April 20, 2013

A Realistic Look At The Economic Calculation Problem

A realistic look at the economic calculation problem.
By Neil Kiernan

The economic calculation problem is at the core of debate between free market advocates and socialists. And because a Resource Based Economy suggests distribution of resources to people absent a price tag we find ourselves not only being labeled socialists, but the same arguments being leveled at us that are leveled at socialists. So we have the economic calculation debate. At it's core is the question:

“Will we be able to efficiently distribute resources absent the price mechanism?”

First lets get some background on the positions of the Austrian/Free Market school of thought and then talk about how this relates to our own arguments on the subject.

So how does the price mechanism supposedly function insofar as distributing resources?

The idea behind the price mechanism is that in in the market resources will be given a value by the market. This value would be calculated based on the cost of production which includes resources expended and labor. And then finally consumer demand. The theory is that if a producer of a given product charges too much for that item then no one will buy it. Hence forcing the producer to lower the cost. Competitive forces also play a part here as rival producers of a given product will vie for dominance in the market by offering competitive prices.

So breaking this down into an analogy:

Bob produces widgets. Bob calculates a price based on the cost of the resources that were used in making his widgets, including how much he had to pay his employees at the widget factory. He of course wants to make a profit so he charges a price that is above and beyond the costs involved in production. If he gets too greedy then people instead may buy a rival product that has a lower price.

So Mises and the other Austrian economists basically contend that this is the most efficient way to distribute resources. And in fact is the only way that would actually work. Lets get into why.

From Wikipedia:

Ludwig von Mises argued in a famous 1920 article "Economic Calculation in the Socialist Commonwealth" that the pricing systems in socialist economies were necessarily deficient because if government owned or controlled the means of production, then no rational prices could be obtained for capital goods as they were merely internal transfers of goods in a socialist system and not "objects of exchange," unlike final goods. Therefore, they were unpriced and hence the system would be necessarily inefficient since the central planners would not know how to allocate the available resources efficiently. This led him to declare "...that rational economic activity is impossible in a socialist commonwealth."


“Without money to facilitate easy comparisons, socialism lacks any way to compare different goods and services. Decisions made will therefore be largely arbitrary and without sufficient knowledge, often on the whim of bureaucrats.”

But what about the inefficiencies in the price system? Just how good of a job does it actually do when it comes to efficiently distributing resources? Lets take a look.

Mises suggests that no rational prices can be reached without a price system. But are rational prices actually reached within a price system? No. The reason? The entire price engine is driven by the profit motive. And profit by no means depends on rationality.

First of all, lets talk about advertising. Advertising has evolved over the years into what amounts to outright brainwashing. They specialize in ensuring that consumers have irrational desires for products that they do not even need. Or are even harmful to them! The work of Edward Bernays in assisting the cigarette companies in their quest to give women the irrational desire to smoke is an example I have frequently brought up on V-RADIO. Documentaries such as “Psywar” and “Consuming kids” really dig deep into the very dark reality of advertising and it's ability to target our minds in a way that causes us to feel “needs” for objects that have no rational purpose.

One such industry is the fashion industry. A never ending cycle of convincing people that unless they wear certain clothing, (and more specifically are willing to pay a higher price for it) they are worth less as a human being. The $3,000 hand bags mentioned in “Zeitgeist: Moving Forward” are just one of many absurd fashions that resources are devoted to. A company named Louis Vuitton will also be happy to sell you a shoulder bag for $8,000. A pair of sneakers for $1,000. Or a belt for $3,000! The price mechanism has attached to it elements of social stratification. This brings us back to the reason that Air Jordan shoes that were purchased at Foot Locker were somehow more valuable then those purchased at K-Mart. Solely because the person could afford to pay the price. It was therefore more fashionable.

The fashion issue goes beyond clothing. Accessories. Cars. Houses. Etc. The entire system is designed to tell people that the higher price paid the better. But we are not talking about the higher price paid meaning the better the product. We are talking about an industry that convinces people that the higher price someone paid the more value someone has as a person! Psychological and Sociological research is done by advertising firms to plug their products into our self esteem, our attractiveness to the opposite sex. And our status within society. If your carrying a $8,000 shoulder bag then it means you are superior on a fundamental level to the person carrying a $30 shoulder bag.

The price system is subject to corruption in other ways. Planned obsolescence and perceived obsolescence of goods is also built into this system to ensure that people are forever in stores moving inventory. Products are made to break down or to not be easily fixable intentionally for the sake of profit. The price to fix a given product is set in such a way to artificially make it more expensive to simply repair an item then it is to buy an entirely new item. The price system creates the motivation to do all of this contradictory to the ecological and environmental impact of such wanton production. Because it is a system for an economy with profit as the motivator producers of given products are encouraged to find as many ways to cut corners as much possible when it comes to ecological safety of their products. Products are made without recycling in mind because a product that is easy to take apart to be recycled is in many cases easy to repair. This would allow the consumer to simply repair their products rather then buying new ones.

The price system because it is based solely on the whims of consumers also permits the production of goods completely irrespective of the long term effects of using up given resources. The consumer at the counter of a store does not consider, nor are they encouraged to consider the long term implications of their purchases. What will buying all these plastic products do to the environment? What if this useless junk I am purchasing has resources in it that will be required for mankind's survival? What impact will the fact that I purchase a new I-Pod every year have on my grand children? Or their children? None of this is taken into account in the price system.

Because you want to be able to offer your goods at the lowest possible prices the price system also encourages worker exploitation. Wal-Mart's goods made in sweat shop factories can be offered at a far lower price then products produced locally. And the profit motivated price system will only serve to perpetuate this. Outsourcing to more and more desperate economies where people are willing to accept a lifestyle no better then conventional slavery.

Another example of corruption of the price model is when businesses collude to sell a vital product at an ever increasing price. Take the oil industry. The oil companies formed a cartel to cooperate on what the price of gasoline should be. They agreed to compete by no more then a few cents at the pump. The benefit of this is that profits in all of the oil companies collectively went up to record heights. It was to the benefit of everyone in the cartel to see this happen. And because gasoline is not an optional commodity they were able to get away with it. It was not as if the consumers could simply choose not to drive to work.

A further proof of the price mechanism's failure is that outside of the stores that sell these products there are often homeless people lying on the street. People who could feed themselves for MONTHS if they had even a quarter of the money spent on a single item purchased at the prices above. When it comes to a system of allocating resources the billions of people starving on this planet are a testament to the absolute failure of the market system to give any option to these people. There is no mechanism in the market or the price system that will distribute resources to these people despite the fact that technologically we could provide for them.

When attacking any centrally planned system, the Austrian economists point to examples such as the various instances of mass starvation supposedly created by centrally planned economies. They point to death camps and gulags as the inevitable solutions of failed centrally planned economies. That when scarcity exists we will be forced to somehow depopulate. Of course they leave out that a great deal of these death tolls were created by fascist regimes trying to stay in power. But they go on to heap praise on the market system with it's price based economies with an absence of death camps and gulags. They leave out of course that even in the free markets there would still be huge pockets of poor and starving people. The “death camps” of the market system are places like Africa. Where hundreds of thousands of people starve every day. The price system has no place for people who cannot find ways to be useful to people who have more. Basically, suggesting that centrally planned economies lead to starvation ignores the blatantly obvious truth that the market system does the exact same thing. But far more insidious is that the entire time people are inclined to think it is a fair system that is leaving all these people to die. And even encourages people to think that it is somehow their fault for dying. If they just worked a bit harder or started their own business they would be fine. They sell everyone the pipe dream that they too can be rich and famous if they just apply themselves. And this delusion helps everyone agree to be part of a system where 1% of the population has 40% of the wealth. And where statistics are greatly against people who are not part of that 1% ever becoming part of it.

It's ironic that the same incident of the rules suddenly changing in the book “Animal Farm” that was supposed to be a story about communism applies just as well to people living in a capitalist system.

“All animals are equal. But some animals are MORE equal then others...”

Mises and his disciples stated that centrally planned economies fail due to the fact that the resources would be distributed according to the “whims” of bureaucrats. And that apparently instead we should allow resources to be distributed according to the “whims” of consumers. Consumers who's “whims” are being controlled by a profit motivated system. If we were talking about a world of infinite resources this might work. But as was demonstrated earlier, the “whims” of consumers in a profit motivated world are not by any means rational. And the fact that there is anyone anywhere who on a whim will buy an $8,000 shoulder bag while people are starving outside of the store they purchased it in is testament that the price mechanism is not efficient at all. And that “rational” prices are not being achieved. There is nothing rational about an $8,000 hand bag. Period.

So lets look at the obstacles that Mises and Hayek suggest we will never be able to overcome.

The knowledge problem: Will we be able to effectively get the information we need as far as the needs of our consumers within a society? Mises seems to think that this is an insurmountable problem. That we will never be able to get enough information to be able to make rational decisions about what to produce. This like many other Austrian theories is obviously way out of date. Information technology is vastly superior to anything that Mises would of even conceived of in the 1920's when he said this would be impossible.

The other notion that is presented by Hayek is that people would have no incentive to share information they have. Which simply does not make any sense. Obviously in a resource based economy the incentive is we want to eat. We want shelter, clothing, etc. So we share that information so that the system works.

Another argument against Austrian economists from Wikipedia:

“It has also been claimed that the contention that finding a true economic equilibrium is not just hard but impossible for a central planner applies equally well to a market system; As any Universal Turing Machine can do what any other Turing machine can, a system of dispersed calculators (i.e. a market) has no in principle advantage over one central calculator.

Austrian economists emphasise that a central planner cannot have access to all the necessary information (including local conditions, know-how and changing individual preferences) to feed into such a central calculator.”

As I have already illustrated earlier the price mechanism has many failures and is far too open to corruption. So they were never operating from any sort of superior system to begin with. As pointed out above there is no special advantage to mankind operating as a mob of people making economic decisions based on whims. And the claims that any centrally planned economy would fail due to lack of information is based on a completely out of date idea as far as what information any central planner would have access to. 
The idea that desires are infinite or irrational:

This concept basically works on the assumption that people's desires are infinite and are not trackable or understandable. And this assumption is flawed. The needs of human beings are in fact calculable. And in fact once all of the noise that has polluted the “desires” of mankind is gone, (advertising, fashion, etc.) deciding what to produce will be far easier. The reason it is hard to calculate now is because mankind has an inflated idea of what it “needs” that is based largely on the conditioning we are given through advertising from the earliest ages. This entire industry of convincing people to consume things they do not need will vastly change the amount of resources expended. I have already felt this myself as my own consumption habits have changed once I became aware of the vast propaganda machine that was put in place to make people believe that the act of consumption in of itself was an expression of freedom. I watch now as people chain themselves to debt for endless amounts of junk that is designed to be sure to fail as soon as it is paid off. My entire perspective changed on what I buy and why. There is no reason the rest of mankind will not experience this as well. 

So what is different between what we suggest and other “centrally planned” economies? 
Well first of all, all of those systems advocated force or coercion to achieve their goals. Every one of those systems were run by people who did not understand the environmental impact on human behavior. They relied on laws, prisons, etc. to deal with the inevitable problems that arise from circumstances of scarcity. 

Secondly, and more importantly the points that Mises and Hayek used to point to failings in those systems do not apply to ours. There are no “whims” being used to decide the allocation of resources. All of those systems were microcosmic attempts at human opinion based central planning. As pointed out previously it was at the “whims” of bureaucrats. And no such whims will exist in our system that is based on the scientific method. Every citizen of the society would be acutely aware of the state of resources on our planet and the implications of their consumption. 

Thirdly, the technology available to us is vastly superior to what was available at the time that any of these monetary thinkers were contemplating their limitations. 

Even without the modern technology we have today this was achievable. In early 1970 the government of Chile asked a British operations research scientist named Stafford Beer to develop a system for tracking information all over the country for the purposes of a computer controlled economy. The system was highly advanced for it's time and did work. It was called Project Cybersyn. When I was doing research on it I was not surprised to see that several conservative bloggers have made really bogus reports as to it's success. But without fail people who were actually involved in the project came forward and refuted the nonsense that was being portrayed. Chile had decided to nationalize it's copper production. In typical “economic hitman” fashion the United States didn't like that very much and eventually went out of it's way to cause problems for the socialist Chilean government. The following is from one of the accounts of someone involved in the project: 

“Across Chile, with secret support from the CIA, conservative small businessmen went on strike. Food and fuel supplies threatened to run out. Then the government realised that Cybersyn offered a way of outflanking the strikers. The telexes could be used to obtain intelligence about where scarcities were worst, and where people were still working who could alleviate them.(ref Andy Beckett/Guardian)
The interconnected telex machines, exchanging 2,000 messages a day, were a potent instrument, enabling the government to identify and organize alternative transportation resources that kept the economy moving.”

Because of project Cybersyn, the Chilean government was able to keep their economy running using a fraction of the resources previously demanded. And the strike that was an attempt to get rid of the president who had the audacity to think that Chilean copper should be used for the people of Chile failed. 

I am hoping to get someone who was involved in this project on V-RADIO at some point. But suffice it to say, with some ancient telex machines they were able to keep their economy moving. And that technology is dwarfed by the capabilities of our information technology now. More complex versions of Project Cybersyn's style of cybernetic management are already being used by blue chip corporations all over the world to maintain their own infrastructures. 

In conclusion, it is important to remember that the Austrian school of economics and the opinions of Ludwig Von Mises are not infallible. They represent limitations that are set by men who have limitations in their understanding of the capabilities of technology. Those limitations are inherent in mankind as technology always manages to exceed our expectations. The Wright brothers were making flying machines while the intellectuals of the day were being paid to write books about why man would never fly. It is important to understand when your dealing with people who are advocates of this school to remind yourself that the Austrian school of economics is a fringe philosophy. It is not embraced by the majority of economists and is in fact rejected as a mainstream school of economics because of the attitude in the philosophy of throwing one's hands up in the air and letting everything just play out what way it may. “It won't work because Mises said so!” is not an argument anymore then continuing to quote the physics experts who said man would never fly would be a viable argument today. Something to consider when people are quoting Mises as if they are quoting something empirical and infallible:

"‎Mises wrote of his economic methodology that "its statements and propositions are not derived from experience... They are not subject to verification or falsification on the ground of experience and facts."

So in other words. He made it up. This is why Austrian theory is rejected by the mainstream.  

During my presentation during the Agora conference I used the analogy of a space ship. When a space ship is going on a prolonged trip there is no free market economy set up on board to determine how the resources on board will be used. They are calculated by scientists on the ground before the vessel ever gets underway. Though mankind lives on a really big spaceship we call earth, the more our population grows and the more our technological capability to impact our environmental conditions the “smaller” the earth effectively gets. In a situation of limited resources allowing the “whims” of anyone to determine resource allocation would not only be dangerous. They would be suicidal. And the danger of anyone “owning” those resources exclusive to themselves with a profit motive as a factor would be obvious. Nobody should have such power. You wouldn't let anyone own all the oxygen on a space ship you were on. The oxygen should be considered the common heritage of everyone on board.

In the end I have noticed a trend while debating these topics. People don't want to consider that they might not be free to buy whatever their hearts desire. The market system and it's price mechanism allow people to continue to look at resources as something that will always be at the store waiting for them. They see people like us pointing out these limitations and they project that we would want to enforce some limitations on them. They fail to see that no matter how free they believe they are if there are only six ounces of a given resource left on the earth they don't have the right to take seven. Not because we are going to force anything on them. But because there are only six ounces left. And if great care is not taken in the use of those limited resources nobody will have access to them.

Then there is the very real issue of the "Golden Billion" effect. A theory  that points to the fact that the "Western world" is consuming resources at a rate that far exceeds the rest of the world. It is through imperialism that we have maintained this circumstance of a few privileged countries gaining all of the benefits of civilization while we loot resources out of any country that might wish to use it's own resources to better itself and the standard of living of the people in it. In an article called: "A clash of civilizations: A possibility?"  by David Bryan he describes this issue:

"Under the once popular “golden billion” theory, people living in the economically advanced European nations, Japan and the United States enjoy in full measure the fruits of civilization at the expense of their less lucky brethren sweating elsewhere in the world. These days this “golden billion”, is being increasingly diluted by a steadily widening influx of migrants coming in from the Third World which means that we are now talking about a considerably larger number of “privileged” ones whose comfortable existence the rest of the world may no longer be will to ensure. Which may also mean that we are in for a new redrawing of the global map say, by China, which is working so hard to get rich and is already setting its sights on global leadership."

The people you see who are addicted to the lifestyle that they have brainwashed themselves into believing is "fair" are trying desperately to ignore the fact that we cannot hold on to 40% of the world's resources in the hands of a small percentage of the population forever. And we can only keep that hold through imperialism masked as "Making the world safe for democracy..." There are not enough resources for everyone on the planet to live the wasteful lifestyle of the average American. World wars have always been the means by which these struggles for dominance have been waged. From the Roman empire to WWII. And with technology getting more and more dangerous we are now looking at destruction on a scale never seen before.

Mankind has to rise above this idea that fighting for the position of dominance in the world economy is acceptable. We need to rise above the idea that any one nation should be better off then the majority of nations. The reality is that the lifestyles that we enjoy in the 1st world are not due to the magic of the market system. The entire system is upheld through imperialism. And the rest of the world is not going to put up with that forever. The market system spreading to such a global scale would either A. set the stage for an apocalyptic WWIII or B. drag the standard of living of everyone on the planet down. The market system hinges on the idea of equal opportunity. And there quite simply is no equal opportunity for the entire world to live the wasteful selfish lifestyle we do in the west. The resources do not exist for this to happen. But a society designed using the scientific method to come to rational values, strategic access of goods, and an egalitarian approach can provide a great lifestyle for everyone. 

The price mechanism is no more based on rationality then a bureaucracy arbitrarily deciding how resources should be expended. And neither the whims of bureaucrats in a centrally planned economy nor the whims of consumers in a price mechanism profit motivated economy are sufficient for adequately deciding how resources should be allocated on a planet with finite resources. We don't as a species have the freedom to use resources irrespective of what impact it will have on the earth we all live on. And that is why we must use the scientific method for social concern if we are going to survive.

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