Abba Lerner and

the Political Economy

of Bureancracy and
Organizations
Daniel L. Cuda

A previously unpublished paper by Abba P. Lerner offers one of the first

examples of economic ideas interacting with issues of bureaucracy and
public organization. Written in 1942, the paper is titled "Design for a
Streamlined War Economy," and it appears in this journal after this intro-
duction. An alternate title could easily be "Application of the Price Sys-
tem to National Security." The paper argues that for the wartime US econ-
omy to achieve maximum performance. Congress should maintain a
price system in lieu of bureaucratic rationing. When the United States
entered World War II in December 1941, the need for price stabilization
gained new urgency. The government severely restricted the production
of consumer goods and rationed their distribution. The Roosevelt admin-
istration had already created the Office of Price Administration (OPA)
earlier in 1941 to bureaucratically administer selective price and rent con-
trols. Lerner's proposal, coupled with appropriate tax policies and forced
savings, operates largely without bureaucratic "rationing, priority regula-
tions, allocations and price ceilings."
Lerner's argument, particularly in its tax and savings provisions, broadly
resembles John Maynard Keynes's proposals for British war finance in
How to Pay for the War (1940). Both are policy arguments, not theory.
Both clearly prefer to minimize rationing. How aware Lerner was of

Correspondence may be addressed to Daniel L. Cuda, Institute for Defense Analyses, 4850
Mark Center Drive, Alexandria, VA 22311-1882; e-mail: dcuda@ida.org.
History of Political Economy 45 A DOI 10.1215/00182702-2369940
Copyright 2013 by Duke University Press
614 History of Political Economy 45:4 (2013)

Keynes's proposal from two years earlier is as yet unknown. But now
with the publication of "Design for a Streamlined War Economy," the
similar efforts of Lerner and Keynes can again be examined and com-
pared. On first impression. Lerner more than Keynes extols the price sys-
tem as an alternative to bureaucratic controls. Richard Toye (1999) notes
that Keynes's more elaborate and nuanced work was designed to increase
its chances for implementation. As will be discussed, this has never been a
characteristic of Lerner's work.
Keynes aside, my argument here for the paper's significance is not for
its macroeconomic features. Many of the paper's underlying concepts are
more completely expressed in Lerner's 1944 book The Economics of Con-
trol. Although both Lerner's famous book and a majority of "Design"
address the macroeconomy, only the latter explicitly extends Lerner's
thinking into the internal organization of a bureaucratic defense establish-
ment. This is new and noteworthy. I will argue that Lerner's paper repre-
sents one of the first examples of twentieth-century economic thinking
applied to bureaucracy. A broader, more sustained effort by economists
would emerge several decades later. There is direct evidence that the
RAND Corporation, a California defense research organization where
Lerner served as a consultant for a short time after the war, played a com-
mon role in these developments.
Although Lerner's paper was unpublished, it was not unknown. It circu-
lated privately in infiuential economic circles during and after the war. In
a survey of the cost-benefit defense literature, A. R. Prest and R. Turvey
(1965, 727) introduce Lerner's paper as "that most public of all unpub-
lished works." For many, the creation of a series of artificial markets among
wartime commanders was its most memorable element. Tibor Scitovsky
(1984, 1567) remembered he thought the scheme wildly impractical and
argued with Lerner not to publish the paper for the sake of his career. On
refiection decades later he playfully suggested that similar ideas in use
before World War II might have changed the course of history (1566-67).
Paul Samuelson (1964, 177), in discussing Lerner's paper, called its orga-
nizational concepts "audacious" and noted with irony, "Not for Lerner
are crude considerations of feasibility." Brilliant but impractical is a com-
mon judgment of Lerner's ideas both in this and his other work. In a
similar vein, Charles Hitch, the director of economics at the RAND Cor-
poration in the 1950s, cautiously used the paper to illustrate the applica-
tion of economics to national security. In the still infiuential Econom-
ics of Defense in the Nuclear Age (1960), Hitch and Roland N. McKean
 Cuda / Lerner and Bureaucracy and Organizations 615

described Lerner's proposal as one approach to creating institutional effi-

ciency within the Department of Defense. Hitch introduced the econom-
ics-based Planning, Programming, and Budgeting System into the defense
department that same year.
The publication of Lerner's paper certainly helps expand Craufurd D.
Goodwin's (1991) edited work on the notable but limited connections
between economics and national security. In Goodwin's compilation,
RAND's proposal for a Planning, Programming, and Budgeting System
was a noted example. Lerner's paper provides a new connection. Seventy
years later, its organizational implications for the defense establishment
are still difficult to place on the spectrum of public policy. The history of
Lerner's role in developing Keynesian economic policy is well known,
yet the paper plays against expectations. It embodies Lerner's inclination
to work at the edges of two intellectual camps: "steer[ing] a path between
two dogmas," as he describes himself in The Economics of Control
(1944, 2).
Lerner undoubtedly worked closer to the center of market socialism
than to the market-focused outposts of Friedman, Mises, and Hayek. But
Irvin Sobel (1983) points out how both sides found objections to Lerner's
works. To the right. Lerner was a formidable intellectual opponent pro-
viding elegant theory guiding government management of the economy.
But to the left, while technically and theoretically brilliant. Lerner was
something of a loose cannon. Tibor Scitovsky (1984,1548) acknowledged
that some viewed his friend Lerner as a "crank." In May 1935 Keynes
wrote privately to Lionel Robbins and intimated that Lerner lacked judg-
ment to prevent logical errors "from leading him to preposterous conclu-
sions" (quoted in Colander and Landreth 1996, 114). Even David Colan-
der (2005), who is as close as we have to Lerner's biographer, concluded
that Lerner failed as a political economist.'
If political economy is the application of economic theory to matters
of state (Waterman 1993), Lerner's paper, particularly in its organizational
remedies, arguably demonstrates Colander's conclusions. Lerner here
again fails, so the argument goes, to practice realistic political economy
and takes theory too far. To follow Colander's analysis, he fails to make the
distinction between "pure" and "applied" economic theory. Milton Fried-
man (1947) essentially comes to this same judgment regarding Lerner's

1. See also Colander's 2010 testimony to a congressional subcommittee in Building a Sci-

ence of Economics for the Real World (2010).
616 History of Political Economy 45:4 (2013)

ideas in The Economics of Control. Likewise, Hitch and McKean (1960,

222), anticipating Colander, discuss Lerner's paper only as a straw man,
"not because it is a practicable solution to defense problems of choice, but
because it is frequently instructive to press good ideas to the extreme logi-
cal conclusions." Yet, as Evsey Domar scolded a laughing crowd after he
told them of Lerner's scheme, "You laugh at it at first; then you ask why?"
(quoted in Colander and Landreth 1996, 186).
The "why" is still elusive. A price system is a powerful, flexible mecha-
nism for decentralized decision making. In his memoirs, George Stigler
(1988) tells how he was mistakenly accused of advocating the use of a
price system to evacuate Manhattan during World War II if it came to be
bombed. He denied the accusation, but when he thought about it, he con-
cluded it would prove more flexible over time than other systems (61). But
in seeking answers to Domar's question. Tibor Scitovsky may have at least
identified the social institutions whose implicit acceptance makes Lerner's
ideas laughable at first. When Scitovsky (1984, 1565) described why he
and other friends argued against the paper's publication, he says, "[We]
seemed to have more faith in the army's collective wisdom than in the
judgment of its individual commanding officers."
Of course, this was and is the status quo alternative to Lerner's argu-
ment. But to Domar's point, exactly why is Lerner's use of the price sys-
tem impractical? In a sense, it is part of the larger tension between the
collective and the individual. Perhaps, after reflection, it is because the
wartime commanders and their assigned work, whose local knowledge
Lerner puts so much faith in, are not so perfectly analogous to market
system consumers. It is more accurate to say that local commanders are
players in a competitive game against an adaptive opponent. This point is
not completely absent in Lerner's concept of the military consumer, yet it
seems to fall short of the deadly competition of combat. Under these cir-
cumstances. Hitch notes the local commander's focus is on the present
and they are therefore likely to heavily discount "the new, the untried, and
the different" (Hitch and McKean 1960, 224).
This appears to be a hallmark of soldiers in combat everywhere, and
Hitch's point essentially remains the argument against empowering mili-
tary combatant commanders in the way outlined by Lerner. There must be
incentives, so the argument goes, to upgrade "the old, the tried, and the
unchanged" before technologically surprised by an opponent. Specifically,
Hitch seems to argue that in peacetime, greater relative weight must be
given to the military suppliers than military consumers (224). Lerner and
 Cuda / Lerner and Bureaucracy and Organizations 617

others might argue that in wartime, relative weighting should shift toward
military consumers. The recent US wartime experience of struggling to
provide more effective counter-weapons and armored vehicles to their
forces in combat suggests this problem of balance is real and ongoing. Its
practical mechanisms remain to be worked out.
I do not here argue issues of military policy or contest Lerner's reputa-
tion as a political economist or economic statesman. In "Design for a
Streamlined War Economy," Lerner himself writes that he did not expect
his plan to be implemented. "Yet it is of great value," he advises, "to con-
sider what would be the design of our economy if our prejudices did not
interfere with the war effort." As Lemer suggests, and as Hitch and Domar
both agree, I argue that the paper contains important value as a think
piece. With its publication, Lerner's paper can profitably be read with
Ronald Coase's (1937) almost contemporary observations on the alterna-
tive coordination provided to economic systems by prices or by organiza-
tions. Coase's observation addresses only market organizations and seeks
to understand their scope within a wider system of markets. Lerner's
paper alternately addresses an organization of very large scope, the US
military, and conversely finds value in creating a series of internal mar-
kets. Both Lerner's and Coase's papers remained essentially dormant
for many decades. Oliver E. Williamson (1987) eyentually made use of
Coase's work through his transaction cost economics. But unlike many
of Lerner's ideas, which seemed outlandish at the time and later became
commonplace, "Design" remains both audacious and unimplemented
seventy years later.
These many decades later, the theoretical use of a price system to shape
public bureaucracies in general, let alone military bureaucracies them-
selves, remains only tentatively explored (Frederickson and Smith 2003).
The mid-twentieth-century Hoover Commission addressed the subject of
user charges and other "buyer-seller" devices within the Department of
Defense, but nothing approaches Lerner's scope. Market mechanisms
have rarely been explored within this domain. Even under laissez-faire
economics, military forces were a sovereign activity of government and
largely outside markets. In the concept of market failure that emerged over
the late nineteenth and early twentieth century (Medema 2007), national
defense, then and now, remains the most public of all public goods. As US
government interaction and management of the economy expanded over
the late nineteenth and twentieth centuries, military industrial planning
for mobilization and war grew with the administrative state (Skowronek
618 History of Political Economy 45:4 (2013)

1982). As the size of the peacetime standing military expanded after

World War II, the necessary bureaucratic instruments for its maintenance
expanded also. To be sure, competitive contracting with commercial firms,
even for purely military articles, is quite common. But operating in con-
junction with these private sources, military bureaus essentially supply
combat forces all their component resources. It is in this vein that former
secretary of defense Donald Rumsfeld (2001) described his department's
bureaucracy as "one of the world's last bastions of central planning."
The post-World War II attempt to manage the newly expanded defense
bureaucracy began with the creation of a secretary of defense in 1947.
Both the new Department of the Air Force and ultimately Secretary of
Defense Robert McNamara would call on the RAND Corporation for
assistance in managing this extraordinarily large organization. Robert J.
Leonard (1991) documented the rise of the RAND economics department
as an influential actor within the Department of Defense. Charles Hitch
would serve as the first director of the RAND economics division from
1948 to 1960. In implementing the Planning, Programming, and Budget-
ing System within the Department of Defense, practical economists such
as Hitch sought internal efficiencies within its organizational arrange-
ments. But the political economy of Hitch and his successors appears to
contain a subtle difference from the approach offered by Lerner and oth-
ers. The difference is perhaps best described as a mixed attitude toward
bureaucracy. This approach is evident in Lerner's paper when he indeli-
cately contrasts the price system with "bureaucratic hordes who inevitably
tie up the whole economy, including themselves, in ever more complex
confusions of red tape."
To understand these differences, William A. Niskanen's economic-
based work on bureaucracy from the 1970s usefully contrasts with the
economics of the Planning, Programming, and Budgeting System (PPBS)
introduced by RAND in the 1960s. Niskanen himself was part of the
RAND PPBS experiment within the Department of Defense, and he came
away puzzled and frustrated. The resistance of the military to PPBS and
other McNamara reforms, and in Niskanen's words "its [the PPBS's] ulti-
mate failure" under otherwise favorable conditions, prompted Niskanen to
explore the peculiar economics of bureaucracy. The more conventionally
rooted economic assumptions of PPBS, he wrote, do not "account for the
institutions of bureaucracy and representative government" (Niskanen
1971, vi). His still controversial works from the 1970s constitute an effort
in political economy designed to address these issues.
 Cuda / Lerner and Bureaucracy and Organizations 619

The general orientation represented by Lerner and Niskanen seems

decidedly more aware of bureaucratic limits than the economic viewpoint
Hitch introduced through PPBS. The differences between the two camps,
however, are matters of degree. Hitch himself was not naive about bureau-
cracy. Still, it appears Lerner's inherently more skeptical orientation
would not again appear until economists such as Anthony Downs, Gordon
Tullock, and Oliver Williamson, along with Niskanen, began their work in
the 1960s. Some of these names, particularly Tullock's, can be associated
with the Virginia school of political economy (Medema 2011). Ronald
Coase, whose observations complement Lerner's thoughts on bureaucracy,
also had connections with this group.
The RAND Corporation arguably links Lerner, Niskanen, and other
economists who applied economic ideas to the study of public organiza-
tions. Abba Lerner was a consultant at the RAND Corporation in the
summer of 1949 (Landes 1994) and it is likely "Design for a Streamlined
War Economy" circulated among its staff. Hitch states in a footnote that
Lerner's article "circulated among professional economists" (Hitch and
McKean 1960,222), without specifically identifying their institutions. But
a biographical listing for Lerner lists the article as an internal RAND
Corporation paper (Econometric Society 1957,107). In turn. Hitch appears
to have brought other economists into the field through the RAND Corpo-
ration. At an American Economic Association presentation in 1960, Hitch
and McKean (1961) took public notice of Anthony Downs and his 1957
book An Economic Theory of Democracy. They noted that "Downs' study
helps show the two-way relationship between economic theory and man-
agement economics: it indicates how economics can contribute to the
analysis of an organization's practices and suggests how better under-
standing of these practices may contribute to a theory of organizational
behavior" (151).
Downs then came for a time to RAND in the 1960s. During that same
time, Oliver Williamson was also doing RAND research. Downs in this
period at RAND produced the seminal Inside Bureaucracy (1967). In
producing the work. Downs (1967, vii) acknowledged that "my greatest
debts are to Gordon Tullock, whose ideas inspired my approach." Tullock
at the time was also a visiting fellow at RAND. Tullock had served inside
the state department bureaucracy during the 1950s and then, with James
Buchanan, helped produce the Calculus of Consent in 1962. He then pub-
lished The Politics of Bureaucracy (1965) in which, as part of a larger
work, he explored like Lerner markets and their feedback mechanisms as
620 History of Political Economy 45:4 (2013)

an alternative to bureaucracy. The ubiquitous Tullock then influenced Nis-

kanen (1971, vi) later in the 1960s at the RAND-like Institute for Defense
Analyses outside Washington, D.C. It was there that Niskanen developed
his economic approach to bureaucracy in response to the RAND PPBS
experiment within the Department of Defense. Given Tullock's explicit
connection to these two important works, a reexami nation of the ideas in
The Politics of Bureaucracy may be justified in order to identify its simi-
larities and differences with Downs and Niskanen.
The ideas behind Lerner's 1942 paper can be seen as an early exam-
ple of these efforts. Yet none of the others are expressly works of policy
advocacy and none so boldly extends a price system inside the bureau-
cracy. Niskanen's work generally assumes bureaucratic monopoly for
the supply of services and sensitivity to price competition. The artificial
markets addressed by the two Hoover Commissions of the 1940s and
1950s might be seen as independently inching in the direction of Lerner's
logic. Wartime urgency may explain Lerner's boldness and why Lerner's
work still remains surprising. Unlike Niskanen, whose contributions
to the "Virginia school" were in the free market tradition. Lerner crosses
roughly the same ground, but from a tradition of mid-century market
socialism and Keynesian economics. He was associated with a "mar-
ket failure" tradition. This tradition is caricatured as substituting gov-
ernment agencies for markets (Goodwin 2011,66). In this sense, Lerner's
price-system proposal runs counter to the expectations with which his
work is normally associated. This juxtaposition, along with the even-
tual relative success of wartime planning and controls, may have com-
bined to keep "Design for a Streamlined War Economy" unpublished
until now.

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