are always and everywhere incapable of economic calculation. Without the profit-and-loss test, with private property being a prerequisite, socialism does not allow an economy to emerge. Socialism is, therefore, irrational. If a state allows private-property ownership within its territory, and a free-market economy emerges, it does not follow that such a state is rational. For such a state is incapable of rationally allocating resources under its command, as public entities do not have the ability to measure their performance through the profit-and-loss test. Public entities, ultimately, depend on coercion and theft to fund themselves and their programs. Hence, the mindset of bureaucrats is political and not economic in character.

In a world of scarcity, rational resource allocation is critical to supporting human life. For those of a political mindset, should we expect rationality and logic with respect to matters of economics?

Rational conduct would be divorced from the very ground which is its proper domain. Would there, in fact, be any such thing as rational conduct at all, or, indeed, such a thing as rationality and logic in thought itself? Historically, human rationality is a development of economic life. Could it then obtain when divorced therefrom?[20]

In states where private property is allowed, there exists a false perception that state bureaucrats can rationally allocate resources. This is an illusion foisted on a gullible public. If a public entity runs a surplus, it is hailed as being operated responsibly. If the public entity runs a deficit, it is seen as a problem that must be rectified by the bureaucrats in charge.

Public-sector accounting does measure revenues and expenses. There is, however, no profit-and-loss test precisely because a state or public entity is not a market-based phenomenon. Public-sector accounting, accordingly, is purely self-referential in that state operatives desire to know if enough money is being skimmed from its subjects in order to remain viable. Public-sector accounting also provides an air of respectability in that public entities want to promote the illusion of accountability to the populace. The objectives of public-sector accounting are conveyed as follows:

Note such terms and concepts as compliance with the law, budgeting, stakeholders, creditworthiness, and democratic transparency; throw in the term "sustainability" and public-relations perfection will have been achieved.

Services most often associated with the public sector are police protection, security, legal system, roads, national defense, and money production. Of course, there are numerous welfare programs such as Social Security and Medicare – but these are not services in that they are pure transfers of wealth.

To reiterate, because a state's revenues are generated through coercion, via taxation, there is no way of gauging any organic demand for the services the state provides to its populace. Without a legitimate gauge for measuring the demand for a state's services, as there is no connection between demand and revenues (such as there is in private enterprise), a state has absolutely no means of calculating if it is rationally allocating resources.

It also follows that because state services cannot be tested against the metrics of organic demand, then it is impossible for state bureaucrats to know if they are meeting the most urgent needs of the populace; it is impossible for taxes to act as a substitute for market-generated revenues. Only market-based revenues serve to provide the signals of how much and what type of services are actually demanded by people.

In the United States, for example, there has materialized a web of public entities – municipal, state, and national – that has parasitically fastened to a market society – siphoning resources away from where countless individuals would have otherwise directed their own money and resources. How many smart bombs, drones, fighter jets, military bases, policemen, judges, social workers, CIA spies, and IRS agents are demanded by John Q. Public? Whether or not a public entity runs a surplus or a deficit does not answer this question. Because a state is not a market-based phenomenon, although it still may be able to gauge its expenses using prices that have emerged on the free market, it can never gauge the demand for its services as a state's top-line income is derived from theft and not from free-market demand. This lattice work of public entities, therefore, serves to misallocate resources on an enormous scale.

State-Controlled Money versus the Free Market

Per Ludwig von Mises's regression theorem,

money, in any society, can only become established by a market process emerging from barter. Money cannot be established by a social contract, by government imposition, or by artificial schemes proposed by economists. Money can only emerge, "organically" so to speak, out of the market.[22]

Contra to what public officials and statists assert, there is no economic law prohibiting the private production of money,[23] let alone security services,[24] defense,[25] justice,[26] and roads.[27] Yet governments, being the criminal enterprises that they are, have succeeded in supplanting market-based money (gold and silver) with fiat money.

With the emergence of the state came the multicentury process of governments gaining control over monetary systems. Such usurpations typically began with the state seizing absolute control of the minting business – with the state naming the monetary unit to separate it from the underlying weight of the coin (which opens the door for coinage debasement). The next step was for states to enact legal-tender laws dictating what money could be. As money substitutes were brought into widespread use, in recent centuries, governments gave banks the privilege of suspending payment in specie. All of this set the table to bring central banking into the picture, whereby governments grant central banks a monopoly on the note of issue.[28]

Directly due to the effects of central banking, stock-market bubbles arose in the United States in the 1920s, the 1980s, and the late 1990s /early 2000s. Each bubble was fueled by the Federal Reserve's easy-money policies and led directly to the Great Depression,[29] the record stock-market crash of 1987, and the crash of the NASDAQ/dot-com bubble, which imploded over the period of 2000–2001.[30] The Austrian theory of the trade cycle provides the only explanation for these booms and busts. As Roger Garrison explains,

The Austrian theory of the business cycle emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not. An increase in saving by individuals and a credit expansion orchestrated by the central bank set into motion market processes whose initial allocational effects on the economy's capital structure are similar. But the ultimate consequences of the two processes stand in stark contrast: Saving gets us genuine growth; credit expansion gets us boom and bust.[31]

Famously, after the attacks of 9/11, Federal Reserve Chairman Alan Greenspan reduced the federal-funds rate (which stood at 6.5 percent in November of 2000) to 1 percent in July of 2003. The federal-funds rate remained at 1 percent until June of 2004.[32] Such artificially low interest rates stimulated a housing bubble as enabled by the government-sponsored enterprises of Fannie Mae and Freddie Mac.

Frank Shostak eloquently describes how loose monetary policy was the proximate cause of America's housing bubble:

We can define a bubble as activities that spring up on the back of loose monetary policy of the central bank. In other words, in the absence of monetary pumping these activities would not emerge. Since bubble activities are not self-funded, their emergence must come at the expense of various self-funded or productive activities. This means that less real funding is left for productive activities, which in turn undermines those activities. In short, monetary pumping gives rise to the misallocation of resources, which as a rule manifests itself through a relative increase in non-productive activities against productive activities.[33]

Accordingly, the mass delusion that a long-term consumer durable, such as a house, will increase in price, year after year, directly emanated from the Federal Reserve's monetary pumping. The bubble-headed assumption that housing prices would never decline demonstrates that easy money certainly led to a massive clustering of error, culminating in a terrible bust in the housing market.

By September of 2008, the Federal Reserve's easy-money policy came home to roost when major American financial institutions recognized that their balance sheets were in tatters. Reckless lending for home mortgages led to widespread mortgage-loan defaults. Because Wall Street had turned into a mortgage-debt securitization machine and American financial institutions' balance sheets were stuffed full of such mortgage-backed securities – whose prices dropped precipitously, due to the aforementioned loan defaults – money-center banks and powerhouse Wall Street firms were brought to their knees.

On October 14, 2008, "the U.S. government announced a series of initiatives to strengthen market stability, improve the strength of financial institutions, and enhance market liquidity."[34] The cornerstone initiative was the "Troubled Asset Relief Program (TARP), in which the secretary of the Treasury would expend as much as $700 billion in two installments to purchase rotten paper, such as mortgage-backed derivatives, from banks and other financial institutions."[35]

Wall Street titans such as Citigroup, Goldman Sachs, and JPMorgan Chase initially felt the pain of the 2008 economic collapse. However, because such financial institutions were deemed "too big to fail," Secretary of the Treasury Hank Paulson saw to it that these insolvent behemoths were bailed out at the expense of Main Street. Robert Murphy concludes,

The TARP was crooked from the very start, using taxpayer funds to bail out some of the world's richest people from their own foolish investments. The claims that it made taxpayers money are unfounded. Even worse, TARP taught investment bankers an important lesson: During a boom, make as much money as you can, no matter how short-term the profits will be. When the bubble pops, the Treasury and Fed will be there with a taxpayer-funded pillow.[36]

When government controls money, through a central bank, combined with the power to tax, the criminal activities undertaken by the state can be nothing short of audacious and supremely damaging.

Under a free market, where gold and silver coins are privately minted and used as money, such state-induced boom-bust cycles, as exemplified by America's housing bubble, could not emerge. Conversely, when the criminal enterprise, known as the state, controls the production of money, history illustrates how economically destructive the state can be.

Conclusion

As a state grows, the free market becomes hampered and recedes. Because all states are incapable of rationally allocating resources under their command, it logically follows that the total state must snuff out an economy altogether. When Economic Calculation in the Socialist Commonwealth was published, Mises's "seminal journal article in 1920 on the impossibility of economic calculation under socialism was the most important critique ever leveled at socialism."[37] Fundamental to this critique was the absolute necessity of private ownership in the means of production.

Ludwig von Mises, therefore, was a fierce defender of private-property ownership. For without private property, an economy cannot emerge:

It is an illusion to imagine that in a socialist state calculation in natura can take place of monetary calculation. Calculation in natura, in an economy without exchange, can embrace consumption goods only; it completely fails when it comes to dealing with goods of a higher order. And as soon as one gives up the conception of a freely established monetary price for goods of a higher order, rational production becomes completely impossible. Every step that takes us away from private ownership of the means of production and from the use of money also takes us away from rational economics.[38] (Emphasis in the original)

Mises did not, however, view socialism as systematized robbery.[39] Had he been aware of the Soviet Union's brutal treatment of kulaks during its collectivization process, it is possible he would have changed his mind. Per The Black Book of Communism,

Recent research in the newly accessible archives has confirmed that the forced collectivization of the countryside was in effect a war declared by the Soviet state on a nation of smallholders. More than 2 million peasants were deported (1.8 million in 1930–31 alone), 6 million died of hunger, and hundreds of thousands died as a direct result of deportation.[40]

Such shocking information may have jarred Mises into grasping that all states, by definition, exist based on systematized robbery and violence. In turn, any entity whose very existence depends on systematized theft and coercion inherently must misallocate resources and destroy capital. In a world of scarcity, such an institution must be deemed antihuman and irrational. Socialism, accordingly, isn't the problem; the state itself is.

Mises, to be sure, had serious misgivings about the state:

Private property creates for the individual a sphere in which he is free of the state. It sets limits to the operation of the authoritarian will. It allows other forces to arise side by side with and in opposition to political power. It thus becomes the basis of all those activities that are free from violent interference on the part of the state. It is the soil in which the seeds of freedom are nurtured and in the autonomy of the individual and ultimately all intellectual and material progress are rooted.[41]

Inherent to private property is the right to self-ownership, "a right held by everyone by virtue of being a human being."[42] Every person, in other words, has a property right in his own body. By extending Mises's view of private property to each person's body, the sphere in which mankind would maximize freedom along with intellectual and material progress would be where no state exists at all.

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September 7, 2011