Economic Calculation Problem
An argument about the impossibility of economic planning has been going around since the 1920’s called the Calculation Problem.
"The economic calculation problem is a criticism of using economic planning as a substitute for market-based allocation of the factors of production. It was first proposed by Ludwig von Mises in his 1920 article "Economic Calculation in the Socialist Commonwealth" and later expanded upon by Friedrich Hayek. In his first article, Mises describes the nature of the price system under capitalism and describes how individual subjective values are translated into the objective information necessary for rational allocation of resources in society."
In the P2P and commons transition context, the issue is the following:
- capitalist pricing is very flawed and often miscalculates, but the autonomy of the firms allows a lot of flexibility to coordinate the economy
- central planning only worked well (and at a costly human price), in the early moments of economic modernization and stalls in the informational stage
- democratic central planning, like proposed by Parecon, seems eminently unworkable
- therefore, the P2P proposal, which maintains the autonomy of the firm, but transforms them into commons-oriented entrepreneurial coalitions which 'internalize' the costs that capitalism externalizes, make a lot of sense, allowing maximum coordination through Stigmergy, both at the level of the work done by the open contributory systems, and at the level of the cooperative firms.
1. From the Wikipedia:
"The economic calculation problem is a criticism of using economic planning as a substitute for market-based allocation of the factors of production. It was first proposed by Ludwig von Mises in his 1920 article "Economic Calculation in the Socialist Commonwealth" and later expanded upon by Friedrich Hayek. In his first article, Mises describes the nature of the price system under capitalism and describes how individual subjective values are translated into the objective information necessary for rational allocation of resources in society.
In market exchanges, prices reflect the supply and demand of resources, labor and products. In his first article, Mises focused his criticism on the inevitable deficiencies of the socialisation of capital goods, but Mises later went on to elaborate on various different forms of socialism in his book, Socialism. Mises and Hayek argued that economic calculation is only possible by information provided through market prices, and that bureaucratic or technocratic methods of allocation lack methods to rationally allocate resources. The debate raged in the 1920s and 1930s, and that specific period of the debate has come to be known by economic historians as The Socialist Calculation Debate. Mises' initial criticism received multiple reactions and led to the conception of trial-and-error market socialism, most notably the Lange–Lerner theorem.
Mises argued in "Economic Calculation in the Socialist Commonwealth" that the pricing systems in socialist economies were necessarily deficient because if a public entity owned all the means of production, no rational prices could be obtained for capital goods as they were merely internal transfers of goods and not "objects of exchange," unlike final goods. Therefore, they were unpriced and hence the system would be necessarily irrational, as the central planners would not know how to allocate the available resources efficiently. He wrote "...that rational economic activity is impossible in a socialist commonwealth." Mises developed his critique of socialism more completely in his 1922 book Socialism, an Economic and Sociological Analysis, arguing that the market price system is an expression of praxeology and can not be replicated by any form of bureaucracy.
However, it is important to note that central planning has been criticized by socialists who advocated decentralized mechanisms of economic coordination, including mutualist Pierre-Joseph Proudhon, marxist Leon Trotsky and anarcho- communist Peter Kropotkin before the Austrian school critique. Central planning was later criticized by socialist economists such as Janos Kornai and Alec Nove. In particular, Trotsky argued that central planners would not be able to respond effectively to local changes in the economy because they operate without meaningful input and participation by the millions of economic actors in the economy, and would therefore be an ineffective mechanism for coordinating economic activity." (http://en.wikipedia.org/wiki/Economic_calculation_problem)
2. Seth Ackerman:
"Resources can be combined in an almost infinite number of possible permutations; some might satisfy society’s material needs and desires fairly well, while others would be disastrous, involving huge quantities of unwanted production and lots of desirable things going unmade. In theory, any degree of success is possible.
This is the problem of economic calculation. In a market economy, prices perform this function. And the reason prices can work is that they convey systematic information concerning how much of one thing people are willing to give up to get another thing, under a given set of circumstances. Only by requiring people to give up one thing to get another, in some ratio, can quantitative information be generated about how much, in relative terms, people value those things. And only by knowing how much relative value people place on millions of different things can producers embedded in this vast network make rational decisions about what their minute contribution to the overall system ought to be.
None of this means that calculation can be accomplished through prices alone, or that the prices generated in a market are somehow ideal or optimal. But there is no way a decentralized system could continually generate and broadcast so much quantitative information without the use of prices in some form. Of course, we don’t have to have a decentralized system. We could have a centrally planned economy, in which all or most of society’s production decisions are delegated to professional planners with computers. Their task would be extremely complex and their performance uncertain. But at least such a system would provide some method for economic calculation: the planners would try to gather all the necessary information into their central department and then figure out what everyone needs to do."
Five Conditions for Top-Down Central Planning to Work
From the Wikipedia:
"Since capital goods and labor are highly heterogeneous (i.e. they have different characteristics that pertain to physical productivity), economic calculation requires a common basis for comparison for all forms of capital and labour.
As a means of exchange, money enables buyers to compare the costs of goods without having knowledge of their underlying factors; the consumer can simply focus on his personal cost-benefit decision. Therefore, the price system is said to promote economically efficient use of resources by agents who may not have explicit knowledge of all of the conditions of production or supply. This is called the signalling function of prices as well as the rationing function which prevents over-use of any resource.
Without the market process to fulfill such comparisons, critics of non-market socialism say that it lacks any way to compare different goods and services and would have to rely on calculation in kind. The resulting decisions, it is claimed, would therefore be made without sufficient knowledge to be considered rational.
The common basis for comparison of capital goods must also be connected to consumer welfare. It must also be able to compare the desired trade-off between present consumption and delayed consumption (for greater returns later on) via investment in capital goods. The use of money as a medium of exchange and unit of account is necessary to solve the first two problems of economic calculation. Mises (1912) applied the marginal utility theory developed by Carl Menger to money.
Marginal consumer expenditures represent the marginal utility or additional consumer satisfaction expected by consumers as they spend money. This is similar to the equi-marginal principle developed by Alfred Marshall. Consumers equalize the marginal utility (amount of satisfaction) to the last dollar spent on each good. Thus, the exchange of consumer goods establishes prices that represent the marginal utility of consumers and money is representative of consumer satisfaction.
If money is also spent on capital goods and labor, then it is possible to make comparisons between capital goods and consumer goods. The exchange of consumer and capital/labor goods does not imply that capital goods are valued accurately, only that it is possible for the valuations of capital goods to be made. These are foundational elements of economic calculation, namely that it requires the use of money across all goods. This is a necessary, but not a sufficient condition for successful economic calculation. Without a price mechanism, Mises argues, socialism lacks the means to relate consumer satisfaction to economic activity. The incentive function of prices allows diffuse interests, like the interests of every household in cheap, high quality shoes to compete, among buyers, with the concentrated interests of the cobblers in expensive, poor quality shoes. Without it, a panel of experts set up to "rationalise production", likely closely linked to the cobblers for expertise, would tend to support the cobblers interests in a "conspiracy against the public". However, if this happens to all industries, everyone would be worse off than if they had been subject to the rigours of market competition. The latter forces producers to produce superior products at appropriate prices to please their consumers.
The Mises theory of money and calculation conflicts directly with Marxist labour theory of value. Marxist theory allows for the possibility that labour content can serve as a common means of valuing capital goods, a position now out of favour with economists following the success of the theory of marginal utility.
The third condition for economic calculation is the existence of genuine entrepreneurship and market rivalry.
According to Israel Kirzner (1973) and Don Lavoie (1985), entrepreneurs reap profits by supplying unfulfilled needs in all markets. Thus, entrepreneurship brings prices closer to marginal costs. The adjustment of prices in markets towards equilibrium (where supply and demand equal) gives them greater utilitarian significance. The activities of entrepreneurs make prices more accurate in terms of how they represent the marginal utility of consumers. Prices act as guides to the planning of production. Those who plan production use prices to decide which lines of production should be expanded or curtailed.
Entrepreneurs lack the profit motive to take risks under socialism and so are far less likely to attempt to supply consumer demands. Without the price system to match consumer utility to incentives for production, or even indicate those utilities "without providing incentives", state planners are much less likely to invest in new ideas to satisfy consumers' desires. Entrepreneurs would also lack the ability to economize within the production process, causing repercussions for consumers.
The fourth condition for successful economic calculation is plan coordination among those who plan production. The problem of planning production is the knowledge problem explained by Hayek (1937, 1945), but first mentioned and illustrated by his mentor Mises in Socialism (1922), not to be mistaken with Socialism: An Economic and Sociological Analysis (1951). The planning could either be done in a decentralised fashion, requiring some mechanism to make the individual plans coherent, or centrally, requiring a lot of information.
Within capitalism, the overall plan for production is composed of individual plans among capitalists in large and small enterprises. Since capitalists purchase labour and capital out of the same common pool of available yet scarce labor and capital, it is essential that their plans fit together in at least a semi-coherent fashion. Hayek (1937) defined an efficient planning process as one where all decision makers form plans that contain relevant data from the plans from others. Entrepreneurs acquire data on the plans from others through the price system. The price system is an indispensable communications network for plan coordination among entrepreneurs. Increases and decreases in prices inform entrepreneurs about the general economic situation, to which they must adjust their own plans.
As for socialism, Mises (1944) and Hayek (1937) insisted that bureaucrats in individual ministries could not coordinate their plans without a price system due to the local knowledge problem.Opponents argued that in principle an economy can be seen as a set of equations. Thus, using information about available resources and the preferences of people, it should be possible to calculate an optimal solution for resource allocation. Friedrich von Hayek responded that the system of equations required too much information that would not be easily available and the ensuing calculations would be too difficult. This is partly because individuals possess useful knowledge but do not realise its importance, may have no incentive to transmit the information, or may have incentive to transmit false information about their preferences. He contended that the only rational solution is to utilize all the dispersed knowledge in the market place through the use of price signals. The early debates were made before the much greater calculating powers of modern computers became available but also before research on chaos theory. In the 1980s, Alexander Nove argued that the calculations would take millions of years even with the best computers. It may be impossible to make long-term predictions for a highly complex system such as an economy.
Hayek (1935, 1937, 1940, 1945) stressed the knowledge problem of central planning, partly because decentralized socialism seemed indefensible. Part of the reason that Hayek stressed the knowledge problem was also because he was mainly concerned with debating the proposal for market socialism and the Lange model by Oskar R. Lange (1938) and Hayek's student Abba Lerner (1934, 1937, 1938) which was developed in response to the calculation argument. Lange and Lerner conceded that prices were necessary in socialism. Lange and Lerner thought that socialist officials could simulate some markets (mainly spot markets) and the simulation of spot markets was enough to make socialism reasonably efficient. Lange argued that prices can be seen merely as an accounting practice. In principle, claim market socialists, socialist managers of state enterprises could use a price system, as an accounting system, in order to minimize costs and convey information to other managers. However, while this can deal with existing stocks of goods, providing a basis for values can be ascertained, it does not deal with the investment in new capital stocks. Hayek responded by arguing that the simulation of markets in socialism would fail due to a lack of genuine competition and entrepreneurship. Central planners would still have to plan production without the aid of economically meaningful prices. Lange and Lerner also admitted that socialism would lack any simulation of financial markets, and that this would cause problems in planning capital investment.
However, Hayek's argumentation is not only regarding computational complexity for the central planners. He further argues that much of the information individuals have cannot be collected or used by others. First, individuals may have no or little incentive to share their information with central or even local planners. Second, the individual may not be aware that he has valuable information; and when he becomes aware, it is only useful for a limited time, too short for it to be communicated to the central or local planners. Third, the information is useless to other individuals if it is not in a form that allows for meaningful comparisons of value (i.e. money prices as a common basis for comparison). Therefore, Hayek argues, individuals must acquire data through prices in real markets.
The fifth condition for successful economic calculation is the existence of well functioning financial markets. Economic efficiency depends heavily upon avoiding errors in capital investment. The costs of reversing errors in capital investment are potentially large. This is not just a matter of rearranging or converting capital goods that are found to be of little use. The time spent reconfiguring the structure of production is time lost in the production of consumer goods. Those who plan capital investment must anticipate future trends in consumer demand if they are to avoid investing too much in some lines of production and too little in other lines of production.
Capitalists plan production for profit. Capitalists use prices to form expectations that determine the composition of capital accumulation, the pattern of investment across industry. Those who invest in accordance with consumers' desires are rewarded with profits, those who do not are forced to become more efficient or go out of business.
Prices in futures markets play a special role in economic calculation. Futures markets develop prices for commodities in future time periods. It is in futures markets that entrepreneurs sort out plans for production based on their expectations. Futures markets are a link between entrepreneurial investment decisions and household consumer decisions. Since most goods are not explicitly traded in futures markets, substitute markets are needed. The stock market serves as a ‘continuous futures market’ that evaluates entrepreneurial plans for production (Lachmann 1978). Generally speaking, the problem of economic calculation is solved in financial markets as Mises argued:
The problem of economic calculation arises in an economy which is perpetually subject to change [...]. In order to solve such problems it is above all necessary that capital be withdrawn from particular undertakings and applied in other lines of production [...]. [This] is essentially a matter of the capitalists who buy and sell stocks and shares, who make loans and recover them, who speculate in all kinds of commodities.
The existence of financial markets is a necessary condition for economic calculation. The existence of financial markets itself does not automatically imply that entrepreneurial speculation will tend towards efficiency. Mises argued that speculation in financial markets tends towards efficiency because of a "trial and error" process. Entrepreneurs who commit relatively large errors in investment waste their funds over expanding some lines of production at the cost of other more profitable ventures where consumer demand is higher. The entrepreneurs who commit the worst errors by forming the least accurate expectations of future consumer demands incur financial losses. Financial losses remove these inept entrepreneurs from positions of authority in industry.
Entrepreneurs who commit smaller errors by anticipating consumer demand more correctly attain greater financial success. The entrepreneurs who form the most accurate opinions regarding the future state of markets (i.e. new trends in consumer demands) earn the highest profits and gain greater control of industry. Those entrepreneurs who anticipate future market trends therefore waste the least amount of real capital and find the most favorable terms for finance on markets for financial capital. Minimal waste of real capital goods implies the minimization of the opportunity costs of capital's economic calculation. The value of capital goods is brought into line with the value of future consumer goods through competition in financial markets, because competition for profits among capitalist financiers rewards entrepreneurs who value capital more correctly (i.e. anticipating future prices more correctly) and eliminates capitalists who value capital least correctly. To sum things up, the use of money in trading all goods (capital/labor and consumer) in all markets (spot and financial) combined with profit driven entrepreneurship and Darwinian natural selection in financial markets all combine to make rational economic calculation and allocation the outcome of the capitalist process.
Mises insisted that socialist calculation is impossible because socialism precludes the exchange of capital goods in terms of a generally accepted medium of exchange, or money. Investment in financial markets determines the capital structure of modern industry with some degree of efficiency. The egalitarian nature of socialism prohibits speculation in financial markets. Therefore, Mises concluded that socialism lacks any clear tendency towards improvement in the capital structure of industry."
From the Wikipedia:
"Efficiency of markets
Some academics and economists argue that the claim a free market is an efficient, or even the most efficient, method of resource allocation is incorrect. Alexander Nove argued that Mises "tends to spoil his case by the implicit assumption that capitalism and optimum resource allocation go together" in Mises' "Economic Calculation in the Socialist Commonwealth". Joan Robinson argued that many prices in modern capitalism are effectively "administered prices" created by "quasi monopolies", thus challenging the connection between capital markets and rational resource allocation.
Socialist market abolitionists argue that whilst advocates of capitalism and the Austrian School in particular recognize equilibrium prices do not exist in real life, they nonetheless claim that these prices can be used as a rational basis when this is not the case, hence markets are not efficient. Robin Hahnel further argued that market inefficiencies, such as externalities and excess supply and demand, arise from buyers and sellers thoughtlessly maximizing their rational interests, which free markets inherently do not deter. Nonetheless, Hahnel commended current policies pursued by free market capitalist societies against these inefficiencies (e.g. Pigouvian taxes, antitrust laws etc.), as long as they are properly calculated and consistently enforced.
Milton Friedman agreed that markets with monopolistic competition are not efficient, but he argued that it is easy to force monopolies to adopt competitive behavior by exposing them to foreign rivals. Economic liberals and libertarian capitalists also argue that monopolies and big business are not generally the result of a free market, or that they never arise from a free market; rather, they say that such concentration is enabled by governmental grants of franchises or privileges. That said, protectionist economies can theoretically still foster competition as long as there is strong consumer switching. Joseph Schumpeter additionally argued that economic advancement, through innovation and investment, are often driven by large monopolies.
Allin Cottrell, Paul Cockshott and Greg Michaelson argued 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 central calculator in principle has no advantage over a system of dispersed calculators, i.e. a market, or vice versa.
In some economic models, finding an equilibrium is hard, and finding an Arrow–Debreu equilibrium is PPAD-complete. If the market can find an equilibrium in polynomial time, then the equivalence above can be used to prove that P=PPAD. This line of argument thus attempts to show that any claim to impossibility must necessarily involve a local knowledge problem, because the planning system is no less capable than the market if given full information.
Don Lavoie makes a local knowledge argument by taking this implication in reverse. The market socialists pointed out the formal similarity between the neoclassical model of Walrasian general equilibrium and that of market socialism which simply replace the Walrasian auctioneer with a planning board. According to Lavoie, this emphasizes the shortcomings of the model. By relying on this formal similarity, the market socialists must adopt the simplifying assumptions of the model. The model assumes that various sorts of information are given to the auctioneer or planning board. However, if not coordinated by a capital market, this information exists in a fundamentally distributed form, which would be difficult to utilize on the planners' part. If the planners decided to utilize the information, it would immediately become stale and relatively useless, unless reality somehow imitated the changeless monotony of the equilibrium model. The existence and usability of this information depends on its creation and situation within a distributed discovery procedure.
One criticism is that proponents of the theory overstate the strength of their case by describing socialism as impossible rather than inefficient. In explaining why he is not an Austrian School economist, anarcho-capitalist economist Bryan Caplan argues that while the economic calculation problem is a problem for socialism, he denies that Mises has shown it to be fatal or that it is this particular problem that led to the collapse of authoritarian socialist states. Caplan also states the exaggeration of the problem; in his view, Mises did not manage to prove why economic calculation made the socialist economy 'impossible', and even if there were serious doubts about the efficiency of cost benefit analysis, other arguments are plentiful (Caplan gives the example of the incentive problem).
Joan Robinson argued that in a steady-state economy there would be an effective abundance of means of production and so markets would not be needed. Mises acknowledged such a theoretical possibility in his original tract when he said the following: "The static state can dispense with economic calculation. For here the same events in economic life are ever recurring; and if we assume that the first disposition of the static socialist economy follows on the basis of the final state of the competitive economy, we might at all events conceive of a socialist production system which is rationally controlled from an economic point of view." However, he contended that stationary conditions never prevail in the real world. Changes in economic conditions are inevitable; and even if they were not, the transition to socialism would be so chaotic as to preclude the existence of such a steady-state from the start.
The purpose of the price mechanism is to allow individuals to recognise the opportunity cost of decisions. In a state of abundance, there is no such cost, which is to say that in situations where one need not economize, economics does not apply, e.g. areas with abundant fresh air and water. Otto Neurath and Hillel Ticktin argued that with detailed use of real unit accounting and demand surveys a planned economy could operate without a capital market in a situation of abundance.
Use of technology
In Towards a New Socialism's "Information and Economics: A Critique of Hayek" and "Against Mises", Paul Cockshott and Allin Cottrell argued that the use of computational technology now simplifies economic calculation and allows planning to be implemented and sustained. Len Brewster replied to this by arguing that Towards a New Socialism establishes what is essentially another form of a market economy, making the following point:
- [A]n examination of C&C's New Socialism confirms Mises's conclusion that rational socialist planning is impossible. It appears that in order for economic planners to have any useful data by which they might be guided, a market must be hauled in, and with it analogues of private property, inequality and exploitation.
In response, Cockshott argued that the economic system is sufficiently far removed from a capitalist free-market economy to not count as one, saying:
- Those that Hayek was arguing against like Lange and Dickinson allowed for markets in consumer goods, this did not lead Hayek to say : Oh you are not really arguing for socialism since you have conceded a market in consumer goods, he did not, because there remained huge policy differences between him and Lange even if Lange accepted consumer goods markets. It is thus a very weak argument by Brewster to say that what we advocate is not really socialist calculation because it is contaminated in some way by market influences.
Leigh Phillips' and Michal Rozworski's 2019 book The People's Republic of Walmart argues that multinational corporations like Walmart and Amazon already operate centrally planned economies in a more technologically sophisticated manner than the Soviet Union, proving that the economic calculation problem is surmountable. There are some contentions to this view however, namely how economic planning and planned economy ought to be distinguished. Both entail formulating data-driven economic objectives but the latter precludes it from occurring within a free market context and delegates the task to centralized bodies.
Karras J. Lambert and Tate Fegley argue that artificial intelligence systems, no matter how advanced, cannot assume the role of central planners because they do not fulfill the prerequisites of effective economic calculation. This includes the ability to convert the ordinal preferences of producers and consumers into commensurate cardinal utility values, which are available and agreed upon, and forecast future market interactions.
One reason includes how they are dependent on Big Data, which in turn is entirely based on past information. Hence, the system cannot make any meaningful conclusions about future consumer preferences, which are required for optimal pricing. This necessitates the intervention of the programmer, who is highly likely to be biased in their judgments. Even the manner by which a system can "predict" consumer preferences is also based on a programmer's creative bias. They further argue that even if artificial intelligence is able to ordinally rank items like humans, they would still suffer from the same issues of not being able to conceive of a pricing structure where meaningful pricing calculations, using a common cardinal utility unit, can be formed. Nonetheless, Lambert and Fegley acknowledge that entrepreneurs can benefit from Big Data's predictive value, provided that the data is based on past market prices and that it is used in tandem with free market-styled bidding."
The Soviet Planned Economy system actually worked in terms of allocative efficiency
"when Western economists descended on the former Soviet bloc after 1989 to help direct the transition out of socialism, their central mantra, endlessly repeated, was “Get Prices Right.”
But a great deal of contrary evidence had accumulated in the meantime. Around the time of the Soviet collapse, the economist Peter Murrell published an article in the Journal of Economic Perspectives reviewing empirical studies of efficiency in the socialist planned economies. These studies consistently failed to support the neoclassical analysis: virtually all of them found that by standard neoclassical measures of efficiency, the planned economies performed as well or better than market economies.
Murrell pleaded with readers to suspend their prejudices:
The consistency and tenor of the results will surprise many readers. I was, and am, surprised at the nature of these results. And given their inconsistency with received doctrines, there is a tendency to dismiss them on methodological grounds. However, such dismissal becomes increasingly hard when faced with a cumulation of consistent results from a variety of sources.
First he reviewed eighteen studies of technical efficiency: the degree to which a firm produces at its own maximum technological level. Matching studies of centrally planned firms with studies that examined capitalist firms using the same methodologies, he compared the results. One paper, for example, found a 90% level of technical efficiency in capitalist firms; another using the same method found a 93% level in Soviet firms. The results continued in the same way: 84% versus 86%, 87% versus 95%, and so on.
Then Murrell examined studies of allocative efficiency: the degree to which inputs are allocated among firms in a way that maximizes total output. One paper found that a fully optimal reallocation of inputs would increase total Soviet output by only 3%-4%. Another found that raising Soviet efficiency to U.S. standards would increase its GNP by all of 2%. A third produced a range of estimates as low as 1.5%. The highest number found in any of the Soviet studies was 10%. As Murrell notes, these were hardly amounts “likely to encourage the overthrow of a whole socio-economic system.” (Murell wasn’t the only economist to notice this anomaly: an article titled “Why Is the Soviet Economy Allocatively Efficient?” appeared in Soviet Studies around the same time.)"
"Two German microeconomists tested the “widely accepted” hypothesis that “prices in a planned economy are arbitrarily set exchange ratios without any relation to relative scarcities or economic valuations [whereas] capitalist market prices are close to equilibrium levels.”  They employed a technique that analyzes the distribution of an economy’s inputs among industries to measure how far the pattern diverges from that which would be expected to prevail under perfectly optimal neoclassical prices. Examining East German and West German data from 1987, they arrived at an “astonishing result”: the divergence was 16.1% in the West and 16.5% in the East, a trivial difference. The gap in the West’s favor, they wrote, was greatest in the manufacturing sectors, where something like competitive conditions may have existed. But in the bulk of the West German economy – which was then being hailed globally as Modell Deutschland – monopolies, taxes, subsidies, and so on actually left its price structure further from the “efficient” optimum than in the moribund Communist system behind the Berlin Wall."" (http://jacobinmag.com/2012/12/the-red-and-the-black/)
Cosma Shalizi is good at the math behind optimization software, among other things. In the excerpts and linked article below, he agrees that an optimally planned economy is impossible, but says that so is an optimally market-driven invisible-hand capitalist economy guided by prices. In other words, the claims of Mises and Hayek that “the market” can rationally allocate resources don’t hold water either. (As we have seen in the latest crash and bailout of finance capital.)
Yet and still, I think that a non-capitalist, democratically planned, and peer-to-peer coordinated economy is possible and necessary. It just won’t be optimal. But do you think the current economy is?
More below, after some excerpts from Shalizi.
In part of a seminar about the book Red Plenty (which described an attempt to optimize economic planning in the Soviet Union), Shalizi writes:
"Planning for the whole economy would, under the most favorable possible assumptions, be intractable for the foreseeable future, and deciding on a plan runs into difficulties we have no idea how to solve. The sort of efficient planned economy dreamed of by the characters in Red Plenty is something we have no clue of how to bring about, even if we were willing to accept dictatorship to do so."
"Both neo-classical and Austrian economists make a fetish (in several senses) of markets and market prices. That this is crazy is reflected in the fact that even under capitalism, immense areas of the economy are not coordinated through the market...This is not just because the market revolution has not been pushed far enough. ("One effort more, shareholders, if you would be libertarians!") The conditions under which equilibrium prices really are all a decision-maker needs to know, and really are sufficient for coordination, are so extreme as to be absurd. (Stiglitz is good on some of the failure modes.) Even if they hold, the market only lets people "serve notice of their needs and of their relative strength" up to a limit set by how much money they have. This is why careful economists talk about balancing supply and "effective" demand, demand backed by money."
This is just as much an implicit choice of values as handing the planners an objective function and letting them fire up their optimization algorithm. Those values are not pretty. They are that the whims of the rich matter more than the needs of the poor; that it is more important to keep bond traders in strippers and cocaine than feed hungry children. At the extreme, the market literally starves people to death, because feeding them is a less "efficient" use of food than helping rich people eat more.
"If it's any consolation, allowing non-convexity messes up the markets-are-always-optimal theorems of neo-classical/bourgeois economics, too. (This illustrates Stiglitz's contention that if the neo-classicals were right about how capitalism works, Kantorovich-style socialism would have been perfectly viable.) Markets with non-convex production [added note: that is, all real-world markets] are apt to see things like monopolies, or at least monopolistic competition, path dependence, and, actual profits and power. (My university owes its existence to Mr. Carnegie's luck, skill, and ruthlessness in exploiting the non-convexities of making steel.) Somehow, I do not think that this will be much consolation."
Shalizi is much better at thinking about optimization than I am. He has the math and the experience. I have neither. So I will accept his conclusion that optimizing a whole economy is impossible, and plunge ahead regardless."
Why the Economic Calculation Problem Prevents a Direct Transformation Towards a Marketless and Stateless Society
by Seth Ackerman:
"The lofty vision of a stateless, marketless world faces obstacles that are not moral but technical, and it’s important to grasp exactly what they are.
We have to assume that we would not want to regress to some sharply lower stage of economic development in the future; we would want to experience at least the same material comforts that we have under capitalism. On a qualitative level, of course, all sorts of things ought to change so that production better satisfies real human and ecological needs. But we would not want to see an overall decline in our productive powers.
But the kind of production of which we are now capable requires a vast and complex division of labor. This presents a tricky problem. To get a concrete sense of what it means, think of the way Americans lived at the time of the American Revolution, when the typical citizen worked on a small, relatively isolated family farm. Such households largely produced what they consumed and consumed what they produced. If they found themselves with a modest surplus of farm produce, they might sell it to others nearby, and with the money they earned they could buy a few luxuries. For the most part, though, they did not rely on other people to provide them with the things they needed to live.
Compare that situation with our own. Not only do we rely on others for our goods, but the sheer number of people we rely on has increased to staggering proportions.
Look around the room you’re sitting in and think of your possessions. Now try to think of how many people were directly involved in their production. The laptop I’m typing on, for example, has a monitor, a case, a DVD player, and a microprocessor. Each was likely made in a separate factory, possibly in different countries, by various companies employing hundreds or thousands of workers. Then think of the raw plastic, metal, and rubber that went into those component parts, and all the people involved in producing them. Add the makers of the fuel that fired the factories and the ship crews and trucking fleets that got the computer to its destination. It’s not hard to imagine millions of people participating in the production of just those items now sitting on my desk. And out of the millions of tasks involved, each individual performed only a tiny set of discrete steps.
How did they each know what to do? Of course, most of these people were employees, and their bosses told them what to do. But how did their bosses know how much plastic to produce? And how did they know to send the weaker, softer kind of plastic to the computer company, even though it would have been happy to take the sturdier, high-quality plastic reserved for the hospital equipment makers? And how did these manufacturers judge whether it was worth the extra resources to make laptops with nice LCD monitors, rather than being frugal and making old, simpler cathode ray models?
The total number of such dilemmas is practically infinite for a modern economy with millions of different products and billions of workers and consumers. And they must all be resolved in a way that is globally consistent, because at any given moment there are only so many workers and machines to go around, so making more of one thing means making less of another. Resources can be combined in an almost infinite number of possible permutations; some might satisfy society’s material needs and desires fairly well, while others would be disastrous, involving huge quantities of unwanted production and lots of desirable things going unmade. In theory, any degree of success is possible.
This is the problem of economic calculation. In a market economy, prices perform this function. And the reason prices can work is that they convey systematic information concerning how much of one thing people are willing to give up to get another thing, under a given set of circumstances. Only by requiring people to give up one thing to get another, in some ratio, can quantitative information be generated about how much, in relative terms, people value those things. And only by knowing how much relative value people place on millions of different things can producers embedded in this vast network make rational decisions about what their minute contribution to the overall system ought to be.
None of this means that calculation can be accomplished through prices alone, or that the prices generated in a market are somehow ideal or optimal. But there is no way a decentralized system could continually generate and broadcast so much quantitative information without the use of prices in some form. Of course, we don’t have to have a decentralized system. We could have a centrally planned economy, in which all or most of society’s production decisions are delegated to professional planners with computers. Their task would be extremely complex and their performance uncertain. But at least such a system would provide some method for economic calculation: the planners would try to gather all the necessary information into their central department and then figure out what everyone needs to do.
So something needs to perform the economic calculation function that prices do for a market system and planners do for a centrally planned system." (https://www.jacobinmag.com/2012/12/the-red-and-the-black/)
Is this a fruitless debate on a false problem ?
"My own suggestion is do not waste your time on this problem! I thought you had been referring to the problem I heard you explain a long time ago: we already know very well the means to collectively create value that is neither the capitalist (corporate) nor the socialist (State) top-down approach, but in a peer-to-peer way; but we still need to discover how such values can be appropriated so that they will go back to those who contributed towards creating them, instead of being appropriated privately. I thought you had coined the term "economic calculation" for this problem, referring to the problem of keeping track of individual contributions to the common pool and how their individual contributions can be rewarded, thus enabling those who contributed to support themselves out of these rewards, instead of having to find a separate job to support themselves while contributting freely to the common pool.
That capitalist vs socialist calculation debate is waste of time, as far as I'm concerned, because both approach the problem of coordinating the economy as a deterministic problem with a calculable solution. By the way, just as an aside (but I would not really be interested in this engaging in this capitalist vs socialist debate), price is not the only way to determine when you should produce less (or more). Another way to do it is to look at inventories: if they run low too often, you should produce more; if they aren't used up for too long, you should produce less. That calculation debate about solving a set of equations to find a unique solution, as if it can be done for an entire economic system, is really ridiculous."
(email, January 2016)
The role of the Austrian Economic School in the Calculation Debate
1. Summary of the Austrial critique, by Renato Flores:
"As posed by Ludwig von Mises, the original economic calculation problem states that central planning can never be a substitute for the market, as planners lack an objective measure of value and thus cannot rationally allocate between producer and capital goods or effectively discipline producers. A further development of this problem is Friedrich Hayek’s formulation, which is that a planned economy misses the role of the entrepreneur and can never go through the innovation or creative destruction characteristic of capitalism because this role is absent. Furthermore, Hayek critiques that planners have an information problem, and cannot know the real preferences of consumers."
2. FIKRET ADAMAN & PAT DEVINE:
"The debate on the possibility of rational economic calculation in a socialist economic system, defined as a system in which the means of production are publicly owned, was effectively initiated by Barone in 1908, gathered momentum in the German literature during the 1920s, continued in the English literature during the 1930s, and then died out in the 1940s, after the summing-up article by Bergson in 1948. The two principal sides in the debate were economists from the Austrian school, who denied the possibility of rational calculation under socialism, and socialist economists arguing within the neoclassical paradigm, who defended such a possibility. Underlying the debate were not only different views on the desirability of capitalism and socialism, but also different epistemological and methodological approaches. These differences of approach were, however, largely implicit at the time and it has been argued that the distinctive Austrian position only crystallized as a result of the debate itself and subsequent reflection on it.In the neoclassical paradigm, knowledge is conceptualized as being objective, with production possibilities, costs and revenues constituting knowable objective constraints given which economic agents make maximizing decisions. In the Austrian school, by contrast, knowledge is conceptualized as being subjective. Instead of being taken as given for the purpose of decision making, subjective—or ‘tacit’—knowledge must be discovered through action, through competitive entrepreneurial activity in the market. The emphasis on the centrality of the ‘discovery’ process is the hallmark of the modern Austrian school and the basis of its reworking of the debate on the possibility of rational calculation under socialism which gathered pace during the 1980s. It is the foundation of the modern Austrians’ claim that the impossibility of a rational socialist economic system has been established not just historically but, more significantly, also theoretically.
In the debate, the role of the market in making rational economic calculation possible has been discussed under three headings— calculation, motivation and discovery. In 1920 Mises argued that economic calculation is only possible in a free-market system, based on private property, which establishes the exchange value of all goods and services and thus provides economic agents with the necessary information, in the form of prices, for them to decide how to act. It then emerged that Barone had already refuted Mises’s argument by demonstrating that a socialist economy could achieve the same level of efficiency as its capitalist counterpart by solving the set of simultaneous equations, based on production and utility functions, that describes the interdependent behaviour of the economic actors in the system. Hayek’s 1935 contribution in response to this has historically been interpreted as arguing that, although Barone’s analytic solution is conceivable in theory, it is impossible in practice, given both the amount of information that would have to be collected centrally and the scale of the computation required to solve the simultaneous equations. Lange responded to Hayek’s argument by producing his seminal model of market socialism, drawing on earlier decentralized models."
The Socialist Calculation Debate Today: what the left should do
"If the Socialist Calculation Debate teaches us anything, it’s that the left should not waste time debating the merits of the price mechanism in isolation from its embeddedness in the broader system of capitalist competition, which generates non-price knowledge—reputation and so on—and produces the general social norms and patterns of legibility which allow the price system to do so much with so little. While it’s true that, evaluated on its own terms, the price system appears a marvel of social coordination, it’s also true that, without capitalist markets, it doesn’t exist. It thus makes sense to strive for a more comprehensive assessment, looking at how the existence of capitalist competition—and of capitalism in general—affect social coordination tout court. Social coordination can be mediated by a whole ecology of mechanisms, including law, democratic deliberation, decentralized ‘radical bureaucracy’ and feedback control, as well as the price system. Consider, for example, the non-price knowledge that circulates in capitalist economies, which not only informs the price system but also shapes our assessment of the urgency of threats, helping to inform our responses. The more accurate that information, the more likely we are to ensure social coordination in solving tasks which—like climate change—are crucial to the survival of the species.
Yet capitalist competition often ends up contaminating that knowledge, making an accurate assessment of the situation nearly impossible. After the neoliberal turn, competition is increasingly becoming a non-discovery procedure. Consider the energy companies or pharmaceutical firms who deliberately manufacture ignorance by selectively funding academics and think tanks. Or the media-military-industrial complex, shaping how the public thinks about the latest war. Or the increasingly privatized education system, unable to ‘discover’ the sort of knowledge that has no easily quantifiable impact. Or the credit rating agencies, whose business models often obscure the real state of the firms they are supposed to be evaluating. An entire academic industry—under the quirky name of ‘agnotology’—has sprung up to study the production of such manufactured ignorance and its use by capitalist firms.footnote38 The best possible outcome of this research would be a recalibration of how we assess the comparative advantages of various systems of social coordination—and a shift of focus, from measuring solely their respective contributions to economic efficiency, to weighing up their ability to perceive existential social problems, in all their complexity, and to propose possible solutions.
The ideological residue of the Cold War, with its binary choice between central planning and the price system, has obscured the existence of this broader ecology of modes of social coordination. The emancipatory promise of information technology is to rediscover and enrich this repertoire, while revealing the high invisible costs of relying on the current dominant mode of social coordination—capitalist competition. Given this possibility, the agenda of the neoliberal establishment is clear. On the one hand, they will rally behind a slogan of ‘There Is No Alternative (to Google)’, depicting any departure from the cartelized Silicon Valley model—or at least, any moves that dare go beyond the consumerist utopia of a ‘New Deal on Data’—as yet another step on the road to serfdom. On the other hand, they will continue filling in the empty social and political spaces which previously had their own logics and ways of doing things, with the ‘smart’ capitalist logic of digital platforms.
The left, then, should focus on preserving and expanding the ecology of different modes of social coordination, while also documenting the heavy costs—including on discovery itself—of discovering exclusively via competition. This mission, meanwhile, will be all but impossible without regaining control over the ‘feedback infrastructure’. The contradiction between collaborative forms of knowledge discovery and the private ownership of the means of digital production is already becoming apparent in the processes of ‘peer production’—long celebrated by liberal legal academics—used in the production of free software or services like Wikipedia. Under the current Silicon Valley private-ownership model, the feedback infrastructure is unlikely to be amenable to radical-democratic transformation.footnote39 Freedom, as neoliberals have long understood, must be planned; but so must their ‘spontaneous order’. In the absence of such planning, spontaneity quickly morphs into adaptation to an external reality that is not to be tinkered with. This may be an acceptable —even desirable —development for conservatives, but it should be anathema to the left."
From the Wikipedia:
The Interwar Debate (20th Cy)
Economic calculation problem
Ludwig von Mises believed that private ownership of the means of production was essential for a functional economy, arguing:
- Every step that takes us away from private ownership of the means of production and from the use of money also takes us away from rational economics.
— Ludwig von Mises, Economic Calculation in the Socialist Commonwealth[
His argument against socialism was in response to Otto Neurath arguing for the feasibility of central planning. Mises argued that money and market-determined prices for the means of production were essential in order to make rational decisions regarding their allocation and use.
Criticism of the calculation problem
Bryan Caplan, a libertarian economist, has criticized the version of the calculation problem advanced by Mises arguing that the lack of economic calculation makes socialism impossible and not merely inefficient. Caplan argues that socialism makes economic calculation impossible, yet that problem may not be severe enough to make socialism impossible "beyond the realm of possibility". Caplan points out that the fall of the Soviet Union does not prove that calculation was the main issue there. He suggests that more likely the problems resulted from bad incentives arising out of the one-party political system and degree of power granted to the party elite.
Proponents of decentralized economic planning have also criticized central economic planning. Leon Trotsky believed that central planners, regardless of their intellectual capacity, operated without the input and participation of the millions of people who participate in the economy and so they would be unable to respond to local conditions quickly enough to effectively coordinate all economic activity.
- If a universal mind existed, of the kind that projected itself into the scientific fancy of Laplace – a mind that could register simultaneously all the processes of nature and society, that could measure the dynamics of their motion, that could forecast the results of their inter-reactions – such a mind, of course, could a priori draw up a faultless and exhaustive economic plan, beginning with the number of acres of wheat down to the last button for a vest. The bureaucracy often imagines that just such a mind is at its disposal; that is why it so easily frees itself from the control of the market and of Soviet democracy. But, in reality, the bureaucracy errs frightfully in its estimate of its spiritual resources. [...] The innumerable living participants in the economy, state and private, collective and individual, must serve notice of their needs and of their relative strength not only through the statistical determinations of plan commissions but by the direct pressure of supply and demand. (Leon Trotsky, The Soviet Economy in Danger)
Oskar Lange responded to Mises' assertion that socialism and social ownership of the means of production implied that rational calculation was impossible by outlining a model of socialism based on neoclassical economics. Lange conceded that calculations would have to be done in value terms rather than using purely natural or engineering criteria, but he asserted that these values could be attained without capital markets and private ownership of the means of production. In Lange's view, this model qualified as socialist because the means of production would be publicly owned with returns to the public enterprises accruing to society as a whole in a social dividend while workers' self-management could be introduced in the public enterprises.
This model came to be referred to as the Lange model. In this model, a Central Planning Board (CPB) would be responsible for setting prices through a trial-and-error approach to establish equilibrium prices, effectively running a Walrasian auction. Managers of the state-owned firms would be instructed to set prices to equal marginal cost (P=MC) so that economic equilibrium and Pareto efficiency would be achieved. The Lange model was expanded upon by Abba Lerner and became known as the Lange–Lerner theorem.
Paul Auerbach and Dimitris Sotiropoulos have criticized the Lange model for degrading the definition of socialism to a form of "capitalism without capital markets" attempting to replicate capitalism's efficiency achievements through economic planning. Auerbach and Sotiropoulos argue that Friedrich Hayek provided an analysis of the dynamics of capitalism that is more consistent with Marxian economics' analysis because Hayek viewed finance as a fundamental aspect of capitalism and any move through collective ownership or policy reform to undermine the role of capital markets would threaten the integrity of the capitalist system. According to Auerbach and Sotiropoulos, Hayek gave an unexpected endorsement to socialism that is more sophisticated than Lange's superficial defense of socialism.
Networked digital feedback
Peter Joseph argues for a transition from fragmented economic data relay to fully integrated, sensor-based digital systems, or an Internet of things. Using an internet of sensory instruments to measure, track and feed back information, this can unify numerous disparate elements and systems, greatly advancing awareness and efficiency potentials.
In an economic context, this approach could relay and connect data regarding how best to manage resources, production processes, distribution, consumption, recycling, waste disposal behavior, consumer demand and so on. Such a process of networked economic feedback would work on the same principle as modern systems of inventory and distribution found in major commercial warehouses. Many companies today use a range of sensors and sophisticated tracking means to understand rates of demands, exactly what they have, where it is or where it may be moving and when it is gone. It is ultimately an issue of detail and scalability to extend this kind of awareness to all sectors of the economy, macro and micro.
Not only is price no longer needed to gain critical economic feedback, but the information price communicates is long delayed and incomplete in terms of economic measures required to dramatically increase efficiency. Mechanisms related networked digital feedback systems make it possible to efficiently monitor shifting consumer preference, demand, supply and labor value, virtually in real time. Moreover, it can also be used to observe other technical processes price cannot, such as shifts in production protocols, allocation, recycling means, and so on. As of February 2018, it is now possible to track trillions of economic interactions related to the supply chain and consumer behavior by way of sensors and digital relay as seen with the advent of Amazon Go.
Paul Cockshott, Allin Cottrell, and Andy Pollack have proposed new forms of coordination based on modern information technology for non-market socialism. They argue that economic planning in terms of physical units without any reference to money or prices is computationally tractable given the high-performance computers available for particle physics and weather forecasting. Cybernetic planning would involve an a priori simulation of the equilibration process that idealized markets are intended to achieve.
Proposals for decentralized economic planning emerged in the late 20th century in the form of participatory economics and negotiated coordination.
Decentralized pricing without markets
David McMullen argues that social ownership of the means of production and the absence of markets for them is fully compatible with a decentralized price system. In a post-capitalist society, transactions between enterprises would entail transfers of social property between custodians rather than an exchange of ownership. Individuals would be motivated by the satisfaction from work and the desire to contribute to good economic outcomes rather than material reward. Bids and offer prices would aim to minimize costs and ensure that output is guided by expected final demand for private and collective consumption. Enterprises and startups would receive their investment funding from project assessment agencies. The required change in human behavior would take a number generations and would have to overcome considerable resistance. However, McMullen believes that economic and cultural development increasingly favors the transition.
James Yunker argues that public ownership of the means of production can be achieved the same way private ownership is achieved in modern capitalism through the shareholder system that separates management from ownership. Yunker posits that social ownership can be achieved by having a public body, designated the Bureau of Public Ownership (BPO), owning the shares of publicly-listed firms without affecting market-based allocation of capital inputs. Yunker termed this model pragmatic market socialism and argued that it would be at least as efficient as modern-day capitalism while providing superior social outcomes as public ownership of large and established enterprises would enable profits to be distributed among the entire population rather than going largely to a class of inheriting rentiers.
Beginning in the 1970s, new insights into the socialist calculation debate emerged from mechanism design theory. According to mechanism design theorists, the debate between Hayek and Lange became a stalemate that lasted for forty years because neither side was speaking the same language as the other, partially because the appropriate language for discussing socialist calculation had not yet been invented. According to these theorists, what was needed was a better understanding of the informational problems that prevent coordination between people. By fusing game theory with information economics, mechanism design provided the language and framework in which both socialists and advocates of capitalism could compare the merits of their arguments. As Palda (2013) writes in his summary of the contributions of mechanism design to the socialist calculation debate, "[i]t seemed that socialism and capitalism were good at different things. Socialism suffered from cheating, or 'moral hazard', more than capitalism because it did not allow company managers to own shares in their own companies. [...] The flip side of the cheating problem in socialism is the lying or 'adverse selection' problem in capitalism. If potential firm managers are either good or bad, but telling them apart is difficult, bad prospects will lie to become a part of the firm."
Discussion 3: Proposed Alternatives
See also the threefold typology of alternatives, summarized by Evgeny Morozov, in the entry: Feedback Infrastructure for Non-Market Forms of Social Coordination
"Proposed units for accounting and calculation", from the Wikipedia:
Calculation in kind
"Calculation in kind, or calculation in-natura, was often assumed to be the standard form of accounting that would take place in a socialist system where the economy was mobilized in terms of physical or natural units instead of money and financial calculation.
Otto Neurath was adamant that a socialist economy must be moneyless because measures of money failed to capture adequate information regarding material well-being of consumers or failed to factor in all costs and benefits from performing a particular action. He argued that relying on any single unit, whether they be labor-hours or kilowatt-hours, would be inadequate and that demand and calculations be performed by the relevant disaggregated natural units, i.e. kilowatts, tons, meters and so on.
In the 1930s, Soviet mathematician Leonid Kantorovich demonstrated how an economy in purely physical terms could use determinate mathematical procedure to determine which combination of techniques could be used to achieve certain output or plan targets.
Debate on the use of money
In contrast to Neurath, Karl Kautsky argued that money would have to be utilized in a socialist economy. Kautsky states the fundamental difference between socialism and capitalism is not the absence of money in the former; rather, the important difference is in the ability for money to become capital under capitalism. In a socialist economy, there would be no incentive to use money as financial capital, therefore money would have a slightly different role in socialism.
Jan Appel drafted a contribution to the socialist calculation debate which then went through a discussion process before being published as Foundations of Communist Production and Distribution by the General Workers' Union of Germany in 1930. An English translation by Mike Baker was published in 1990."
Pricing is not adequate but firms' autonomy is crucial
Seth Ackerman outlines why the neoclassical assumption of perfect equilibrium is wrong, but that the autonomy of firms and their reliance on capital markets, is what makes capitalist allocation function:
1. Capitalist prices do not reflect social value adequately:
"So the pursuit of profit leads firms to maximize their production of socially desired outputs while economizing on their use of scarce inputs. On this logic, profits are an ideal coordinating device.
But the logic only holds to the extent that that an item’s market value is actually a good measure of its social value. Does that assumption hold? Leftists know enough to scoff at that idea. The history of capitalism is a compendium of mis-valued goods. Not only do capitalists draw from a treasury of tricks and maneuvers to inflate the market value of the outputs they sell (e.g., through advertising) and drive down the value of the inputs they have to buy (e.g., by deskilling labor). But capitalism itself systematically produces prices for crucial goods that bear little rational relation to their marginal social value: just think of health insurance, natural resources, interest rates, wages.
So if profit is a signal, it invariably comes mixed with a lot of noise. Still, there’s an important signal there. "
2. Theoretical problems and new research undermined neoclassical assumptions
"If all these facts and findings represented one reason to doubt the neoclassical narrative, there was a more fundamental reason: economists had discovered gaping holes in the theory itself. In the years since Arrow and Debreu had drafted their famous proof that free markets under the right conditions could generate optimal prices, theorists (including Debreu himself) had uncovered some disturbing features of the model. It turned out that such hypothetical economies generated multiple sets of possible equilibrium prices, and there was no mechanism to ensure that the economy would settle on any one of them without long or possibly endless cycles of chaotic trial-and-error. Even worse, the model’s results couldn’t withstand much relaxation of its patently unrealistic initial assumptions; for example, without perfectly competitive markets — which are virtually nonexistent in the real world — there was no reason to expect any equilibrium at all.
Even the liberal trope that government interventions are justified by “market failures” — specific anomalies that depart from the Arrow-Debreu model’s perfect-market assumptions — was undermined by another finding of the 1950s: the “general theory of the second best.” Introduced by Richard Lipsey and Kelvin Lancaster, the theorem proves that even if the idealized assumptions of the standard model are accepted, attempts to correct “market failures” and “distortions” (like tariffs, price controls, monopolies or externalities) areas likely to make things worse as to make them better, as long as any other market failures remain uncorrected — which will always be the case in a world of endemic imperfect competition and limited information.
In a wide-ranging review of “the failure of general equilibrium theory,” the economist Frank Ackerman concluded:
- A story about Adam Smith, the invisible hand, and the merits of markets pervades introductory textbooks, classroom teaching, and contemporary political discourse. The intellectual foundation of this story rests on general equilibrium. . . . If the foundation of everyone’s favorite economics story is now known to be unsound . . . then the profession owes the world a bit of an explanation.
3. The autonomy of the firm and access to capital markets is key
The point is this: If a deterministic story about free markets generating optimal prices, leading to maximum output was no longer viable, then the failure of planned economies could hardly be attributed to the absence of those features. As Communist systems were collapsing in Eastern Europe, economists who had lost faith in the neoclassical narrative began to argue that an alternative explanation was needed. The most prominent theorist in this group was Joseph Stiglitz, who had become famous for his work on the economics of information. His arguments dovetailed with those of other dissenters from the neoclassical approach, like the eminent Hungarian scholar of planned economies, János Kornai, and evolutionary economists like Peter Murrell.
They all pointed to a number of characteristics, largely ignored by the neoclassical school, that better accounted for the ability of market economies to avoid the problems plaguing centrally planned systems. The aspects they emphasized were disparate, but they all tended to arise from a single, rather simple fact:in market systems firms are autonomous.
That means that within the limits of the law, a firm may enter a market; choose its products and production methods; interact with other firms and individuals; and must close down if it cannot get by on its own resources. As a textbook on central planning put it, in market systems the presumption is “that an activity may be undertaken unless it is expressly prohibited,” whereas in planned systems “the prevailing presumption in most areas of economic life is that an activity may not be undertaken unless permission has been obtained from the appropriate authority.” The neoclassical fixation with ensuring that firms exercised this autonomy in a laissez-faire environment — that restrictions on voluntary exchange be minimized or eliminated — was essentially beside the point.
Thus, free entry and multiple autonomous sources of capital mean that anyone with novel production ideas can seek resources to implement their ideas and don’t face a single veto point within a planning apparatus. As a result, they stand a much greater chance of obtaining the resources to test out their ideas. This probably leads to more of the waste inherent in failed experiments — but also far greater scope for improved products and processes, and a constantly higher rate of technological improvement and productivity growth.
Firms’ autonomy to choose their products and production methods means they can communicate directly with customers and tailor their output to their needs — and with free entry customers can choose between the output of different producers: no agency needs to spell out what needs to be produced. To illustrate the relative informational efficiency of this kind of system, Stiglitz cited a Defense Department contract for the production of plain white t-shirts: in the tender for bidding, the physical description of the t-shirt desired ran to thirty small-print pages. In other words, a centralized agency could never learn and then specify every desired characteristic of every product.
Meanwhile, East European economists realized that an essential precondition for firms to be truly autonomous was the existence of a capital market — and this helped explain the failure of Hungary’s market-oriented reforms. In seeking an explanation for the persistence of shortages under the new market system, the Hungarian economist János Kornai had identified a phenomenon that he called the “soft budget constraint” — a situation where the state continually transfers resources to loss-making firms to prevent them from failing. This phenomenon, he argued, was what lay behind the shortage problem in Hungary: expecting that they would always be prevented from going bankrupt, firms operated in practice without a budget constraint, and thus exerted limitless demand for materials and capital goods, causing chronic production bottlenecks.
But why did the state keep bailing out the troubled firms? It’s not as if the Hungarian authorities were opposed to firm failures on principle. In fact, when bankruptcies did happen, the Communist leadership treated them as public relations events, to demonstrate their commitment to a rational economic system.
The ultimate answer was the absence of a capital market. In a market economy, a troubled firm can sell part or all of its operations to another firm. Or it can seek capital from lenders or investors, if it can convince them it has the potential to improve its performance. But in the absence of a capital market, the only practical options are bankruptcy or bailouts. Constant bailouts were the price the Hungarian leadership was forced to pay to avoid extremely high and wasteful rates of firm failures. In other words, capital markets provide a rational way to deal with the turbulence caused by the hard budget constraints of market systems: when a firm needs to spend more than its income, it can turn to lenders and investors. Without a capital market, that option is foreclosed." (https://www.jacobinmag.com/2012/12/the-red-and-the-black/)
The Parecon Proposals
Seth Ackerman finds them wanting:
"As it happens, an attempt has been made to spell out exactly what would be required for economic calculation in a world with no states or markets. The anarchist activist Michael Albert and the economist Robin Hahnel have devised a system they call Participatory Economics in which every individual’s freely made decisions about production and consumption would be coordinated by means of a vast society-wide plan formulated through a “participatory” process with no central bureaucracy.
Parecon, as it’s called, is an interesting exercise for our purposes, because it rigorously works out exactly what would be needed to run such an “anarchist” economy. And the answer is roughly as follows: At the beginning of each year, everyone must write out a list of every item he or she plans to consume over the course of the year, along with the quantity of each item. In writing these lists, everyone consults a tentative list of prices for every product in the economy (keep in mind there are more than two million products in Amazon.com’s “kitchen and dining” category alone), and the total value of a person’s requests may not exceed his or her personal “budget,” which is determined by how much he or she promises to work that year.
Since the initial prices are only tentative estimates, a network of direct-democratic councils must feed everyone’s consumption lists and work pledges into computers, in order to generate an improved set of prices that will bring planned levels of production and consumption (supply and demand) closer to balance. This improved price list is then published, which kicks off a second “iteration” of the process: now everyone has to rewrite their consumption requests and work pledges all over again, according to the new prices. The whole procedure is repeated several times until supply and demand are finally balanced. Eventually, everyone votes to choose between several possible plans.
In their speaking and writing, Albert and Hahnel narrate this remarkable process to show how attractive and feasible their system would be. But for many people — I would include myself in this group — the effect is exactly the opposite. It comes off instead as a precise demonstration of why economic calculation in the absence of markets or state planning would be, if perhaps not impossible in theory, at least impossible to imagine working in a way that most people could live with in practice. And Parecon is itself a compromise from the purist’s point of view, since it violates the principle “from each according to ability, to each according to need” — individuals’ consumption requests are not allowed to exceed their work pledges. But of course without that stipulation, the plans wouldn’t add up at all." ((https://www.jacobinmag.com/2012/12/the-red-and-the-black/))
The failure of really-existing Central Planning
"Why not a centrally planned economy where the job of economic calculation is handed over to information-gathering experts — democratically accountable ones, hopefully. We actually have historical examples of this kind of system, though of course they were far from democratic. Centrally planned economies registered some accomplishments: when Communism came to poor, rural countries like Bulgaria or Romania they were able to industrialize quickly, wipe out illiteracy, raise education levels, modernize gender roles, and eventually ensure that most people had basic housing and health care. The system could also raise per capita production pretty quickly from, say, the level of today’s Laos to that of today’s Bosnia; or from the level of Yemen to that of Egypt.
But beyond that, the system ran into trouble. Here a prefatory note is in order: Because the neoliberal Right has habit of measuring a society’s success by the abundance of its consumer goods, the radical left is prone to slip into a posture of denying this sort of thing is politically relevant at all. This is a mistake. The problem with full supermarket shelves is that they’re not enough — not that they’re unwelcome or trivial. The citizens of Communist countries experienced the paucity, shoddiness and uniformity of their goods not merely as inconveniences; they experienced them as violations of their basic rights. As an anthropologist of Communist Hungary writes, “goods of state-socialist production . . . came to be seen as evidence of the failure of a state-socialist-generated modernity, but more importantly, of the regime’s negligent and even ‘inhumane’ treatment of its subjects.”
In fact, the shabbiness of consumer supply was popularly felt as a betrayal of the humanistic mission of socialism itself. A historian of East Germany quotes the petitions that ordinary consumers addressed to the state: “It really is not in the spirit of the human being as the center of socialist society when I have to save up for years for a Trabant and then cannot use my car for more than a year because of a shortage of spare parts!” said one. Another wrote: “When you read in the socialist press ‘maximal satisfaction of the needs of the people and so on’ and … ‘everything for the benefit of the people,’ it makes me feel sick.” In different countries and languages across Eastern Europe, citizens used almost identical expressions to evoke the image of substandard goods being “thrown at” them.
Items that became unavailable in Hungary at various times due to planning failures included “the kitchen tool used to make Hungarian noodles,” “bath plugs that ﬁt tubs in stock; cosmetics shelves; and the metal box necessary for electrical wiring in new apartment buildings.” As a local newspaper editorial complained in the 1960s, these things “don’t seem important until the moment one needs them, and suddenly they are very important!”
And at an aggregate level, the best estimates show the Communist countries steadily falling behind Western Europe: East German per capita income, which had been slightly higher than that of West German regions before World War II, never recovered in relative terms from the postwar occupation years and continually lost ground from 1960 onwards. By the late 1980s it stood at less than 40% of the West German level.
Unlike an imaginary economy with no states or markets, the Communist economies did have an economic calculation mechanism. It just didn’t work as advertised." (https://www.jacobinmag.com/2012/12/the-red-and-the-black/)
Socialized Capital Markets
"As resistance against Communism rose, those in Eastern Europe who wished to avoid a turn to capitalism drew the appropriate lessons. In 1989, the dissident Polish reform economists Włodzimierz Brus and Kazimierz Łaski — both convinced socialists and disciples of the distinguished Marxist-Keynesian Michał Kalecki — published a book examining the prospects for East European reform. Both had been influential proponents of democratic reforms and socialist market mechanisms since the 1950s.
Their conclusion now was that in order to have a rational market socialism, publicly-owned firms would have to be made autonomous — and this would require a socialized capital market. The authors made it clear that this would entail a fundamental reordering of the political economy of East European systems — and indeed of traditional notions of socialism. Writing on the eve of the upheavals that would bring down Communism, they set out their vision: “the role of the owner-state should be separated from the state as an authority in charge of administration. . . .[E]nterprises . . . have to become separated not only from the state in its wider role but also from each other.”
The vision Brus and Łaski sketched was novel: a constellation of autonomous firms, financed by a multiplicity of autonomous banks or investment funds, all competing and interacting in a market — yet all nevertheless socially owned."
"What is needed is a structure that allows autonomous firms to produce and trade goods for the market, aiming to generate a surplus of output over input — while keeping those firms public and preventing their surplus from being appropriated by a narrow class of capitalists. Under this type of system, workers can assume any degree of control they like over the management of their firms, and any “profits” can be socialized— that is, they can truly function as a signal, rather than as a motive force. But the precondition of such a system is the socialization of the means of production — structured in a way that preserves the existence of a capital market. How can all this be done?
Start with the basics. Private control over society’s productive infrastructure is ultimately a financial phenomenon. It is by financing the means of production that capitalists exercise control, as a class or as individuals. What’s needed, then, is a socialization of finance — that is, a system of common, collective financing of the means of production and credit. But what does that mean in practice?
It might be said that people own two kinds of assets. “Personal” assets include houses, cars, or computers. But financial assets — claims on money flows, like stocks, bonds, and mutual funds — are what finance the productive infrastructure. Suppose a public common fund were established, to undertake what might be euphemistically called the “compulsory purchase” of all privately-owned financial assets. It would, for example, “buy” a person’s mutual fund shares at their market price, depositing payment in the person’s bank account. By the end of this process, the common fund would own all formerly privately-owned financial assets, while all the financial wealth of individuals would be converted into bank deposits (but with the banks in question now owned in common, since the common fund now owns all the shares).
No one has lost any wealth; they’ve simply cashed out their stocks and bonds. But there are far-reaching consequences. Society’s means of production and credit now constitute the assets of a public fund, while individuals’ financial wealth balances are now its liabilities. In other words, the job of intermediating between individuals’ money savings and society’s productive physical assets that used to be performed by capitalist banks, mutual funds, and so on, has been socialized. The common fund can now reestablish a “tamed” capital market on a socialized basis, with a multiplicity of socialized banks and investment funds owning and allocating capital among the means of production.
The lesson here is that the transformation to a different system does not have to be catastrophic. Of course, the situation I’m describing would be a revolutionary one — but it wouldn’t have to involve the total collapse of the old society and the Promethean conjuring of something entirely unrecognizable in its place.
At the end of the process, firms no longer have individual owners who seek to maximize profits. Instead, they are owned by society as a whole, along with any surplus (“profits”) they might generate. Since firms still buy and sell in the market, they can still generate a surplus (or deficit) that can be used to judge their efficacy. But no individual owner actually pockets these surpluses, meaning that no one has any particular interest in perpetuating or exploiting the profit-driven mis-valuation of goods that is endemic under capitalism. The “social democratic solution” that was once a contradiction — selectively frustrating the profit motive to uphold the common good, while systematically relying on it as the engine of the system — can now be reconciled.
To the same end, the accrual of interest to individuals’ bank deposits can be capped at a certain threshold of wealth, and beyond that level it could be limited to simply compensate for inflation. (Or the social surplus could be divided up equally among everyone and just paid out as a social dividend.) This would yield not exactly the euthanasia of the rentier, but of the rentier “interest” in society. And while individuals could still be free to start businesses, once their firms reached a certain size, age and importance, they would have to “go public”: to be sold by their owners into the socialized capital market.
What I’m describing is, in one sense, the culmination of a trend that has been proceeding under capitalism for centuries: the growing separation of ownership from control. Already in the mid-nineteenth century, Marx marveled at the proliferation of what we now call corporations: “Stock companies in general — developed with the credit system — have an increasing tendency to separate this work of management as a function from the ownership of capital, be it self-owned or borrowed. Just as the development of bourgeois society witnessed a separation of the functions of judges and administrators from land-ownership, whose attributes they were in feudal times.” Marx thought this development highly significant: “It is the abolition of capital as private property within the framework of capitalist production itself.”
By the 1930s this “socialized private property” had become the dominant productive form in American capitalism, as Adolf Berle and Gardiner Means signaled in The Modern Corporation and Private Property. The managerial-corporate model seemed to face a challenge in the 1980s when capitalist owners, dissatisfied with languishing profit rates, launched an offensive against what they saw as lax and complacent corporate managers. This set off a titanic intra-class brawl for control of the corporation that lasted more than a decade. But by the late 1990s, the result was a self-serving compromise on both sides: CEOs retained their autonomy from the capital markets, but embraced the ideology of “shareholder value”; their stock packages were made more sensitive to the firm’s profit and stock-market performance, but also massively inflated. In reality, none of this technically resolved the problem of the separation of ownership and control, since the new pay schemes never came close to really aligning the pecuniary interests of the managers with the owners’. A comprehensive study of executive pay from 1936 to 2005 by MIT and Federal Reserve economists found that the correlation between firms’ performance and their executives’ total pay was negligible — not only in the era of mid-century managerialism, but throughout the whole period.
In other words, the laboratory of capitalism has been pursuing a centuries-long experiment to test whether an economic system can function when it severs the one-to-one link between the profits of an enterprise and the rewards that accrue to its controllers. The experiment has been a success. Contemporary capitalism, with its quite radical separation of ownership and control, has no shortage of defects and pathologies, but an inattention to profit has not been one of them.
How should these socialized firms actually be governed? A complete answer to that question lies far beyond the scope of an essay like this; minutely describing the charters and bylaws of imaginary enterprises is exactly the kind of Comtist cookshop recipe that Marx rightly ridiculed. But the basic point is clear enough: since these firms buy and sell in the market, their performance can be rationally judged. A firm could be controlled entirely by its workers, in which case they could simply collect its entire net income, after paying for the use of the capital.2 Or it could be “owned” by an entity in the socialized capital market, with a management selected by that entity and a strong system of worker co-determination to counterbalance it within the firm. Those managers and “owners” could be evaluated on the relative returns the firm generates, but they would have no private property rights over the absolute mass of profits.3If expectations of future performance needed to be “objectively” judged in some way, that is something the socialized capital markets could do.
Such a program does not amount a utopia; it does not proclaim Year Zero or treat society as a blank slate. What it tries to do is sketch a rational economic mechanism that denies the pursuit of profit priority over the fulfillment of human needs. Nor does it rule out further, more basic changes in the way humans interact with each other and their environment — on the contrary, it lowers the barriers to further change." (https://www.jacobinmag.com/2012/12/the-red-and-the-black/)
The Proposals for replacing money with labour certificates, by Cockshott and Cottrell
Nick Dyer-Witheford in Red Plenty Platforms:
...its twenty-first century super-computer planning follows to the letter the logic of the late nineteenth century Critique of the Gotha Program (Marx, 1970), which famously suggests that at the first, ‘lower’ stage to communism, before conditions of abundance allow ‘to each according to his needs’, remuneration will be determined by the hours of socially necessary labour required to produce goods and services. In the capitalist workplace, workers are paid for the reproduction of the capacity to labour, rather than for the labour actually extracted from them; it is this that enables the capitalist to secure surplus value.
The elimination of this state of affairs, Cockshott and Cottrell contend, requires nothing less than the abolition of money—that is, the elimination of the fungible general medium of exchange that, through a series of metamorphoses of money in and out of the commodity form, creates the self-expanding value that is capital. In their new Socialism, work would be remunerated in labour certificates; an hour’s work could be exchanged for goods taking, on a socially average basis, an equivalent time to produce. The certificates would be extinguished in this exchange; they would not circulate, and could not be used for speculation. Because workers would be paid the full social value of their labour, there would be no owner profits, and no capitalists to direct resource allocation. Workers would, however, be taxed to establish a pool of labour-time resources available for social investments made by planning boards whose mandate would be set by democratic decisions on overall social goals.
Cockshott and Cottrell’s answer [to the Calculation Problem] involves new tools, both conceptual and technical. The theoretical advances are drawn from branches of computing science that deal with abbreviating the number of discrete steps needed to complete a calculation. Such analysis, they suggest, shows their opponents’ objections are based on ‘pathologically inefficient’ methods (Cockshott, in Shalizi, 2012).
The input-output structure of the economy is, they point out, ‘sparse’—that is to say, only a small fraction of the goods are directly used to produce any other good. Not everything is an input for everything else: yogurt is not used to produce steel. The majority of the equations invoked to suggest insuperable complexity are therefore gratuitous. An algorithm can be designed to short-cut through input-output tables, ignoring blank entries, iteratively repeating the process until it arrives at a result of an acceptable order of accuracy."
P2P Proposals for a Mutual Coordination economy through Stigmergy
For more details, see our special section on Mutual Coordination Economics.
"0. What market pricing is to capitalism and planning is to state-based production, mutual coordination is to commons-based peer production!
1. Today we have the emergence of a new proto-system of production, Commons-Based Peer Production in which contributors are free to contribute to a common pool of shareable knowledge, code and design, which may be associated through physical production in microfactories using distributed machinery such as 3D printing.
2. This emerging new system of value creation and distribution is not sustainable if contributors need to find work as labour for capital, so contributors need to be able to generate livelihoods for themselves, keeping the generation of surplus value within the sphere of the commons and its contributors.
3. To achieve this, we advocate the use of Commons-Based Reciprocity Licenses such as the Peer Production License. This allows for the creation of a non-capitalist 'counter' economy based on Open Cooperativism and other forms of an ethical economy. In this proposal, the commoners or peer producers, i.e. the contributors to the commons, are also cooperators of their own corporate entities, which create livelihoods and insure the surplus value remains within the commons. So, in between the sphere of the accumulation of the commons (open input, participatory process, commons-oriented output), and the sphere of capital accumulation, there is a intermediary sphere of cooperative production, which regulates physical production and the social reproduction of the commoners-cooperators.
4. The production of immaterial common pools is already regulated through mutual coordination and stigmergy, i.e. coordination based on open and transparent signals of what is needed by the system; but physical production cannot be coordinated without similar signals, i.e. the coordination of production through information. It is therefore a next logical step to advocate and practice, within the ethical entrepreneurial coalitions that coalesce around particular commons through their shared adherence to the commons-based licenses, to also practice open accounting and open supply-chains and logistics. This means that within these coalitions, physical production can also be coordinated through stigmergic signals; and negotiated coordination and even voluntary common planning can take place on the basis of the shared production information."
* Article: The economic calculation debate: lessons for socialists. By Fikret Adaman and Pat Devine. Cambridge Journal of Economics. Vol. 20, No. 5 (September 1996), pp. 523-537 (15 pages)
"This paper summarises the standard account of the economic calculation debate, the modern Austrian reinterpretation of the debate based on the centrality of tacit knowledge and discovery, and a neglected third strand in the historical debate, Dobb's insistence on the uncertainty associated with atomistic decision making and the need for ex ante planning. It then draws some lessons for socialists from the debate and considers a possible market socialist response to the modern Austrian challenge. The paper ends by outlining a model of participatory planning which incorporates both the modern Austrians' insight into the importance of tacit knowledge and Dobb's insistence on ex ante coordination."
- Allin Cottrell and W. Paul Cockshott, ‘Calculation, Complexity and Planning: The Socialist Calculation Debate Once Again’, Review of Political Economy, vol. 5, no. 1, 1993, pp. 73–112;
- Cottrell and Cockshott, ‘Computers and Economic Democracy’, New Historical Project, 8 April 2003;
- Nick Dyer-Witheford, ‘Red Plenty Platforms’, Culture Machine, vol. 14, 2013; Ionela Bălţătescu and Petre Prisecaru, ‘Computability and Economic Planning’, Kybernetes, vol. 38, no. 7–8, 2009, pp. 1399–1408;
- Erick Limas, ‘Cybersocialism: A Reassessment of the Socialist Calculation Debate’, 4 February 2018, available at ssrn.
- Daniel Saros. Information Technology and Socialist Construction.
- Leigh Phillips and Michal Rozworski, The People’s Republic of Walmart: How the World’s Biggest Corporations are Laying the Foundation for Socialism, London and New York 2019.
- Johanna Bockman, Markets in the Name of Socialism: The Left-Wing Origins of Neoliberalism, Stanford 2011.