More on Socialist Calculation

3 April 2007 at 2:07 pm Nicolai Foss 5 comments

| Nicolai Foss |

In an excellent book review of GC Archibald’s Information, Incentives and the Economics of Control, Tyler Cowen raised a number of neglected points concerning the socialist calculation debate. (The review is published in the apparently now closed Journal of International and Comparative Economics 5: 243-249 (1995) and unfortunately isn’t online).

Cowen argued out that the victors in the socialist calculation debate “… have shied away from the hard questions,” and that it is necessary to “push the boundaries of the calculation argument.” For example, what if a dictator who has read Mises instructed his managers to compete as in a regular market economy (i.e., not as in an Oskar Lange-economy), with the dictator being the residual claimant monitor? Would that work? It might not — but that would primarily be because of excessive monitoring costs.

Cowen also indirectly questions the Misesian emphasis on calculating prices. Experience shows that socialist managers systematically set prices too low (because they can gain from creating excess demand, while they cannot gain from setting the right prices). But this would seem to presuppose that socialist “managers are in fact very good at calculating the proper price.” In other words, there is really no “calculational chaos,” as predicted by Mises.

Entry filed under: - Foss -, Austrian Economics.

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5 Comments Add your own

1. Peter Klein | 3 April 2007 at 2:24 pm

I haven’t read Tyler’s review, but on the first point, does this hypothetical economy have a stock market? If so, then it sounds like a market economy with very high marginal tax rates. If not, then who or what supplies the capital to these managers? If the dictator owns all the capital, then he must decide how much capital to allocate to each manager. If he gives each one an arbitrary amount, then they cannot be competing “as in a regular market economy,” because real managers compete to attract investment dollars. If the dictator is supposed to allocate to each manager some “efficient” quantity of capital, then he needs market prices to compute these quantities, which means we’re back to the Misesian calculation problem, even abstracting from monitoring costs. Right?
2. srp | 3 April 2007 at 6:40 pm

On calculating prices, it isn’t hard to price low enough to get a queue. For example, zero prices would probably work nicely. I don’t see how that shows great pricing ability.

But that’s a partial equilibrium analysis of a general equilibrium problem anyway. If your inputs come to you through a production-quota rationing system, in which prices convey no information about scarcity, it is very hard to know whether your pricing decision is creating or destroying economic surplus (even assuming you had the incentive to care). And if your output is an intermediate one, then you are now trapped between two sets of non-informative prices.
3. Carl Marks | 7 April 2007 at 12:01 am

Just because firm managers were able to set price too low does not presuppose that they know the correct price, they may instead know only a crude range and attempted to far undershoot, which might explain why there was such a large overhang in old Mother Russia.
“calculational chaos” also may not have shown itself because Mises made assumptions that were very gracious towards to socialists. These other problems may just have screwed up the economy enough to hide the price issues.

On the idea of competing managers there are a number of issues. First, managers would need to be compensated for good work, which would introduce inequality. While entrepreneurship could arise through appointment by the dictator, he will not be able to determine which ones are correct, so it would be in his best interest to allow a number of competing ideas exist. These entrepreneurs would also need rewards for good work, adding to more inequality. But most importantly, the duplication that would need to exist would undermine one of the principle reasons to moving to a socialist economy in the first place. Not allowing entrepreneurs in order to avoid duplication will only destroy the growth mechanism.
4. Joseph Wang | 9 April 2007 at 1:51 pm

Q: For example, what if a dictator who has read Mises instructed his managers to compete as in a regular market economy (i.e., not as in an Oskar Lange-economy), with the dictator being the residual claimant monitor?

This isn’t a hypothetical question, since what the question describes is basically the Chinese economy. The basic problem in this situation is that in order to set up a “real market economy” you basically have to set up a legal framework which limits the power of the dictator to expropriate property and allows decisional authority to be decentralized, which again the Chinese economy has done. The benefit to the dictator is that by avoiding micromanagement, the dictator ends up for firmly in power because the economy basically works.

The reason I tend to be a fan of Austrian economics is that the socialist calculation problem explains nicely what was basically broken about the Chinese economy in 1975 and why it basically works today, and why Russian economic reform failed in the 1990’s.
5. Joseph Wang | 9 April 2007 at 1:58 pm

One of the lessons from Chinese economic reform is that corporate competition is Darwinian and not Lamarckian. It is not that the market magically encourages companies to be better, it doesn’t. If you have an inefficient company that is marginally profitable, it can sustain this indefinitely, and there is no particular market pressure to have a marginally profitable company improve if the managers don’t care.

What the market does do is to kill companies that are particularly badly run. When a company is badly run, it runs out of cash and dies. The beauty of this situation is that the market doesn’t care what the managers do. If you have managers that are sufficiently bad, they will run out of money and cease being managers, and the business will fold, and this is an automatic process.