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Mises vs. the Socialists: The Economic Calculation Argument

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I gave this talk last night for the Evergreen Tea Party. Below are my notes.

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Intro:

Why I wanted to talk about this.

Soviet Union – the beginnings:

Lenin comes to power in October 1917. Soviet Union is born and the socialist economy begins.

Lenin an interesting character. What he thought reveals a lot about why central planning fails.

Lenin smarter than managers, businessmen he knew. Running an economy is like running a business! It’s going to easy!

From Oct 1917 to Dec 1991, many people pointed out the many problems with the socialist economy.

Mises writes “Economic Calculation in the Socialist Commonwealth” in 1920.

Problems with socialism:

Several problems with the socialist economy arise. Socialists respond:

  1. Incentive problem – who will take out the trash? Why work hard? Answer: we’ll create a new socialist man.
  2. Knowledge problem – what do people want/need? How many loaves of bread in St. Petersberg? Answer: Our leaders know better what our people want than they do. Theoretically, if our leaders had complete information, socialism could work. (Hayek agreed).
  3. Perverse incentive problem – the political leader is king, not the consumer. Make one gigantic nail or millions of small nails. Answer: Our new man will overcome these miscommunications.
  4. Entrepreneurship problem – Why innovate? Where will new, undiscovered products come from? We’ll look at the rest of the world. We’ll study innovations and new procedures. Plus, we know better what our people want anyway.
  5. Economic calculation problem – the only problem that is not overcome even after granting ALL assumptions.

The economic calculation problem – when government owns the means of productions (factors of production), there is no market for capital goods. Or as Mises says, goods of a higher order. Without a market for capital goods, there are no market prices for capital goods. Without prices for capital goods, there cannot be any profit and loss accounting – in other words, no economic calculation. Thus, there is no way to rationally allocate scare factors of production. Even if the central planners knew exactly what to produce, they would have no idea HOW to produce it. The economy is stuck in a state of shock. Socialism is literally impossible.

Mises called this the paradox of planned economies. “The paradox of planning is that it cannot plan because of the absence of economic calculation. What is called a planned economy is no economy at all. It is just a system of groping about in the dark.”

Seems simple enough. Implications are HUGE.

“Impossible” is a hyperbole?

Granting the assumptions above, we have the fundamental calculation problem: with no prices to guide the production process, planners have no idea which productions plans/materials to choose out of the infinite combinations. If they “grope in the dark” and choose one, they have no idea if it was the right one after the fact!

Even if the socialists have been able to create a mighty army of citizens all eager to do the bidding of their masters, what exactly would the socialist planners tell this army to do?

How would they know what products to order their eager slaves to produce, at what stage of production, how much of the product at each stage, what techniques or raw materials to use in that production and how much of each, and where specifically to locate all this production? How would they know their costs, or what process of production is or is not efficient?

The result? Shortages and surpluses found everywhere. Field ready to be farmed but without the gas to drive the tractors or people to drive them. IOW, millions of people starve to death and millions more on the brink of death.

Had REAL consequences for REAL people!

War Communism – Soviet experience. The economy produced a fraction of what it produced before WC. Workers fled the cities for the farms in order to be closer to food production. Estimated 3 to 10 million people died.

“The collapse of the productive forces surpassed anything of the kind that history had ever seen. The country, and the government with it, were at the very edge of the abyss.” -Leon Trotsky on war communism

WC replaced by the NEP after a destructive 4 years.

Breakdown:

When government owns the factors of production, there is no market for production goods. No market means no trade in the realm of higher order goods.

Why is this important? When trade exists, what is the result? Prices! AKA exchange ratios. Prices are “social phenomena.”

Why are prices important? Embedded information! Example: You don’t need to know there was a big storm in Florida to know that you should economize (ration) oranges. You see the price went up and therefore, buy less.

In addition to providing the basis of profit and loss, prices convey information to entrepreneurs about the resources available in the economy. It tells them what resources are in abundance and what resources are scarce.

Prices guide what is to be used, how much of it to use, when to use it, and when to stop using it.

Example: We own a pizza shop. Pepperoni is scarce. The price for getting our pepperoni went up and we don’t know why. First scenario, you increase the price of your pepperoni pie and consumers gladly pay it. Second, you increase the price of your pepperoni pie and consumers do not want to pay it. What is the result? At that particular time, at that particular place, pepperoni was better used somewhere else. It was “needed” more elsewhere. Prices told us that if we were to continue to use as much pepperoni as before, we would not be maximizing total consumer satisfaction. IOW, our pizza shop was wasting valuable resources.

Important Austrian insight concerning capital:

Prices and calculation would be a lot less important if capital were homogenous or if all capital were 100% specific.

Capital is heterogeneous! Capital goods are not 100% specific or identical. They have different uses and differing values. They can be employed for various means. There are an infinite amount of ways you can produce electricity or make hamburgers. How on earth do you decide what procedure to use? Where to locate?

Money:

Calculation requires a common medium of exchange, aka money.

Example: I ran 5, he ran 10. Who ran longer?

Money is what allows the profit and loss test. Why is the profit and loss test so important?

Without money as the common denominator, there exists no way to compare differing factors of production and structures of production. “Money is the vehicle of economic calculation.”

Money is the means of putting all competing interests on the same level playing field. The baker must compete with the cobbler. The cobbler must compete with the pizza guy. The pizza guy must compete with the Wall St executive. And so on.

All these differing interests compete with one another for the scarce higher order goods and labor. Only with money can they determine whether their actions are satisfying consumer desires.

Real world example:

Granting all assumptions to socialists, here is an example: We “know” we must produce 1,000 purses. With no money prices at a level beyond final consumer goods, how do we figure out HOW to produce 1,000 purses? How much labor should we employ? Should we have just a couple of workers and lots of machinery or lots of workers making them by hand? What material should the purses be made of? Cotton, suede, leather, canvas, wool, etc? If we choose suede, how should we obtain the suede? And on and on and on…

Being advanced technologically can tell you exactly HOW to produce 1,000 purses efficiently, but it cannot tell you:

1. Whether you SHOULD produce 1,000 purses

2. What materials to use

3. Where and how to get the materials

4. WHEN to make them

5. WHERE to put your factories.

Mises on technology’s limit: “[Technology] ignores the economic problem:  to employ the available means in such a way that no want more urgently felt should remain unsatisfied because the means suitable for its attainment were employed – wasted – for the attainment of a want less urgently felt.”

Objections to economic calculation:

  1. Play market: We’ll have our factory managers pretend to pursue profit. (not reality. Managers are beholden to the central planners, not the market. They cannot rationally pursue profit. Instead they pursue not getting murdered).
  2. We’ll have our managers trade with each other! (Trade without ownership is meaningless. Again, succumbs to political interests)
  3. We’ll watch the world market and take their prices (ignores circumstances of time, place, resources, labor, subjective valuation etc)
  4. We’ll copy production practices elsewhere (see above).

Implications for today?

I-70 traffic problems?

Single payer health care?

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Written by jlongo12

March 13, 2012 at 10:09 am

Posted in economics

Santorum’s Greatest Hits

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***Updated 3 times at the very bottom***

I have been asked why I believe Santorum is more collectivist and authoritarian than many on the Left. All you have to do is listen to Santorum’s own words. Then, check his record. Let’s start with some great quotes by the man himself:

“They have this idea that people should be left alone, be able to do whatever they want to do, government should keep our taxes down and regulations low, that we shouldn’t get involved in the bedroom or in cultural issues. That is not how traditional conservatives view the world.”

“One of the criticisms I make is to what I refer to as more of a libertarianish right. You know, the left has gone so far left and the right in some respects has gone so far right that they touch each other. They come around in the circle. This whole idea of personal autonomy, well I don’t think most conservatives hold that point of view.”

So far, those are my two favorite Santorum quotes. Clearly he is not apologetic at all for his anti-individual, pro-collective views. Let’s now turn to his record:

The Club for Growth wrote a little bit on Santorum’s dismal voting record a few years back:

“Some of those high profile votes include his support for No Child Left Behind in 2001, which greatly expanded the federal government’s role in education. He supported the massive new Medicare drug entitlement in 2003 that now costs taxpayers over $60 billion a year and has almost $16 trillion in unfunded liabilities. He voted for the 2005 highway bill that included thousands of wasteful earmarks, including the Bridge to Nowhere. In fact, in a separate vote, Santorum had the audacity to vote to continue funding the Bridge to Nowhere rather than send the money to rebuild New Orleans after Hurricane Katrina. In the 2003-2004 session of Congress, Santorum sponsored or cosponsored 51 bills to increase spending, and failed to sponsor or co-sponsor even one spending cut proposal. In his last Congress (2005-2006), he had one of the biggest spending agendas of any Republican — sponsoring more spending increases than Republicans Lisa Murkowski, Lincoln Chafee and Thad Cochran or Democrats Herb Kohl, Evan Bayh and Ron Wyden.”

Then we have the classic Red State roundup of Santorum’s big government record here.

Michael Tanner of National Review had this to say about ol’ Rick:

“He never met an earmark that he didn’t like. In fact, it wasn’t just earmarks for his own state that he favored, which might be forgiven as pure electoral pragmatism, but earmarks for everyone, including the notorious “Bridge to Nowhere.” The quintessential Washington insider, he worked closely with Tom DeLay to set up the “K Street Project,” linking lobbyists with the GOP leadership. He voted against NAFTA and has long opposed free trade. He backed higher tariffs on everything from steel to honey. He still supports an industrial policy with the government tilting the playing field toward manufacturing industries and picking winners and losers.

I could fill this entire blog with commentary about his voting record. Those quotes above are from a quick Google search. If you want the Cliff’s Notes, take a good look at Red State’s post. Otherwise, use your Google machine to dig into his voting record.

Now Santorum again in his own words:

In this video Santorum likens government to the family and maintains the position that people have an obligation to the collective just like they have an obligation to family members. He states that individuals are not responsible for themselves, but to everyone else as well. Unlike the standard Conservative view, he doesn’t believe in personal responsibility. He believes in collective responsibility. He repeats over and over that people should work “for the common good.” Even the Leftist interviewer points out that “working for the common good” is seen by many as a “little pink, a little socialistic.” Santorum disagrees.

Here is Santorum’s tirade against individualism (sorry Ayn Rand). By the way Rick, there is a society that believes in individualism. It’s called America. David Boaz of the Cato Institute then goes on to rip Santorum for being so openly against liberty and freedom.

Here Rick explains that he has “real concerns” about the Tea Party:

Rick defends SOPA here because our rights and freedoms are limited and should be regulated.

I could go on here, but I think I’ve made my point. Never in my life have I witnessed a GOP candidate for any office so openly hostile to the fundamental ideals of liberty and freedom. He does not believe that individuals have inalienable rights that cannot and shall not be infringed by government. In fact, he believes the exact opposite: that whatever rights we have are ours to keep only if government can’t find a good reason to undermine them (take a look at his SOPA answer again if you don’t see that). He most certainly does not believe in “limited government,” but rather, “limited freedom.”

That makes him a collectivist of the worst kind – precisely because many people don’t believe he is.

UPDATE: Santorum doesn’t understand basic economics. Lots of great quotes from the Cato Institute here.

UPDATE II: Reason Magazine nailed it way back in 2005: America’s Anti-Reagan Isn’t Hillary Clinton. It’s Rick Santorum.

UPDATE III: Ari Armstrong makes the case over at the Objective Standard that Santorum is just another big government collectivist. Here’s a small dose: “While Santorum claims to invoke the Founders, his views are diametrically opposed to theirs. The right to the pursuit of happiness is one of the “unalienable rights” the Founders sought to protect in creating America. That’s why it’s specified in the Declaration of Independence.”

Written by jlongo12

February 8, 2012 at 11:17 am

Quotes of the Day

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This from Robert Higgs:

Even Marx understood the economics of war better than the Keynesians do. In the Grundrisse, he wrote: “The impact of war is self-evident, since economically it is exactly the same as if the nation were to drop a part of its capital into the ocean.” Neglecting capital leads Keynesians into error again and again, both coming (to the bust) and going (out of it).

This from Daniel Lin:

If cigarette packs are required to have pictures of diseased lungs, college brochures should be required to have pictures of graduates working at Starbucks.

This from Velogogo:

How long before someone gets “SHUT” and “UP” tattooed on their legs?

This from Ted King:

Look, let’s not kid ourselves, Colorado has been due for a signature bike race for some time now. I feel fairly certain in saying Colorado is the cycling mecca of America.

This from Howard Roark (speaking through Ayn Rand) in the Fountainhead:

It stands to reason that where there’s sacrifice, there’s someone collecting sacrificial offerings. Where there’s service, there’s someone being served. The man who speaks to you of sacrifice, speaks of slaves and masters. And intends to be the master.

Written by jlongo12

August 31, 2011 at 9:25 am

Food Stamps Are No Free Lunch

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I was just alerted that the op-ed I wrote was published in the Summit Daily News today. I also learned that it will be featured in a point, counterpoint in the Denver Business Journal next week. This is exciting for a couple reasons. For one, I rarely ever write for myself. 99% of the writing I do at my job is ghostwriting. It’s nice to have your name in lights every now and again. Secondly, I’ve only penned 3 op-eds in my life, this new one being the third. So far I’m 3 for 3 in getting them placed in newspapers across the state. Score!

In this op-ed I take on some basic economic ignorance I’ve seen spewed across the Internet. This bit of ignorance is the typical Keynesian story about stimulating the economy with government spending. In particular, I take on the food stamp and unemployment insurance “stimulus” fallacy.

Here is the link to the Summit Daily article.

What’s the quick takeaway? I’d say it’s this bit,

Since there is no magic money fairy, food stamp and unemployment programs have to get their money from somewhere. That somewhere is productive people — entrepreneurs, employers, employees, and anyone else who created wealth and earned money. Taking from wealth creators to give to wealth consumers does not “stimulate” our economy or make our country richer.

Written by jlongo12

August 26, 2011 at 2:15 pm

Posted in economics

Thoughts on the Price System

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When Vladimir Lenin came to power in 1917, he mistakenly believed that running the Soviet economy would be easy. I remember reading a quote from him where he more or less said, “I know a lot of businessmen and they are not nearly as smart as I am. If they can run a business successfully, I can run an economy. After all, an economy is just one giant business.” Under War Communism, Lenin and his team nationalized everything and set all the prices in the economy. The result of these actions is not surprising to anyone who understands markets: millions of people died of starvation and Lenin suffered several major uprisings. After 3 years of this, Lenin woke up to the reality of the starving masses and implemented the New Economic Policy (NEP). The NEP was Lenin’s attempt at introducing markets – albeit on a small scale – to his centrally planned Soviet economy. With the introduction of some small markets and market prices (signals), agricultural production soared and many people who would have died under War Communism were fed and survived. The NEP was incredibly successful at pulling the Soviet economy out of its death march.

Where did Lenin go wrong? Lenin suffered from what Hayek called the “fatal conceit.” He believed he could design a functioning economy with the help of some smart friends. What he did not recognize was that markets work because of the decentralization of knowledge and of people acting on that knowledge. Knowledge is tacit, incomplete, local, and diffuse. There is no possible way one man, no matter how smart, can know what millions upon millions of people know individually. Moreover, there is no way one person, or group of people, can accurately replicate the signals that arise from the spreading of knowledge.

Prices are signals traversing from location to location. As people interact with each other in the marketplace using their local, tacit, and incomplete knowledge, prices emerge from the transactions. They contain important information that would be impossible to uncover otherwise. Like whether there is a drought in southern Florida or hoards of gluten-free fans in Boulder. Yes, it would be easy to observe a drought in Florida or gluten-free fanatics in Boulder, but prices reflect what those particular situations mean for the real people interacting there. They quantify the subjective values and desires of the people in Florida and Boulder.  All while simultaneously indicating where scarce resources ought to flow. Additionally, with repeated interactions, prices are never “out of date.” Again, you can observe a drought in Florida, but only prices can dictate how hard the orange community was hit, the depth of the devastation, and how long it will take for them to recover. A person cannot replicate these vital processes.

Prices allow for a profit and loss system. The importance of profit and loss cannot be overstated. Mises proved, long before 1989, that socialism was impossible because a socialist economy “cannot calculate.” What he meant was, when the means of production are owned by the government, there are no markets for these capital goods. Without prices in the capital goods market, there are no prices in the consumer goods market. So what’s the big deal? As the Soviets learned, with no prices to determine what should be made and how much, there is no rational way to determine the allocation of scarce resources. Massive inefficiencies would be putting it lightly.

For example, Lenin knows that his people like bread and vodka. Okay, well how much bread should be made? How much vodka? How much bread should go to St. Petersberg? How many kinds of vodka should be produced? What ratio of bread to vodka makes sense? Do the people want more wheat bread or more oat bread? How the hell do we get bananas over here??? These questions are impossible to answer. Lenin could only guess. Worse, innovation is completely stifled. What incentive is there to come up with new and better products? And how would Lenin know what new and better products people want? (Can you imagine trying to figure out how many soccer balls, nails, and vacuums to make?)

Profit and loss are the measuring stick to determine whether a business is using its resources efficiently. When a business earns a profit, this signal is absolutely crucial. It tells the owner that not only are they using resources efficiently, they are providing a good or service to consumers that they want and in a way that pleases them. On the contrary, when a business loses money, it is a signal that they need to shape up or go under. The loss part of the profit and loss scenario is just as critical, if not more so, than the profit part. Losses are what weed out bad businesses and transfer their previously owned labor and resources elsewhere, where they can be put to better use. (Side note: this is yet another reason why bailouts are so devastating to an economy. You destroy wealth by insulating bad companies from going under).

Mises’ a priori critique of socialism was devastating in that it conceded all the assumptions that socialists wanted (a “new socialist man,” observing world prices and using them, altruistic responses to incentives, etc) and still defeated them. Without prices, an economy cannot rationally allocate scarce resources. Without prices, there is no profit and loss mechanism to alert the planners of what is working and what is not. It is literally impossible to not starve a population on a massive scale if a country rejects markets and attempts to centrally plan their economy.

Lenin was no doubt a very smart man. Definitely smarter than anyone I’ve ever met. But he could not know, nor replicate, the knowledge embedded in the price signals that emerge from a functioning marketplace. If you’ve ever seen a long line for a good or service, then odds are someone messed with the prices. Take for example the food lines in Soviet Russia or the Weimar Republic. Or take the long lines for gas during the Nixon administration’s price controls. Lines are an indication that prices are not accurately reflecting current conditions. And it doesn’t necessarily have to be government intervention. If a venue does not price concert tickets high enough, there will be a line. If a road owner does not increase the price to drive on his road during peak hours, then there will be traffic (sound familiar…?) But at least when a private entity misses the correct price, they can adapt to the situation and correct it either in the short term or in the future. Government on the other hand, does not face the same incentives.

The foremost authority on prices and the importance of knowledge is Nobel Prize winner F.A. Hayek. Hayek has received some much deserved popularity of late due to a certain rap video or two, but perhaps his greatest contribution (in my opinion) is his essay, “The Use of Knowledge in Society.”

Hayek demanded his readers respect the power of the price system. I took heed many years ago. I hope you will too.

Written by jlongo12

July 13, 2011 at 9:54 am

Posted in economics

Comeback Post

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It’s been a long time hasn’t it? I’m going to try my best to give a little update on everything that’s happened in the last month, so expect this post to be more rambling and incoherent than usual.

In terms of music, I’ve been digging into my old CD cases and uncovering some lost gems. CDs (yes, CDs) that I rocked on the regular in high school have been getting fresh spins in my car. In other words, I’m partying like it’s 1999. So what have I been rocking? Here’s a small list: Blink 182’s Cheshire Cat, both Bigwig records, Good Riddance, Operation Ivy, Poison the Well’s Opposite of December (which does NOT hold up over time), Past Mistakes, Strung Out’s Twisted by Design, DeLaHoya, The Break, No Use for a Name’s Making Friends, Digger’s Powerbait, and some other punk rock classics that escape me at the moment.

As far as TV goes, Briks and I have been suffering through AMC’s The Killing each Sunday night. God what an awful show. The only reason we keep watching is the fact that we’ve invested so much time in the show already and it’s a murder mystery, which we’re suckers for no matter how poorly executed. In case you haven’t been watching, I’ll give you a quick run down of what the show’s all about. Think of all the cop cliche’s you have ever heard. Add to that cliche’s about Seattle’s weather (it’s constantly pouring down rain). And finish it off with a god awful storyline about a mayor’s race we could give a shit less about. Oh, and a local high school girl was killed and we still don’t know who did it.

Ok, books time. I just made an Amazon order because I broke my cell phone case the other day. I’m unaware of any other venue that sells HTC Android cases as cheap as Amazon does. $5 cell phone case? Yeah, I’ll take it. So in addition to a couple really cheap cases, I ordered a couple books I’ve had my eye on. I will be receiving Adapt: Why Success Always Starts With Failure by economist Tim Harford. Tim is known in economics circles as one of the few economists who can write really well. Another economist who knows a thing or two about writing is the great Walter Williams. Walter recently came out with two books. One was an autobiography that eventually I’ll read and the other is a economics book on race and discrimination. I ordered Race and Economics: How Much Can Be Blamed on Discrimination? There are few economists better than Walter Williams, and there are no economists better than Walter on issues of race.

What about libertarianism? Well, is there a better time in history to be a libertarian than right now? Obama has solidified George W. Bush’s third term with more undeclared, unconstitutional (and hardly covert) wars, more civil rights busting surveillance state controls, an official American citizen assassination list, and more executive branch secrecy. Don’t believe me? Just read the news. Or Glenn Greenwald. You’d have to be the most hardcore partisan loyalist to refuse to admit that the two parties are actually one party. And yes, there are many of you out there.

Let’s get to a little home life. I’ve had the smartest friend I’ve ever had and literally the first friend I ever had Mike visit me at the beginning and the end of his trip to Colorado. He flew in for a friend’s wedding held coincidentally at the Boettcher mansion on top of Lookout, and ended up hanging out and staying with us a couple of days. What a great surprise! There is no one on earth I can more nerdy with than Mike. I’ll miss that when he’s gone.

Economics? I guess I sort of covered that in my books section. But I’ll say this as well. Go read Mises.org and learn something.

And now to granddaddy of them all: cycling. I don’t want to get into all the gory details on this post but I will give the Cliff’s Notes version. After taking 6 full weeks off the bike to rest and rehab my knee, I started testing my knee out early this month with a few short, easy rides. After a couple of weeks of testing and increasing my volume, we decided to start getting me training again. So last week I met with my coach and outlined my comeback plan for the end of the season. I officially started training 2 weeks ago and will race again at the end of June up in Wyoming at the Dead Dog stage race. I obviously won’t be fit by then but it will be great to get back in the ol’ saddle and race a bit. By the time August rolls around, I should be fit again and ready to do well at the AFA state road race championship, Rist Canyon race, and finally the Steamboat Springs stage race. Definitely looking forward to those.

In other bike news, thanks to all my stretching, PT, and chiropractic care, I am tons more flexible now with miles of new range of motion. Therefore, I feel extremely comfortable and loose on my bike. So George and I decided to stretch me out a cm and drop me down 1.5 cm’s. It feels soooo good. But I’m still slow at the moment, which is frustrating. I feel like a million bucks, but I can’t push 200 watts without huffing and puffing.

I’d like to end with a public mid-year resolution to get back into regular blogging again. I’ve been so distracted with trying to get my cycling back in order that I’ve neglected this outlet. I had to put it on hold while I was mentally broken because of my knee. I’m back now though. And I’m ready to start training and writing regularly again. Wish me luck.

Written by jlongo12

May 29, 2011 at 7:49 am

Keynes Today

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“Keynesianism has conquered the hearts and minds of politicians and ordinary people alike because it provides a theoretical justification for irresponsible behaviour. Medical science has established that one or two glasses of wine per day are good for your long-term health, but no doctor would recommend a recovering alcoholic to follow this prescription. Unfortunately, Keynesian economists do exactly this. They tell politicians, who are addicted to spending our money, that government expenditures are good. And they tell consumers, who are affected by severe spending problems, that consuming is good, while saving is bad. In medicine, such behaviour would get you expelled from the medical profession; in economics, it gives you a job in Washington.” -Prof. Luigi Zingales

From this Economist Magazine debate on Keynesianism.

And of course I would be remiss if I didn’t at least mention the second Keynes vs. Hayek rap video. I think round two is even better than the first one.

Written by jlongo12

May 5, 2011 at 11:12 am

Posted in economics