Economic Calculation

Economics Economics Questions
21

Basically in market socialism the managers get their revenues from customers and they are given some kind of “incentive” (While incentives are extremely important, it is even more important that they be conceded - the goal is to prove that even with perfect humans we cannot have socialism be plausible) to maximize this revenue. Because of this they strive to allocate land, labor and capital to whatever combination yields the highest revenue (indeed, this is incredibly similar to capitalism) within the bounds of the ownership rights given to them by their superiors. Thus after they get revenue from their customers they then spend it on goods given a centrally published list of prices. The list of prices then changes as shortages are reported or surpluses arise.

This is, indeed, very similar to how a market works.

22

Avram,

I suggest you read this:

He sets up his theory on purely essentialist grounds from Rothabardian monopoly theory. All systems are planned the question is of what type is the planning: competitive or non-competitive.

This paper is truly excellent.

23

Physiocrat, thanks for the recommendation buuuuuut… If you click on the link I provided in one of my posts above you’ll see I based my ideas on the exact same paper! :wink:

It is good and it identified that crucial difference which I tried to lay out in simpler terms, however it does not provide for a case of why this is better than the socialist alternative.

Moreover he is inconsistent with his approach to the consumer market, first saying it is done by allowing consumers to spend on whatever they will and later as with his theatre example it becomes a product of the central list, which is, in fact, not the case under the theory of market socialism as expounded by its supporters

As an aside there might also be something important in the thought of profits as a signaling mechanism on what should be produced. I have not yet thought about it in great detail but I have a sneaking suspicion that market socialism might be more inefficient in this regard, although the basic mechanics might appear superficially similar.

24

Sorry about that. As I’ve been in a lengthy calculation debate recently I couldn’t be bothered to read everyone’s contributions but thought I’d post a link to the best article I’ve read on it.

Well that parts easy-

  1. All monopolies are inefficient compared to the free market (Rothbardian monopoly theory)

  2. The State is a monopoly.

  3. Therefore the state is ineffecient.

I can’t comment on that as I haven’t read the paper for a while.

They do but aren’t fundamental.

25

Well, basically the market allocates resources towards the most urgent uses.

How does the market do the job?

Through prices. Imagine money as votes, and prices reflecting the number of votes each resource(either capital or consumer goods) gets. The market place is where people bid for resources with money votes. So, basically the market is about, as already mentioned, allocating scarce resources towards the most urgent uses.

So, what’s the calculation problem?

Without a pricing system, there is no scope of any rational allocation of resources, that is, towards the most urgent uses(based on the number of votes each resource gets).

This is the most basic explanation of the calculation problem you need to know.

Next, there were some of these neo-classicals who started conceding that without any pricing system rational allocation of resources would be impossible. So, they said that the pricing mechanism would still be intact without private property. But, they did not concede the disadvantages the lack of private property rights would bring to their system. The neo-classicals proposed a system in which pricing mechanism does exist, but it would be entirely controlled by the State.

What was this neo-classical pricing system like?

I basically consider two important neo-classical economists to be worthy of rebuttal. One was Oscar Lange, and the other was Enrico Barone.

Oscar Lange basically accepted that people should vote in the market place with their money votes, and prices of consumer goods should be ascertained. But Lange was not able to solve the problem of pricing of capital goods. Why? In a market economy, multiple individuals or companies own capital resources(like land, mines, etc.). These individuals bid in the capital goods market to ascertain the prices of these capital goods. But, in the socialist economy where there is just a single owner of capital resources. So there is no question of competitive bidding happening. The best that the planner could do would be to impute values to capital goods based on the price of the consumer goods that are made out of it. This imputation process is quite impossible. There are so many components that go into making a consumer good, and ascertaining the price of each component is not just impossible. The Capitalist economy on the other hand has decentralized ownership, which makes it possible for the economy to price individual components in the market place.

Enrico Barone on the other hand did not want any type of genuine pricing. His model for ascertaining prices basically assumes that the State has all knowledge that it wants to price commodities. The State needs to have the consumer preferences, the current technological capabilities of the economy, the amount of capital goods in the economy’s stock, etc, etc.. And when the State has all this required information, prices can be ascertained. Sure, it can be. If God helped us!

The other solutions

There have been other solutions to the problem. And mostof these solutions are just ways to sneak through a rational pricing system but with the same prejudice against private property rights. Some guys proposed that there would be competing branches of the government which would bid for capital resources, and thereby ascertain their prices. The disadvantage of such a system is obvious. There is no surety that the monopolies will be efficient, for they are appointed by their political masters. The State still owns the capital resources, the monopolies just bid. So the State can still make arbitrary allocations. There is no guarantee that the monopolies have all the knowledge of techniques that could be used to make products. In a Capitalist economy an entrepreneur who thinks he can do better than others does not have to petition the State to get to apply his ideas. Things would be quite pathetic in a Socialist State. And I can go on!

26

I have read the work. It is a better bet for beginners than Mises(it’s impossible for any beginner to comprehend Mises’ essay on the calculation problem), and it deals with other aspects of the Socialist economy, like interest rates for example. It is worth the read, definitely!

27

Which has what to do with private ownership of capital goods? Mises characterised the above as a form of mock ownership, at best guessing a resource’s worth with its owner’s wishes in mind, the owner being some monopoly such as the commune or the state with no threat of competition - any appraisal of opportunity costs &c. will be at a divergence from those which would obtain by an entrepreneur in a competitive free market with private ownership, and there is no external reference point any more to test one’s valuations against. Hence Mises’s characterisation of this process as arbitrary. The managers are made to play entrepreneurs, unlike a genuine market in which there are multiple competing owners of capital goods.

28

As far as I understand the calculation problem, it goes somehow like this:

Society’s knowledge is dispersed among millions of market participants. Since most of that knowledge is tacit knowledge, it is impossible to transfer it to one single entity, like a super computer or a central planning agency. In a free market economy, everyone is free to use his knowledge, in order to improve his situation and that of society. By means of market prices, the market participants can communicate which resources are scarce and which are abundant, so they can coordinate their actions. In a centrally planned economy, there is only one planning entity, which is allowed to allocate ressources. Hence, there is no communication and no market prices.

It is absolutely impossible for a central planning agency to get all the dispersed knowledge of society. Therefore, a centrally planned economy will always be poorer than a comparable free market economy.

29

Hello Jon,

Thank you for your well thought out response.

I understand that this process is only a “mock” of what would occur under private ownership and that there would be a divergence. Even though this is true it doesn’t answer why the market would be the better alternative or why the system must break down. The answer to why this might happen to socialism proper is pretty clear, however the answer to why the system of market socialism would break down, at least to me, is not so clear.

You stated that at best it is “guesses at” the worth of a resource. Well, maybe. The way I see it is like this: we have two producers of the same product and they both need the same resource, now at the current price the super computer in charge of the whole price list sees the stock of this particular resource dwindling and raises the price, the price is raised to the point where the resource is allocated to the producer whose future expectations of its particular yield are higher.

There’s no difference between the price given in this situation and the price given under a true market situation.

As I tried to reflect on earlier the difference arises because of how much freedom the producer is given with what his capital goods do. This can lead us to the conclusion that market socialism is at best an inferior “mock” of the market. For, If he must only produce one thing then this lack of private property indeed creates a Hayekian knowledge problem. Here the knowledge of a certain combination of capital goods is prevented from being conveyed through market prices because a potential competitor in one market cannot enter due to this action being forbidden by the state. Furthermore, If the manager must produce only one thing given a certain allocated amount of land then this creates a large spacial co-ordination problem that we can readily say the market solves better.

So to answer my own hypothetical allegation that the socialist planner might be able to open new industries or put more producers in a certain market in a superior way to the market, I can say that this is indeed impossible. Due to a lack of private property the knowledge and anticipation function of prices cannot exist, and that a presence of both is indeed the only optimal way of allocating goods at any one given point in time.

However here is another challenge the market socialist might pose: Suppose he says all land is rented, and producers are allowed to produce with their capital goods whatever they wish, the ultimate owner still being the state, exchange among current holders of goods still being forbidden, and the list of prices published by the super computer.

Now what can be seen in market socialism is a set of prices that DO take into account all possible combination of capital goods to produce all manner of consumer goods as well as the future expectations of producers (who are, as is conceded revenue maximizers) just like in a market with private ownership. The only difference here in terms of prices (not ownership rights, just the numbers produced by market socialism vs market prices), and what I think is a key difference and the difference that goes right down to the core of socialism is that there are no profits. There are no price differentials, there cannot be lets say a production expenditure of $40,000 and a revenue of $60,000 because in market socialism all that a producer earns he must spend. There must be a significant difference in terms of price formation between revenue maximizers and profit diminishers but its very hard for me to think about because I have difficulty understanding and imagining a world where all revenue must go into factors of production thus yeilding no spread between expenditure and revenue, I find it very difficult.

Now, don’t get me wrong, I know in my mind that socialism must fail but I cannot accurately describe how.

30

No, no, no, no, no! This is not true at all!

The quoted form of market socialism is very powerful, and very dangerous. I have explored its implications as has the author of the article physiocrat and I posted and the author certainly wasn’t able to provide any decisive blow instead calling for the debate to be continued and neither can I

31

Through a set of prices which aim at balancing supply and demand a central planner can obtain the dispersed knowledge in society in the exact same way the market does. The thing is, how much knowledge is embedded in prices is determined by the extent to which property rights exist. The knowledge problem is crucial and important but it is not impossible for a central planning agency to make a price system which reflects dispersed knowledge.

The question to be answered is given managers who act with perfect incentives, given full control over what they can and cannot with the factors of production given to them, given the fact that they must necessarily spend all their money on factors of production priced by a central list, and given that there are no profits and that they are instead assigned a salary by the state, how will prices in market socialism differ with prices in capitalism and which is better and why?

32

That is what they are.

Actually, there will definitely be a difference in price depending on the owner’s subjective valuation of the good and not merely whatever expectations they publish. The fact that the owner undergoes no real risk with the good and is playing with money given to them compounds this.

**

So no exchange is allowed of the goods and yet this is just like a market with private ownership, when it is one of the key processes in determing the prices of capital goods (or any good for that matter)?

33

Lange’s argument was false in light of the original calculation theory and subjective value. It’s very simple. The prices are only relevent because prices in a market reflect the values of the individuals generating them. The fake prices in market socialism are based on the imposed values of the dictator. Mises’ original argument was 100% correct and complete. The entire debate contributed nothing to knowledge.

The reason that commies don’t get it is because they don’t value anyone elses values. If they think that a picture is worth a thousand words, that is the objective worth of a picture, the opinions of others be damned. It’s a symptom of extreme anti-social pathology to not just disrespect the opinions of others, but to deny their existence, like a bible thumper denies the existence of homosexuality in wishful thinking.

34

Well the price in the case of the list IS determined by producer’s subjective valuation. That is, producers will buy capital goods till the price exceeds their reservation prices and these reservation prices are formed precisely by their valuations and their expectations. The list is just a means to facilitate this communication throughout market socialism. There is no real difference with how this works and how the market price system works. The difference comes from the fact that the producer’s valuations would be different if they had restrictions on what they could or could not do with the control of goods they bought from the state.

Well in the situation I described it would be very similar. Indeed, it can be best described as a market where profits are abolished yet people act with perfect revenue maximizing incentive.

Can revenues alone co-ordinate the market? What are the non incentive roles of profit? Is it even feasible that that no price differentials could ever exist? Could signals for competition arise in market socialism? If people are revenue maximizers why would any firm ever aim to price consumer goods anywhere other than a perceived midpoint of a demand curve?

I personally find it mind boggling thinking about this hypothetical world, which is to me the last bastion of socialism’s defense.

I think in answering these questions, I could understand how market socialism wouldn’t work. But simply saying the subjective appraisal of entrepreneurs does not determine prices in market socialism does not bring my understanding any closer to the truth, because this statement is false.

35

This painfully shows your lack of understanding even of the most basic concepts of economics. Mathematically speaking, there is an infinite number of efficient points on a PPF. Pragmatically speaking, there are still many efficient points on a PPF. The problem that a central planner encounters is choosing which efficient point on a PPF is the correct point to choose. Using the classic example of “guns vs. butter,” the central planner doesn’t know whether to produce 100 guns and 0 butter, 1000 butter and 0 guns, or some combination of the two (e.g. 60 guns and 575 butter). Prices and profit are the two determinants of market production that align production with consumer demand. The problem that central planners face here is that they may be able to receive the information of consumer prices, but they are blind when it comes to producer prices. Thus, profits virtually don’t exist in such a system. Go back to my original postulation of the economic calculation problem.

Your statement completely ignores the argument of the economic calculation debate. Consumer prices are of virtually no importance. What is important is the valuation of different inputs into consumer goods and into producer goods. Ultimately, since there is no market for producer or natural goods in any socialistic system, there cannot be a price system for these goods, which destroys the possibility of socialist calculation.

For example: There are two inputs, A and B, and each exist 100 in quantity. There are also two outputs (consumer goods), and consumer demand dictates that you produce each in an equal amount. Ultimately, you need 100 input into one output to produce at full capacity. It doesn’t matter which input. Now, as a central planner, how do you know whether to:

  1. Use 50 A and 50 B to produce Output 1 and 50 A and 50 B to produce Output 2?
  2. Use 60 A and 40 B to produce Output 1 and 40 A and 60 B to produce Output 2?
  3. etc.

The above combinations are, mathematically speaking, infinite in number. Pragmatically speaking, they would represent some measurable number, but still be incredibly large. Worse still, is that even if there were only a few combinations, a central planner would have no way of knowing which is more efficient. Worst of all is that there are many more inputs involved in the production of a single product and that there are literally thousands of inputs when you follow the line of production. A producer good that a producer uses to produce another producer good (mouthful, I know) could literally have hundreds of different combinations for production, and the good that producer good produces good also have many combination possibilities. No computer or human mind is able to even begin to comprehend the complexity of the problem.

The unfortunate aspect here is that the market isn’t “just one big equation solving device.” Believe it or not, humans do not mechanically react to economic situations using complex mathematical concepts. Mathematical concepts can sometimes be used to model human-like behavior, but it can never be used to predict human behavior. If it could, the market would have incorporated this innovation long ago.

The absurdity of the pro-socialist side in the economic calculation debate is that they are forced to argue in favor of setting up a socialist system that acts exactly like a capitalist system. So even if this were possible, why have socialism at all? Wouldn’t it be easier to leave capitalism in place?

36

Yes in some forms of socialism but in the form of market socialism being discussed they’re not imposed by anyone they’re subject to the purchases and production of capital goods’ users and makers respectively. They are, in almost the exact same way as under private property, appraised by the relevant market participants.

37

Firstly let me say I am in no ways pro socialist.

Secondly, market socialism allows money prices for consumer goods, the efficeint point that must be reached on the PPF is known. The reason just solving for PPFs doesn’t work isn’t cause its mathematically impossible it is in fact quite easy, the reason it doesn’t work is because it is just equilibrium theorizing, It leaves out the market process of entrepreneurial appraisal expectations knowledge of combination and the rest of it . Yes, I agree, this leaves the planners groping in the dark when it comes to producer’s goods. We are in 100% agreement here.

Thirdly thats not even what I’m talking about, I’m talking about prices done by trial and error b a super computer who tries to avoid shortages and surpluses.

I 100% agree here too, as I have discussed the more and more a socialist want sthe system to work the more and more it needs to become like a capitalist system. I have narrowed it down to allowing money prices in consumer goods and allowing producers full control of the property they buy from the state, however they are still not allowed profits and they are not allowed to trade with one another. They sell directly to the state and the state sells directly to other producers. I myself am not capable of narrowing it down further, I would love to be able to but I really do have trouble thinking about this sort of hypothetical world.

KrazyKaju, I was saying all along that you can’t view the market as a big equation solving device and that, yes, if you do view it this way then yes socialism must fail. I was saying Kirzner’s interpretation of Mises and Hayek completely demolished Lange in this case. I do not see why you had to antagonize me as if I was actually saying well the market just solves equations so market socialism works, I was just saying “look krazykaju you characterized the market as a big equation solving device and if it was well socialism would work so that was a bad example you used” I wasn’t saying the market actually is an equation solving device.

And you used the same bad example again when you said

Yes, every line curve or anything has infinite points, that doesn’t mean its hard to find what exact point gives an exact result. Really if you think its impossible you’re wrong, its possible, its just meaningless. The problem with socialist calculation isn’t that he can’t figure out trade offs as they’d exist in equilibrium its that these have no meaning.

Once again, I do not support socialism in anyway, I’m saying your example is precisely why people thought Lange won the debate because if it really were just solving the equations it IS possible. So don’t use that as the reason why socialism doesn’t work, it doesn’t work because equilbrium theorizing is meaningless.

Now I’m looking at an alternate version of market socialism where prices are formed by trial and error which is where socialism still hasn’t been fully dealt with.

38

Economic calculation has practically nothing to do with monopoly theory. The “economic calculation argument” takes the absurd premise that government can be efficient as truth and proceeds to show how socialism is impossible. Any attempt at a pure socialist system would decimate an economy to its core, as no price signals would exist for capital and natural resources. Such a system would collapse within itself as goods no longer would be able to be produced efficiently.

The basic argument is this: OK, it is possible for central planners to imitate the market for consumer goods by using a price system. The problem is that no such price system can be recreated in the market for goods used only by producers. To quote myself extensively here:

39

That is impossible and contradicting. Any intervention in the market necessarily changes prices as compared with no intervention. To deny this is to deny the very purpose of intervention, which is to alter distribution according to imposed values. Not imposing values would not be socialism at all. This argument has been addressed many times.

40

Imagine a machine, it has no will of its own, it just looks at the first, second, third and nth derivative of the depletion rate of some good and adjusts price accordingly.The depletion rate of the good is determined by how much of it exists and is being produced as well as the amount of the good purchased by producers at the given price.

This is basically a machine which gives a price that ensures the participants who value the goods the most get it which therefore fulfills the exact same co-coordinating role as the price given on the market.