Economic Calculation Problem

Introduction

An argument about the impossibility of economic planning has been going around since the 1920’s called the Calculation Problem.

Wikipedia says,

"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."

Description

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.[1][2] 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.[citation needed]

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.[1] He wrote "...that rational economic activity is impossible in a socialist commonwealth."[1] 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)

Discussion

Jean-Daniel Cusin:

"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 that, 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."

But also:

"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.

Moreover:

"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."