Perhaps not integral to government by definition or design, but it’s hard to escape it once you look at how the state operates. Who will succeed in influencing government policy?
I will have to read this, but it seems to me that even vertically oriented businesses must still allocate resources based upon a calculation of profitiability, even in intermediate stages. The amount of labor invovled in each stage is one cost. And because ownership of such capital is subject to speculative value in use, exchange rates of stock imply exchange rates of capital goods. Where owners can make businesses more profitable by selling capital goods and outsourcing production stages, they will. Similarly, when owners can influence management to devise better means of using capital goods, they will. They will result in calculated profit, which still has a market beyond the single firm. Where capital value is based upon accounting practices, rather than choice of one private property vs. another, owners have the means to identify accounting values they believe are in error and to choose to exchange some private property for some other.
In the end, capital goods can be exchanged, even when owners want complete vertical integration of a firm. Owners still base choices on the calculation of profit. Where there is least total profit, there is more opportunity to come to own and thus control the firm, which can then result in different management of property.
Basically, the difference between the calculation problem in socialism and a vertically-integrated business is that socialists can’t change the owners of capital goods. Without choice of ownership, there never occurs the calculation of whether one is better off with A or B good and the establishment of exchange ratios, only a management question of how to arrange them. But the arrangement cannot be determined because “profit” is shared throughout society, thus the system must be calculated as a whole, with every individual’s satisfaction a constitute part. This public profit calculation is simply impossible. Management is not tied to ownership, thus private profit calculation is impossible. A large firm, however, faces choice over private property. It can either function as is, rearrange the use of goods, or buy/sell them. The owners and managers must calculate their own private profit for the organized use of the property. In the end, the owners, the managers, and the laborers can all calculate private profit, and have means to determine if such use of some property is the most profitable. Where it is not, they have the choice to acquire or create their own capital, and this is calculable.
I guess I think of it like this: if there are two firms sell the same product that are completely vertically integrated, one will likely succeed and the other fail, because of the management of its capital. Profitability can be calculated - owners can see they are better off owning one version of capital arrangement as opposed to another. Owners can also choose how to arrange their property, and calculate if it is more profitable.
Yes, calculation can take place at both ends. But the difficulty is what goes on in between. Labor moves from one project to another, when dealing entirely with intermediate goods, by the order of the manager. The manager has a goal - minimize cost of inputs and maximize profitability of outputs. It is possible to picture a central planner having these same goals, but that doesn’t imply that the central planner is able to accomplish them.
Within the firm, raw materials are processed into, say, A1, A2, and A3. Those are then, in various combinations, processed into B1, B2, B3, and B4, which are then, again in various combinations, processed into C1 and C2, the finished products. How do we determine the relative proportions of As to make, and the relative proportions of Bs? Well, to meet certain output quotas. The output quotas, in an element of saving grace, are themselves determined on the market, as are the prices of raw materials - that’s the difference between a firm and a socialist planner. The output quotas make sense. But just being given output quotas doesn’t help us differentiate between various ways of getting there - if a C1 can be made from either an A1, an A2, and a B1, or a B2, a B3, and an A3, which way should we make it? If one way is more labor intensive, does that matter? If each product were being made separately, by a different firm, then the firm making C1 would look at the relative prices on the market to figure it out. But within a firm, there are no prices. There are costs, but costs exist in socialism too, so they clearly aren’t stand-ins for prices. Sometimes there are things displayed called prices - as is done with Walmart - but those are “play-market” prices, as Mises called them. Just because one workshop “buys” from the other workshop, using common “company money,” and does so according to a list of things called “prices” doesn’t make it a market when no other producers are competing for those items. The prices reflect some chart management made up, based on costs and perhaps some referenence to the real markets for similar goods. This was tried in some communist countries too.
So in the end, the method chosen has to do with the tastes and desires of management. This doesn’t help us any more than the tastes and desires of central planners help us. The only people who might be able to figure this out are both marginalized in the decision-making process, being subject to orders, and negatively incentivized anyway. The workers think “making decisions isn’t my job” and anyway, their desire is to do the minimum necessary to not be fired or, if bonuses are available, to do the minimum necessary for the highest attainable bonus - not to ensure the profitability of the firm, which half the time they don’t like anyway.
That is simply wrong. The fact that there is only one supplier of the intermediate good does not imply that there is no market price. It implies that this single supplier is in fact the most efficient supplier of the intermediate good, and that vertical integration is efficient, because no one else chooses to supply the good at a price lower than the cost incurred by the corporation to supply itself.
Stay away from Carson man.
I don’t think this is exactly true…at least not in all cases. The worker is motivated in several manners. He may value a company career, choosing to increase productivity to be noticed and increase pay. He may own shares in the company, personally profiting from enhancing production processes.
On the other hand, he may find that private enterprise in the mismanaged area of the corporation that he has knowledge about would be more profitable than buying stock in and improving the corporation. And as you mentioned, he may simply work hard enough to meet management satisfaction, not true production potential.
I think the ultimate point is that corporate assets ARE private property, subject to owner choice of exchange. If we ignore that owners and stock values can change, our vertically-complete firm appears to be no different than socialism. Yet…new production processes and capital goods can arise outside the firm, and the firm can exchange with such to acquire such goods, either by buying direct or merging ownership. At any given time, some corporate asset has a true market value, because it CAN be bought and sold by exclusive parties. The “play prices” are what-ifs that can’t actually occur and thus can’t be accurate. The real prices work because someone’s consumption and happiness is ultimately effected. If corporate ownership chooses to retain or implement a vertical production structure, it does so not as a failure of the calculation problem, but in that it calculates less profit to sell its capital goods or buy intermediate products than to produce them itself. When property management is inefficient, for owners it is either more profitable to sell or rearrange some capital, or to sell the stock to all the capital.
Ultimately, a true vertical producer would also own the raw materials. In the extreme case, they also own the laborers. Still, there is a market price for more than just the entire bundle and its arrangement. In that its capital goods are private property that CAN be exchanged, proposed exchange rates are calculated on future anticipated private profit, not knowledge of past prices. Profit can be calculated against true market alternatives, not simply simulations that are incapable of calculating value in the real world. And ownership is a choice, determinably made to be profitable.
The only situation I could see where the calculation problem might set in is where all the intermediate goods are only useful to produce that firm’s product, which only that firm makes. Thus, the goods are only valuable inside the firm, and through common ownership, no market values can appear. Yet even in this scenario, laborers may notice inefficiency in property management and thus develop actual market demand for their ownership of the capital, outside the firm.
While I don’t think the calculation problem itself is the issue, mismanagement and inefficiency can set in. As pointed out, where mismanagement is a profit-reducing problem, entrepreneurs will be swift to finance alternative production methods and uses of capital, and current capital owners will be swift to sell such capital goods and outsource the production of intermediate goods for less. Similarly, if consolidation promotes profit, you’ll get a large firm. Whether or not these things are distorted by government or not is not the ultimate point, unless government interferes with the ability to competitively own and profit from capital goods. Such ownership (or potential real ownership) allows economic calculation of profit.
We went over this claim and my response yesterday, I see no point in repeating the conversation.
There wouldn’t be, it being wrong.
For the millionth time: we don’t have a free market. Let’s repeat that: we don’t have a free market. So stop assuming that current conditions are somehow “proof” that the buisinesses and groups in question are efficent. This is a misuse of free market theory. Stop being an apologist for what we have now.
There’s a reason for this you know: we don’t have a free market. There are massive barriers for people to do so. Stop ignoring them.
I think you two are probably arguing two different things. Do you each know exactly what you are arguing? Do you know what the other is arguing? I think this whole question posed a lot of hypotheticals.
And we shouldn’t be concerned with whether or not we have a free market. If we are talking about in-practice, real-world cases, we must identify what restrictions of the free market would create the calculation problem. Obviously, public ownership of capital goods would. Regulatory barriers to entry may create it in some situations, at some times, but this doesn’t seem so convincing. Couldn’t a large corporation also supply capital goods to the market, rather than use them in vertical integration? Thus, you may have one corporation vertically integrated and another who simply sells the capital goods that the first corporation uses.
It seems such an argument rests on some capital goods having small markets, best provided by small businesses, subject to barriers of entry. (Even in this case, couldn’t we argue this simply raises the market price, rather than eliminates it? At some point, profit margins would overcome barriers to entry, if means of production become horribly inefficient in the vertical producer.) Again, this seems to be an efficiency problem, not an inability to calculate.
And why can’t many efficient producers cartelize or merge to avoid barriers to entry?
The point that the market is not free is important in responding to a claim that “well, big business must work, since we have them.” If instead we have an unfree market that favors big business, this no longer looks like a good point. I’m not claiming persay that regulatory barriers to entry create the calculation problem. Instead, I’d claim that the barriers cause big vertically integrated business, and that these suffer from calculation problems. I’m not sure I see what your last question is asking. Are you asking if we can have a large, non-vertically integrated corporation? I’d say yes, but I’m still not convinced that the market would develop them. Historically, I cannot think of a big business which did not rest on government privileges. Can you think of one?
The best way to answer questions about predicting what a free market would do is to have one and see. However, I don’t think that works if we keep all sorts of arrangements inherited from the unfree market. Suppose society consisted of 100 people, and each of these lived on homesteaded land. The economy developed, etc. etc., but in the meantime, the state took all the property and gave it to 2 people, making the rest into renters. Then the libertarians come to power and dissassemble the state, but the property arrangement is left as it was. Can we really call the result a free world?
I don’t know what you’re saying here. Can you rephrase?
How does cartelization avoid barriers to entry?
Sure, JAlanKatz.
My first point was simply this: can lack of smaller competition create the calculation problem? It seems that while the calculation problem becomes more notable with greater size and greater orders of production, it’s existence is based upon the inability to calculate profit, due to the inability to calculate market prices for capital goods, at each production stage. Does lack of smaller competitors producing intermediate goods create the problem? It seems to me that there are still ways to determine market prices and profitability, without drifting into the “play prices” that socialist planners use.
As far as big business, I don’t think Standard Oil rested on government; in fact, that worked the other way around. Same with James J. Hill’s Great Northern Railway. The latter was a case where vertical integration was used when there was no prior established market for such goods in certain territories. If there were no nearby steel plants, new ones were built next to the rail line, by the rail company. And depending upon your view of intellectual property rights, many modern software corporations are big business without government privileges. I would agree that in the majority of cases, however, big business is the byproduct of government policies.
Obviously, there is injustice that must be corrected before we can simply say, “ok, free market activity only, starting…now!” but we’re also going to have to arbitrarily limit such. I said recently in a different post - how do we recover the trillions and trillions taxed away from producers? It is unfortunate but justice from the past is simply impossible. We should be more focused on establishing a free market than correcting prior injustice. I think this is similar to the black community’s plight with slavery. Are they better off spending tons of money and time attempting to use the legal system to give them a financial leg up from the heirs of slaveowners, or could they more quickly earn it in what is now a much more open market for them?
For my second point, I was saying this: if there are barriers to entry for smaller competitors, does this mean that market prices for intermediate goods cannot be calculated, or simply that such market prices will be elevated, due to costs imposed by government. In other words, because barriers of entry are essentially cost barriers, at some point a smaller competitor can still make a profit producing intermediate goods. If these cost barriers can be calculated, can’t the proposed market prices reflect this? If some small entrepreneur offers to buy an intermediate good from the large corporation at $50, the corporation knows that such a price undervalues its productive worth to the corporation, since the smaller producer must buy input lower and sell output higher than the corporation does to make the same profit, due to his higher cost per unit output stemming from larger government imposed costs. So if the corporation calculates the cost barrier as $10 per unit, it can use a market price of $60, rather than the offered price of $50, for that intermediate good. In other words, small producers can and will exist; they simply need a larger profit margin when excluding government-imposed costs in relation to larger producers. If smaller producers don’t exist, it means that the larger businesses are more efficient, after weighing government costs.
Now, the corporation’s perceived “market prices” may not be accurate, but market prices are what they are - they aren’t perfect valuations of something. Market distortions will certainly lead to prices that are not accurate to a free market or to some other scale of value. What I am curious is to whether this would be more similar to Hayek’s interpretation of the calculation problem, which he said didn’t even exist. He simply believed the system relied too much on either trial and error or on computing endless amounts of differential equations, and thus inefficiency. Perhaps large vertical producer suffer similar problems, especially when there is a lack of a market in the intermediate goods they use.
Mises believed it was simply impossible - he believed there was no means to know whether one arrangement of production was more efficient than another. There were no equations to be solved - doing such would be meaningless. Part of the reason that socialism could exist at all (as I believe Mises and Rothbard argued), was that socialism wasn’t universal - market prices from capitalist systems were used in calculation of profit for socialist system. Where socialism tried to create their own prices, they were called “play prices” - rather than being based upon personal profit, they were based upon pure guesswork and prior knowledge. They didn’t use Mises’s view of market prices, which aren’t simply based upon prior prices, but are based upon expectations of private profit, based upon expectations of supply and demand.
I think there are two different takes on the calc problem that are confusing us (it is definitely confusing me).
One is that without actual exchange and/or existence of competition (and thus market prices) in intermediate goods, a calculation problem will occur inside a vertical producer.
The other is that the calc problem is caused by the inability of market prices to occur, due to the inability of private ownership. Even without actual exchange or competitive production, a producer can still assign a market value to an intermediate good because the owner can still generate supply and demand curves. In this case, the calculation itself can be wrong, and depending how wrong it is will be reflected in how many competitors eventually come into existence and become successful. But corporate failure to trade doesn’t mean market prices don’t exist, only that they calculate more profit in their vertical structure than trading and buying their intermediate goods.
Cartelization probably wouldn’t avoid the cost barriers, unless such was done illegally. For example, sales revenue could be shifted to the business whose state laws imposed the least taxes, with sales in other territories among the cartel’s members being highly discounted. Actually, I’m not sure if that’s illegal.
Many small businesses merging into a single corporation to avoid the cost barriers would legally work. The question is whether they would now suffer the calculation problem or not. …and now my head is starting to hurt… [:|]
Well, how do you do it? Better yet, don’t tell me - work with me to bring about a free market, then show me that you can build a large, vertically-integrated firm successfully and make a profit.
But leaving the lands in the hands of those it was given to, and not the hands of the rightful owners, would be more analogous to leaving the slaves as slaves, not to competing in the marketplace. The land really is owned illegitimately in large parcels.
That’s a liberal myth. Standard Oil could only succeed because government was willing to build roads and subsidize railroads; railroads received subsidies and were given seized land around their tracks. They were not forced to compete in the marketplace, they were given absurd incentives - pay by the mile, encouraging odd track formations? My view of IP is that modern software corporations are not big business without government privileges.
But the small producer is buying the intermediate goods knowing that he will bring a small quantity of the finished good to market alongside tremendous quantities from the big business. Why would he do that?
Well, yes, Hayek said that, but I’m a Misesian.
Consider that the way prices are actually made in a vertically-integrated firm today is cost+markup, and that managers receive bonuses on the dollar amounts of accounting profits in their departments. So a manager can enlarge his bonus by increasing costs, since he is guaranteed sales. Does this sound more like Misesian play prices, or the way things work in a real market?
What we have in a real company is managers who profit from changing artificial prices, who order around workers who understand the process of production better than they can, and who don’t own the actual materials and don’t internalize actual costs. What does this sound similar to?
If market prices reflect government-imposed costs, we seem to have a different problem → profit at each stage of production can be calculated, however, it is calculated incorrectly according to actual productivity. Isn’t this nearly ALL of Mises’s arguments against government intervention? The calculation problem seems to be highlighted not by miscalculation, but by missing the tools to calculate. No matter how inefficient some global socialist scheme is, so long as there is no black market in capital goods, there is no method for the planners to discover and correct inefficiency. Rather, if a vertical producer becomes inefficient enough, alternate ownership, production, and markets will develop in that producer’s intermediate goods.
This seems to mean the problem exists in corporatist or socialist systems, or those that mix those two, where ownership and production (and thus private profit) are strictly limited. I think barriers to entry do not qualify, unless they are so extreme as to exclude all other owners/producers.
I will get to the rest but wanted to give a quick response here. This is always what i tell liberals who bad mouth Standard Oil - public subsidies and land seizures created a monopolistic railroad system that restricted supply, thus when demand expanded via Standard’s exclusive contracts, new railroads couldn’t find the same privileges, couldn’t compete, and couldn’t supply alternate transportation to fight Standard. But I believe you are wrong about The Great Northern Railway - James J. Hill did it with private money and privately bought land. He purposefully set out to make the straightest, longest-lasting, most efficient railway. He arguably did, only after which government ran him out of business by trying to fix his rates. And government only came into the ICC rate fixing business because of the non-competition they created through the subsidies and land seizures. I am not sure Google exists as such due to government, and they even supply their own power (not sure about 100%). The only way I can see Google using government policies (besides human resources BS) is benefitting from the inflationary money system and receiving more capital than they otherwise would have.
I think this question may be answered by Coase’s Theorum.
http://en.wikipedia.org/wiki/Coase_theorem
Roughly summarized, a firm will grow until the internal transaction costs outweigh the benefits from scale.
(As an aside, I think that Coase also determined that the early Lighthouses in England were not funded by Government, but by local shippers. Lighthouses had previously been frequently used as an example of market failure and a reason for Government intervention. In spite of this, Paul Samuelson continued to have the Lighthouse reason for Governemnt intervention in his textbook, even into the very late editions.)
I will agree that a free market would be unlikely to have a vertical firm. One reason for this is that transaction costs should become much lower, making them closer to the costs to the company of designing a new stage of production. Another is, as pointed out, more competition, in varying sizes, should exist. However, this doesn’t imply that a vertical firm’s problem is the calculation problem. Even in a free market, there is nothing preventing some mastermind owner from hiring managers and using accounting practices that would result in a more efficient production process at each stage than all other producers. Likely, no. Possible, yes. I am not such a mastermind, so I can’t tell you exactly how; but I imagine such would have to hire managers who were somewhat autonomous but still required his direction (perpetual scarce knowledge), such that these combinations allowed better efficiency than if the managers were left on their own, in their own businesses. Additionally, for each stage of production, the profit a manager would see in his own less efficient business would be less than his salary in the vertical firm. Again, this requires a genius owner (or group of owners), who is (are) unrivaled in the market, and is thus highly unlikely.
I was not saying let injustice lie where it may. I am simply saying some situtations imply that complete justice is impossible → you can only undo so much injustice. For instance, if I decide to cut down a burning tree and it falls on your 56 room mansion, completely destroying it, you are screwed, because I do not have the economic ability to produce you a new mansion, directly or indirectly. In other cases, it may cost more to enact justice than to simply relieve debt. For example, in the above case, you could take me as your slave, spending time whipping me to rebuild that mansion brick by brick; but you’d be better off using your time to earn money, which would get you a new mansion quicker. Injustice is a sad fact of life. My point is that we should accept some reasonable degree of it. If we simply attempt to reverse, in detail, the past practices of government, we will find and endless road of controversy, preventing us from establishing a system of much less injustice quicker (a free market defended by market “government” services), which would lead to less overall injustice down the road. In the example I use, this would be akin to beating me for a few days, then garnishing a small enough portion of my wages to allow me to survive for the rest of my life. You won’t get everything you are owed, but you are still better off than if you tried (in vain) to exact perfect justice.
In the case where the smaller producer chooses to produce, he does so because he calculates profit in doing so. It doesn’t matter how much of whatever he produces in relation to some other producer. If he is relatively less profitable in doing so, the more efficient producer will likely be able to expand production faster and reduce greater costs through capital investment, reducing prices, which will make the smaller producer less and less profitable, until he has no reason to continue business.
I’m a Misean too. I simply mentioned all that to demonstrate how seemingly subtle variations in the core of underlying theories can make for drastic differences down the road.
Such a price structure (cost + markup) sounds like “play prices,” incapable of generating true profit calculation. Obviously, allowing such practices to go on for long periods of time in a free enterprise system will result in competitors out-competing this business.
This is the fundamental question - is the calculation problem embedded in vertical producers? I don’t think so, although it can occur. Rather, in socialism, it is embedded. It is permanent. No matter what the choice or method to get around it, a socialist system cannot get around it.
If a vertical producer chooses “play prices”, independent producers will eventually replace it. Yet, it doesn’t have to. If independent producers already exist, market prices do also, which allows vertical producers to use them in place of “play prices”. The vertical producer does not have to trade with the rest of the market to use the prices. If the vertical producer uses the market prices to calculate profit and finds it is better off out-sourcing, it still may choose not to. This may be due to transactional costs that don’t exist in their vertical arrangement, or simply stubbornness. On the other hand, it may find that it is the most efficient producer of all those intermediate goods. (Unlikely, but possible) Anyway, it avoids the problem in these scenarios.
If there is no market for such goods outside this single producer, then you will have the calculation problem…but only until the problem renders the company inefficient to the point where some (or many) stage(s) of its production must be out-sourced. In a regulated market, with high transactional costs or barriers to entry, it may require a large difference in efficiency between an out-sourced producer and the internal production stage before it is actually more profitable to out-source. But as soon as market prices develop between multiple owners, the problem disappears for that stage of production. Accounting costs can again reflect market prices, and profit at those stages can be calculated, which may reveal a new production structure that can avoid out-sourcing. In these cases, the problem is only temporary.
I think we’ll agree on the main points though. Monopoly vertical producers (no other provider/buyer of intermediate goods) can suffer from the calculation problem, or may face unprofitably high costs to avoid it (such as putting its intermediate goods up at auction, then refusing to sell, incurring legal costs). It is highly unlikely such producers would exist in a free market. I think relatively few non-monopoly vertical producers would exist as well. There would likely be an efficiency problem, as barriers to entry and transactional costs are lessened, allowing more efficient organizations to exist and profit, which would happen as greater profit to workers, managers, and owners who specialize and know the most about some production process could not be stopped.
Here is an interesting quote from the wikipedia page on Coase Theorem:
“A way of stating the Coase’s theorem is: “there must be a balance between the costs of the transactions that a company must pay and the opportunity to make everything in house”. This is one of the reasons why, in the past, companies used to grow more and more: it was better to make something in house since the cost of the transaction to buy it was high. In the internet era, Coase’s theorem became even more up to date, but under a slightly different version. The concept is the same, but the way of reading it is the opposite. We could say: “the size of a company will decrease until the cost of doing something inside the company will be lower than doing it outside”. In other words, since in the internet era the cost of the transactions became very small, as a consequence, the size of the companies is decreasing. An example of this phenomenon is the increasing pace of the outsourcing and off-shoring businesses.”
Well, now that we’ve gotten away from the misapplied calculation problem, this gives us a starting point to what was really on people’s minds, the size of corporations. Does the state increase or reduce transaction costs?
It isn’t a misapplied calculation problem to apply it to institutions as such. To only selectively apply the analysis to certain institutions and not others would be a misapplication. An organizational and informational theory applies to all organizations and all cases involving information. This isn’t a misapplication, it’s an expansion or extension upon the calculation problem.
The state’s policies quite blatantly enable economies of scale and externalizes such costs. So yes.
The worldview that state intervention is fundamentally anti-buisiness is bollocks and is accepted from different angles by both the political left and right.
Over the last decade it is clear that the Internet has reduced transaction costs, cutting out the middle man (disintermediation, was the rather ugly term used back then). But, what we have also seen is a huge increase in state interference in everyday life over the last 10 years, outweighing much of this benefit. Hence, the continuing dominance of large companies today.