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May 20, 2013

Socialist Calculation IV: Information, the Market Order, and Beyond

This is the fourth and last in a series of posts on the socialist calculation debate. Here are parts one, two, and three.

In previous installments we looked at some of the problems that one might face in trying to plan an entire economy mathematically, with reference to a set of price-optimizing equations.

Let’s grant though that we could solve all of these problems—we have computers to solve the equations; we can generate a good enough approximation of the set of equations itself; and we can solve the problem of pricing capital goods.

Still, the planners don’t have the data they need about consumer preferences to put into the equations. Recall that in part III, Soviet economist Leonid Kantorovich simply took as a given the menu of consumer goods and the quantities that had to be supplied for each. He then developed optimization methods that would allocate labor efficiently. Assuming, again, that the list of goods was correct.

As it turns out, that’s a very big problem.

IV. Consumers’ Preferences

F. A. Hayek’s distinctive contribution to the socialist calculation debate, over and above that of Ludwig von Mises,[1] was essentially to ask where the data might be found to do economic calculation about consumers’ preferences themselves. (And by extension, producers’ preferences.)

Who has that data? The simplest answer is that everyone has a tiny little piece of it. It’s dispersed among all of us, because each person has a list of consumption goods that they may desire to varying degrees in varying circumstances, as various needs and opportunities arise.

Whenever the needs and opportunities align just so, a given consumer good rises to the top of our list. And we act to acquire it. When we do, prices will emerge.

Yet prices only tell us a part of the story — they tell us that buyers and sellers were able to agree at a given time and place. Often, prices can signal an opportunity, as when a supplier discovers that he or she can undercut the current market price and realize a profit.

But prices in themselves say nothing about other possible agreements that might have arisen in other circumstances. They also say very little about the future: As soon as a price occurs, it’s history. The entrepreneur who discovers that he or she can undercut the current market price still has to get to market. That takes time, and when they get there, the market price may have changed. That’s a risk that entrepreneurs have to take. Consumer demand is fickle and inherently hard to predict.

It’s also very likely that you can’t articulate beforehand just what your list of preferred consumer goods really looks like, including how much you would buy of various goods at various prices. No one really can.

Your list also probably changes very rapidly. Every unexpected event alters your preference set to some degree. Every disaster, every unexpected discovery, every windfall, and every loss. Every new product you didn’t know about before. Every old product that disappears from the market. Every single change upsets everything — all in a hierarchy of values that you can’t even begin to articulate in the first place. 

Weirder still: There are items on your “list” that you don’t know about and never will.

It sounds very strange to put it that way, I know. But we have all had an experience that demonstrates it. We’ve all at one time or another walked into a store, discovered a product, and then bought it — all while having known nothing about it in advance.

Here we must start speaking of a “list” of consumer demands only for want of a better term. If it were to be drawn up comprehensively, such a list would include an infinite number of products, past and present, that aren’t generally available on the market, that are unknown to any of us, and that are therefore of unknown subjective value. Until the opportunity arises, and we act, and only then do potential entrepreneurs get a glimpse into consumer demand.

Much like the concept of a “good” — covered in part two — the concept of a consumer demand hierarchy is a conceptual crutch. It’s not a real thing at all. Markets reveal preferences, but in a sense they also make preferences, because consumers choose only among those options that are available to them, and because we can only speak then, in retrospect, about their having acted as if there were a hierarchy of wants.

Consumers have preferences, no question. They act on those preferences. But can they articulate them? Not in the way that we would need to do planning.

As a result, socialist calculation can’t ever really get off the ground. At least not without some kind of incredibly reliable and thus very probably dystopian brain scanning technology. While we’re at it, we’d need a complete knowledge of all upcoming natural disasters, technological changes, fads, and cultural phenomena that will arrive in the near and distant future. This though is an impossibility — if we knew what technologies or cultural developments the future held, we would have them right now, and they wouldn’t be “future” developments at all.

But without them, we can’t reliably model of consumer preferences over time. And without that, we can’t predict the value of capital goods over time either.

V. And Equilibrium, Too.

Recall that socialist calculation proposed to head straight for the Walrasian general equilibrium — a state of efficiency that markets have never actually reached. Even if socialism only got part of the way there, it might still be better than a market. Right?

Well, yes. It might be, although that’s not altogether clear from the outset.

It’s illuminating to consider now why markets don’t reach equilibrium.[2] Scientific socialists argued that markets were inherently inefficient — all this groping about, trying to find the right prices and quantities by trial and error, and so much attendant waste. In this they were certainly correct, given the assumptions they were using.

There’s another answer, though, and a much more complete one. As Hayek writes:

[I]n order that all [the plans of various people in an economy] be carried out, it is necessary for them to be based on the expectation of the same set of external events, since, if different people were to base their plans on conflicting expectations, no set of external events could make the execution of all these plans possible. And, second, in a society based on exchange their plans will to a considerable extent provide for actions which require corresponding actions on the part of other individuals. This means that the plans of different individuals must in a special sense be compatible if it is to be even conceivable that they should be able to carry all of them out. Or, to put the same thing in different words, since some of the data on which any one person will base his plans will be the expectation that other people will act in a particular way, it is essential for the compatibility of the different plans that the plans of the one contain exactly those actions which form the data for the plans of the other.

In the traditional treatment of equilibrium analysis part of this difficulty is apparently avoided by the assumption that the data, in the form of demand schedules representing individual tastes and technical facts, are equally given to all individuals and that their acting on the same premises will somehow lead to their plans becoming adapted to each other. That this does not really overcome the difficulty created by the fact that one person’s actions are the other person’s data, and that it involves to some degree circular reasoning, has often been pointed out. What, however, seems so far to have escaped notice is that this whole procedure involves a confusion of a much more general character, of which the point just mentioned is merely a special instance, and which is due to an equivocation of the term “datum.” The data which here are supposed to be objective facts and the same for all people are evidently no longer the same thing as the data which formed the starting-point for the tautological transformations of the Pure Logic of Choice. There “data” meant those facts, and only those facts, which were present in the mind of the acting person, and only this subjective interpretation of the term “datum” made those propositions necessary truths. “Datum” meant given, known, to the person under consideration. But in the transition from the analysis of the action of an individual to the analysis of the situation in a society the concept has undergone an insidious change of meaning. (F.A. Hayek, “Economics and Knowledge,” in Individualism and Economic Order.)

In short, I need to know all of what I know, as well as all of what you know. But I don’t even know all of what I know: My brain’s not big enough to hold and analyze a copy of itself. No one’s is. And much economic activity aims, ultimately, not at acquiring wealth or goods, but at acquiring knowledge about what people might want.

As a result, Austrian economists in particular reject economic equilibrium as a yardstick with which to measure the real world. Still, though, equilibrium gives us an idea of how economic interests attempt to interact with one another, and so — up to that point — it’s useful. But the ways in which we fall short of equilibrium are much more interesting: They are both the reasons for economic action and also the proper study of economists.

VI. Beyond the Market

As we’ve seen, a social order that proposes to surpass the market will have to accomplish many things. First, it will have to solve the problem of economic knowledge outlined above as well or better than existing economies, or perhaps better than what an ideal free-market economy might do.

But if we value individual autonomy, we may also have to take steps to preserve it. It might be found, for example, that we could create autonomous economic production agents — hyperintelligent robots, say — that could go around brain-scanning people and then making stuff and distributing it according to rules of utility maximization.

This process might work better than markets. But we might feel less than okay about it when the robots come and level the house we thought we owned. “It’s more efficient to build a factory here,” they say, “and your compensation will take the form not of a cash payment, but of the greater overall utility to be found in our system.”

If you prefer, the problem can be stated in cartoon form.

The system of private property certainly doesn’t protect individual autonomy perfectly. People routinely experience degrading conditions under every economic system mankind has ever implemented. Still, security of property title does a great deal of good work in this area that we might not want to abandon even if it did realize greater efficiency.

It also seems unlikely that trans-market social orders will be able to dispense with the principle of specialization and gains from exchange. As long as individuals and regions have varying production capacities of different goods and services, comparative advantage will be a real thing, and reassignment of goods — trade, in our world — will be a necessity for maximizing welfare. Perhaps in the technologically unimaginable future that reassignment won’t commonly happen through voluntary exchange at market prices, but it will have to happen somehow.

As a blueprint for the future that’s not much to go on, I know. It doesn’t point to scientific socialism, or to much of anything else. Future social orders may end up being very different from our own, but I don’t think it likely that they will move beyond markets in one form or another. And sure, they may tell themselves they have surpassed the market, but we know what that looks like.


Notes

[1] It’s wrong to claim, as some have done, that Ludwig von Mises discounted or neglected the problem of incentives in socialist societies. Although focused most of his attention on certain aspects of the calculation problem, in the very same article that began this series we also read:

The problem of responsibility and initiative in socialist enterprises is closely connected with that of economic calculation. It is now universally agreed that the exclusion of free initiative and individual responsibility, on which the successes of private enterprise depend, constitutes the most serious menace to socialist economic organization… Since we are in a position to survey decades of State and socialist endeavor, it is now generally recognized that there is no internal pressure to reform and improvement of production in socialist undertakings, that they cannot be adjusted to the changing conditions of demand, and that in a word they are a dead limb in the economic organism.

As I so often find with Mises, that’s very prescient for a guy writing in the 1920s.

[2] Given that the concept of “equilibrium” depends on the concept of “goods,” a concept that we have already shown to face severe limits, what follows may be true for more than one reason.

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