Impact of the Calculation Problem

Economics Economics Questions
1

I’ve been struggling with the calculation argument for a while. My understanding is that it asserts that without a rational pricing mechanism, rational economic calculation is impossible due to an inability to calculate profits and losses.

Devil’s advocate; “rational” market pricing is the result of consumer demand, and in doing so transmits information about consumers preferences for/between different goods. Now take the socialist counterargument that this kind of pricing is superfluous. We already know that consumers basically want food/housing/healthcare/entertainment etc. The needs of human beings are established and the information that prices transmit in the market are redundant. We already know that people are willing to pay more for a car than for oreos. Big whoop.

So, plan the economy. Just like sim-city. Presumably the state does not suffer any incentive problems from workers or administrators. The central planner has a vision for society; certain amounts of each type of good that must be produced per year, and a plan to get there (ex more capital investment).

We can admit that this kind of system suffers the hayekian knowledge problem, but turn around and claim 2 things. First, that even if we neglect some people’s esoteric preferences, this system is more utilitarian. Second, that the central planner could simply allow, say, 5% economic freedom for people to satisfy their hedonistic inclines.

So, in summary, why can real life not be run like a real time strategy game ala starcraft? Leaving aside incentive problems of course. The argument typically espoused by misesians here on the forums is that this knowledge problem is so crippling that you can’t move beyond very basic controlled economies. But we can all imagine that a state might say “half of you work to produce food, the rest will work in the service/manufacturing industry”. Pending a wise and benevolent central planner, this seems workable on paper.

Moreover, how does the calculation problem apply in mixed economies? Consider that if prices are set by a market and then government re-allocates resources in some other combination, won’t the inputs/outputs have a price associated with them making an evaluation of the rationality of that action possible?

Is this difference between businesses and a state that businesses have to pay for their inputs? The state overrides price-information when it confiscates wealth.

I have plenty of answers to what was written above. Instead of regurgitating my typical anti-state defenses, the purpose of this post is to try to develop and receive arguments with which I, and many of you, may not be familiar.

The first thing I would point out is that if a price-less infrastructure really were more efficient than one with prices, then businesses would adopt it. Virtually none have. Even non-profit corporations know if they’re losing money (they are called non profit because their profits go towards some cause. But they still have profits). We could imagine the angst of a business that didn’t know what labor/capital cost, or what the products would sell for.

The situation becomes a little different if there were only one business like this, responsible for all goods and services in the economy. It WOULD KNOW that food had to be produced for as little labor/capital as possible, etc.

Anyway, I hope this can be resolved for me. I default to the incentive problem in arguments very quickly. I feel it is very strong if run properly, but people seem to have this mental block about imagining that people in government aren’t selfless devoted public servants.

2

As you should. The incentive problem is merely the flip side of the pricing/calculation coin. Prices are necessary for calculating profit/loss which is the fundamental carrot/stick ingredient for building incentive schemes at every economic agent level.

Z.

3

But I think even socialists have claimed that their governments “profit”, but it is a different kind of profit. Not driven by market-prices, but instead by their own superhumanitarian standards.

4

Grant them the pure socialist man for the sake of argument. He is wise, strong, and eager to work for his fellow man.

Can the planner now engage in economic calculation in the socialist commonwealth?

5

Their governments can not “profit” without a profit/loss pricing mechanism delivering carrots/sticks incentive schemes all the way down to John Doe at the bottom puling the lever of some machine. John will not be pulling that lever well enough and/or long enough without a carrot/stick hanging over his own head. Replacing the carrot/stick of pricing with a police-man handing carrots/sticks to John is simply, at best, too costly and most likely impossible as that still doesn’t solve the problem of paying for another police-man to hand out carrots/sticks to the police-man, and so on ad infinitum.

Z.

6

I just quoted this in the other thread dealing with this, but it definitely fits with that picture DD5:

Epistemological Problems of Economics

7

For me, that’s such a fantastic assumption that I haven’t thought much about what would be possible if it were true. Have you?

Z.

8

But this is precisely the assumption that underlies the socialist calculation problem. It grants the opponents the impossible in order to show them that they still cannot get off the ground. This is why the calculation problem is so devastating. The problem is not the other side of the coin of the incentive problem.

9

It’s unclear to me of you disagree with anything I’m saying. Perhaps I misused the “other side of the coin”. To clarify, I meant that the incentive problem and the calculation problem are one and the same. I could be wrong but wouldn’t granting them the impossible (a human agent with a “socialist” incentive drive) also undermine the AE fundamentals (human action, praxeology, individualistic incentives, etc) upon which this devastating critique is built?

EDIT: Is there a critique showing that I couldn’t build an island “society” consisting of myself as a single central planner and 2 million wise, strong, and perfectly obedient (self-less) robots? This is an honest question.

Z.

10

You grant them the ideal socialist man to show them that they still can’t engage in any rational economic planning, despite having solved the incentive problem. Not that they can’t calculate because we grant them the ideal socialist man. So I don’t get the comparison that you are trying to make with AE.

If by incentive problem, you mean that people will not want to work and contribute more the bare minimum, then no, the calculation problem and the incentive problem are not one and the same.

The ideal socialist man is already a robot. The socialist calculation problem is the critique you are looking for.

11

Yes. Lets continue the calculation problem in the OP instead of talking about the incentive problem.

12

As I said previously:

“Prices are necessary for calculating profit/loss which is the fundamental carrot/stick ingredient for building incentive schemes at every economic agent level.”

No agent at any level of the economy (from John the mechanist, to the CEO) could afford to disregard the incentivising carrot/stick of profit/loss guiding their decisions/actions. That’s what I meant by saying that the incentive problem is the same as the calculation problem.

There was no comparison with AE. I was questioning the feasibility of: (1) granting a socialist robot nature to the fundamental economic (human) agent and (2) using AE and human action to critique the socialist calculation problem. I don’t think you can do (2) while doing (1), but I could be wrong.

I thought I understood the socialist calculation problem but I’ll go back and read about it again. Do you mind outlining a critique for my 2 million robot island “society” in a paragraph or so? And how would the critique change if it was myself with only 2 robots (instead of 2 million)?

Z.

13

I’m sorry if I diverted the thread from your OP. I won’t be pushing the incentive problem = calculation problem line any further here.

Z.

14

youre missing the other part of the picture,which is that pricing directs both consumption and production. production is coordinated with both consumer demand and the scarcity of resources. while it may seem relatively easy for socialists to make an educated guess at how many ppl to employ on farms, it gets trickier when you are trying to plan how much steel should be directed toward building tractors as opposed to building hospitals, trucks, and even the production of more steel. communist china and russia have historically shown how hard it is to actually direct the production of food(tens of millions dead from starvation does not look like anything close to success for me). the simplest economies(ones that provide for only the essentials) are not anywhere as simple as you many would like to imagine.

the price system not only directs production with the wants of the consumer, but directs consumption with the constraints of the producers.

15

Incentive problem: people wont work more unless theres more in it for them.

calc problem: something completely diferent, as we shall see soon.

2 million robots on an island: If you have to feed, clothe, and shelter them, the calc problem will exist.

OK, so what is the calc problem and how does it differ from sim city?

The calculation problem is that in a socialist society, by definition, one guy [or small group of guys] has a huge pile in front of him. In the pile is every last resource in his country. He has all the steel, gold, tin, lumber, everything. So he can do whatever he wants.

The robots come to him and say they are homeless. Ok so he has to build them houses. Does it make a difference to anyone if he makes the houses out of wood or brick or solid gold? Does anyone care? On the one hand, not really. After all a house is a house. On the other hand, every brick [or wood or whatever] that goes into the house cannot be used for something else. Tomorrow something may come up, something really important, that needs wood. And he used it all up building houses.

What about the workers? Should he have them all work by hand, or should he use some of the resources to build a tractor? Either way he’s “wasting” something. On the one hand, they are working at houses, when some of them could be working at something else. On the other hand, building the tractor means building a tractor factory, which uses up a lot of resources. Which is the least wasteful?

These are but two examples of literally millions that have to be made whenever you want to get something done. There are always many ways to do it, each one being a drain on a different part of the pile in front of him. How does he know which ones “gives him the most for his money”, meaning which way of using up the resources is the one that will leave him best off to tackle new needs as they arise?

Sure, any way he decides works for the given project at hand. The houses will get built wether he makes them of wood or of gold, wether the workers use their bare hands or tractors. But future projects will not get done if he made too many wrong choices and used his resources unwisely on earlier projects.

Now, if you toss a coin a million times in a row, what are the odds of it coming up all heads? Very tiny. Which is another way of saying that if he makes his decision at random, and he makes a lot of them, obviously a huge amount of them will be wrong. The society is throwing its resources into the river with every move they make. By which I mean they could have gotten the same product with more efficient use of resources, but they had no clue.

As time goes on, more decisions have to be made, more of them will be wrong, more resources wasted, and poverty is but a few years away.

How is this taken care of in a free market? Different people own different things. If I want to build houses for 2 million robots [or even for myself], I can’t just walk up and take all the wood I want. Other people want it too. And so I have to pay money for it. The price of the wood is an indication oof how badly other people want it, meaning how badly the wood is need for other projects besides the house I want to build. If bricks are cheaper than wood, it means other people don’t need the bricks as badly as they need the wood. So now the whole world knows that using bricks for the house is better than using wood, because now the wood can be used for other things that people want so much they will pay more for wood than for brick.

In other words, a lower price for something means it is not needed as badly by other people to make something else.

In a socialist society, there is no way of pricing the raw materials, beacuse there is no competition for them.

Obviously this whole thing, called the calcualtion problem, has nothing to do with the incentive problem. Even with the best intentions by everybody concerned, the calculation problem is insoluble.

One last note: The above is Mises’ version [as I understand it]. Hayek had a different version of the calculation problem, something I know nothing about.

16

I think this is on the right track, however the notion that price is determine by how much people want something compared to its scarcity is a little misleading. It is also affected by the purchasing power (productivity) of a particular consumer.

The new socialism that we now have to contend with is this sort of retarded pseudo market socialism where you redistribute wealth rather than actually confiscate means of production. In this system, the price would still depend on people’s wants, but not on their productivity, since productive members of society have their purchasing power dampened by taxation. Anyway, you still have prices reflecting “how badly” people want things and therefore serves as a guide to what stuff to produce. The system is simply structured around the normative view that human beings have an equal right to the good life.

Is this different from the calculation problem faced by centrally planned societies? What of the calculation argument applies to redistributive economics?

17

I think there is no calculation problem here, for the reason you mention in your 2nd paragraph.

There is of course a huge incentive problem. Why work or invest just to get it taxed away? And for poorer people, why work if I can get it for free?

There is the slavery problem. If a poor man gets his income from “redistribution”, there will be strings atttached. You must live your life like we want.

In New Zealand, for example, govt inspectors snoop around the homes of single mothers. They ask the neighbors how often a bf spends the night. If there is a man around “too often” the mommies lose their stipend.

Another problem is the shrinking of the common pie. Redistribution by definition means taking money from a productive person to give it to an unproductive person. Taking money from a productive person reduces his ability to be more productive. So there will be more and more lost production the longer this goes on.

18

Thats disappointing. But isn’t there an element of the calculation problem still at work? We noticed that prices were bid up by both consumer demand AND productivity of the consumer base. We admit that in a redistributive society consumer demand information will still be transmitted, but what are the consequences of not transmitting productivity information? Is it only on the incentive-side?

This is the same incentive problem, but told from the perspective of the administrators, who have no incentive to do much of anything properly.

This seems like a bit of a shame because no one really advocates a centrally planned society anymore. I think what is needed is another Austrian focus on the economic impossibility of redistributive economics. The calculation argument is so smashing that its a bit of a let down not to be able to apply something similar to modern socialist dogma.

19

That one is over my head.

All we have is Maggie Thatchers’ classic “Eventually you run out of other peoples’ money”.

A random unrelated thought: After seeing in real life the incredible choking bureaucracy of local govt here, I had an idea. We would all be better off if we could make a deal with them and and say “Close all your offices. We’ll pay your employees the same amount to stay at home and do nothing, or get second jobs. We’ll pay the same taxes. Just leave us alone.”

20

An immediate answer escapes me as well. At least we identified (what might be) a deep problem in economics.

If only…