The Online Library of Liberty

A project of Liberty Fund, Inc.

• Editorial Staff
• Associate Editors
• Editorial
• Bibliographical Essay: Kingsley Widmer, Utopia and Liberty: Some Contemporary Issues Within Their Intellectual Traditions
• I: Economics and the Free Society
• The Compatibility of Justice & the Market
• Is Capitalism Free and Just?
• Is Free Enterprise Coercive?
• Private Enterprise Vs. Central Planning
• Vicious Motivations & Commercial Society
• Economic Policy: Free Trade and Values
• Violence, the State & the Rise of Capitalism
• Braudel's Ideological Theory of Capitalism
• Cognition, Choice, and Entrepreneurship
• Federal Expenditures ‘crowd Out’ Private Investment
• The Mirage of Economic Efficiency
• Private Property and Energy Resources
• Rent Control Vs. Economic Reasoning
• II: Law, Liberty, and Political Thought
• Restitution Vs. Punishment & Crime Prevention
• Criminology & Rationales For Punishment
• Defending Freedom of Contract
• Privatizing Public Parks
• Law and the American Economy
• Sumner, Social Darwinism & Property
• Lagos and Colonial Property Rights
• Price Controls, Legal Regulation & Inflation
• Discrimination and Affirmative Action
• The First Amendment and Pornography
• The Right to Leave Any Country
• The Evolving Notions of Individual and Society

Private Enterprise vs. Central Planning

Richard R. Nelson

• Yale University

Professor Nelson seeks to refute the economic superiority of private enterprise over centralized statist systems. He argues that the twin theorems of welfare economics (which relate competitive equilibrium to a social optimum and which he regards as the basis of the case for capitalism) are weak foundations for economists' faith in free enterprise. Nelson asserts that, if conventional welfare economics were to consider more deeply the three prime virtues claimed for the enterprise form of economic organization (administative parsimony, responsiveness, and innovativeness) it would recognize how these criteria support a centralized economy rather than the free market.

Administration's task in any economic system is to respond to uncertain changes in demand and supply, as well as to the challenge of innovation. Welfare economics, Nelson asserts, avoids the problem of administrative response by assuming a steady state, which allows, however, even a tight, centrally planned system to respond effectively.

On the other hand welfare economics assumes that conditions more complex than static equilibrium would confront a stylized central planning regime with the choice of either working with crude decision rules or else suffering high administrative costs. Nelson counterargues that a stylized private enterprise system would face a similar trade-off. Market transactions that ignore all but a few dimensions of costs and benefits are cheaper than those which realistically consider many. In a free enterprise regime, the trade-off is between leaving externalities and imposing a more costly market-transactional structure.

The problem of unpredicted change leads to the question of responsiveness. In a dynamic economy economic units have no assurance that their past decisions will work in the present circumstances. Proenterprise literature contends that the capitalist system tracks the shifting conditions of the market with low administrative overhead as opposed to the poorer performance of a centralized economy.

Although he concedes that private enterprise responds quickly and at relatively low cost, Nelson challenges whether its responses are well-directed. He argues that without a central mechanism to direct firms (in dividing up increases or decreases in overall industrial capacity, for example), the multitude of competitive firms in any industry would produce chaos rather than intelligent responses to problems of output and inter-industry coordination.

Next, argues Nelson, although the diversity of private enterprise might appear better suited to encouraging innovation and creativity than centralized bureaucracies, the market may in fact erect obstacles to innovation. He alleges that a firm's fear of losing its technological secrets to rival firms tends to discourage outlays for new research and development. In addition, as enterprises grow larger, they suffer a decline in creativity and the ability to monitor performance. To support his contention of free enterprise's weakness in R&D, Nelson points to the large governmental funding of R&D in many capitalist countries.

Nelson judges that the traditional arguments for private enterprise are economic prejudices and result from faulty empirical observation.