Planning vs. [???? - Management?]

Commenter Prateek Sanjay makes a good criticism of central planning in the comment section to this post, and I don't disagree with him. The sorts of price controls and planning he describes are things that the market does very well and that the government does very poorly.

But I see this sort of planning as fundamentally different from the interventionism that Keynesians such as myself and Brad DeLong in his recent Project Syndicate article usually advocate. We need not be reminded about market efficiency. We are well aware of it. Most of us even like Hayek on the uses of knowledge in society. It's excellent stuff. You hear Keynesians complaining about Austrian Business Cycle Theory, but you rarely hear denunciations of his perspective on the uses of knowledge in society. It's because there's no great quarrel (maybe there were a few Hayekian turns of phrase that some Keynesians might have taken issue with - but no fundamental quarrel exists).

The difference between planning as Hayek critiqued it and intervention as Keynesians advocate (I'm not sure what a good word for this is - maybe "management"?) is precisely that Keynesians identify where the market functions Hayek describes aren't really relevant. Some people have taken to calling this "market failure", but I don't really like that phrase much. The market hasn't failed, it simply doesn't have the inputs required for market efficiency. It's silly to blame the market for that!

Several months ago I had a whole series of posts on this issue, which I characterized as "calculation problems vs. incentvie problems". This line of thinking is still what fundamentally informs when I sound like a Hayekian and when I sound like an interventionist, but I realized a lot of people like Prateek probably didn't read or comment here when I was thinking a lot of that through. So in case you're interested in how I approach these questions, my posts with the "calculation vs. incentive" tagline are here. Very closely related are my posts with the "externality" tagline, which are here. I think the concept of an externality is much firmer than the concept of a "market failure". I think my differences with the Austrian school come from two primary places: (1.) the difference in our theory of interest, which drives the difference in the way we think about money and general gluts, and thus the relative emphasis we place on different explanations of depressions, and (2.) our understanding of how the market process works when confronted with externalities - I think Mises, for example, butchers the question which is the source of a lot of subsequent confusion. I discuss Mises's problematic treatment of externalities here.

Anyway - just thought that background was important for people to understand my take on intervention. I'm working on some research right now comparing Calvin Hoover's (an American Keynesian) perspective on this question and one other to Hayek's perspective. Keynes died before he could engage these issues with Hayek, and I'm trying to think about Calvin Hoover as a useful lens through which we can understand how Keynes might have responded - where he would have agreed and disagreed with Hayek.

The Economy Faces a Major Crowding Out Problem...

...private investment poses a serious risk of crowding out public investment.

I don't know how I missed this before, but this is interesting - Brad DeLong and Paul Krugman disucss an original post by Michael Mandel on the age of the capital stock. Residential and non-residential private capital stays about roughly the same age. Seems reasonable - it looks like market forces are maintaining an equilibrium that's probably pretty strongly dependent on productive technology.

Our public capital stock has not been at equilibrium - its been getting older and older. Its no surprise no equilibrium can be maintained. We know from the socialist calculation debate that non-market institutions don't respond to signals that would maintain equilibrium in the same way that the market would. The conclusion a lot of people take from that is "down with the public sector". Another conclusion oughta be "if we want the public sector to do certain things we need to manage it more deliberately - we can't expect natural forces to produce the ideal result."

Space Economics

Excellent short article on the economic payoffs of NASA.

This is why (to my ears at least) when you argue that big externality-ridden, public goods like space exploration shouldn't be done because "if they were worth doing some private actor would have put his money on the line" you sound really, really dumb. This article deals mainly with the technology spin-off benefits which are hard enough to measure for the same reason that the benefits of information and research have always been hard to measure. It doesn't even begin to incorporate the economic benefits of making the human race an inter-planetary species.

And when you don't have costs and benefits markets don't function in the efficient way we apprecaite them functioning.

Externalities, Calculation, and the Market

Trying to address externalities with policy is not the same as central planning. In central planning, the state does the task of economic calculation - an endeavor doomed to failure. In externality policy, the state improves the market's ability to do the task of economic calculation. There are certainly critiques to be leveled against these sorts of Pigovian policies but the economic calculation critique makes no sense, because Pigovian policy doesn't ask the state to do any economic calculation (as it is traditionally conceived in this debate at least).

Jonathan Chait, at The New Republic, makes the distinction in less technical terms when he points out the reaction of the light bulb industry to energy efficiency standards. He is right on target - it's Chait that understands the process of economic calculation, not Weekly Standard writer Andrew Ferguson (to give you a sense of the way Ferguson sees the world, his most recent piece was titled "Are Americans closet statists?").

This is the point I was trying to make when I highlighted the Chinese attempt to increase energy efficiency by centrally identifying a bunch of factories to simply shut down. That is the state doing the task of economic calculation. Policies to address externalities have the market do economic calculation. And when you don't do Chinese central planning and you don't do anything about externalities, you're just ignoring the requisite inputs for market calculation (namely, profit-and-loss prospects, well defined property rights, and internalized costs and benefits).

Some people who object to addressing externalities object on a practicality/public choice basis. That makes some sense but I think these points are usually considerably overblown (what kind of rent-seeking really went on in this Bush-era light bulb energy efficiency decision, for example??), but they do at least make sense. The argument against Pigovian policy from an economic calculation problem perspective, though, makes no sense at all. It completely misunderstands the issue at hand.

Central Planning as a Solution to Externalities

Anyone who has really absorbed the posts I've written on calculation vs. incentive problems, and my thinking on externalities knows that I approach issues like climate change and the environment from a thoroughly market-based angle. Markets are not always the tool in the toolbox that I pull out as a solution, but there is no disillusionment about the power and simply the reality of markets and the knowledge problem.

Inevitably, of course, I'm accused of approaching the issue from an angle that is not cognizant of market processes. I'm at a loss for how this can still be thrown at me (even if you don't agree with my conclusions from a practical standpoint), but it is. I'm guessing it has more to do with ideology than anything else.

Anyway, if you want to see central planning as a solution to an externality problem, look to China. This sort of approach is, of course, disastrous according to the market-based logic that I use. By the "market failure" approach that I take, this is precisely what you shouldn't do. And yet this is exactly the sort of central planning that people like Arnold Kling want to use to test my sort of approach. This is central planning, pure and simple, and the Chinese are proceeding with it in complete contravention to a proper understanding of the market process. It is diametrically opposed to an approach like a carbon tax.

More on Kling, the Soviet Union, and Market Failure

Arnold Kling has another post up which I think is still problematic, but considerably more thoughtful. "More thoughtful" is probably even a little unfair insofar as it suggests the first one wasn't thoughtful - really it's "much better expressed".

That having been said, there are still problems. He's still shoe-horning modern conceptions of market failure into the Soviet outlook. This is simply wrong. I know the idea of "failure" is appealed to by both, but that doesn't quite cut it. Modern ideas of "market failure" are very specific, and they were around in some form or another when the Soviet Union was established, and they did a fine job distinguishing themselves from it then. I am not strictly in the Hayek-Friedman camp or the Lenin camp when it comes to my understanding of the market process. But if you were to figure out where I was, I'd be about six inches outside of the Hayek-Friedman camp and nowhere near the Lenin camp. This is where I think the vast majority of people who appeal to market failure are today. What the Soviet Union taught us is that governments can't plan economies and they can't do what the price mechanism does. It didn't teach us much of anything about the points that modern proponents of "market failure" are talking about.

One of the major mistakes I think Kling makes is in expressing the "market failure" perspective as "experts will know what to do". Needless to say, I disagree with that assessment, and its certainly not what I think. I don't have time to disagree in detail, but my series of posts contrasting "calculation problems" with "incentive problems" does a reasonable job sketching out my take on all that.

The bottom line is this: when we compare the U.S. to the U.S.S.R., what we are doing is comparing the Kuehn-Krugman-DeLong-Pigou-Mankiw "intervention in the case of market failures" position with the Marx-Lenin-Stalin-Lange-Lerner "socialism works" position. In that comparison, the Kuehn-Krugman-DeLong-Pigou-Mankiw position comes out unambiguously on top, and the example of the U.S.S.R. is very useful in that sense. What we don't have is a good clean example of the Hayek-Mises-Friedman-Kling-George-Mason position to compare to the Kuehn-Krugman-DeLong-Pigou-Mankiw position (and honestly, Friedman and Hayek could both arguably go with me in some cases!). As a rough cut, one can use the U.S.S.R. vs. U.S. example to compare the Hayek-Mises-Friedman-Kling-George-Mason position to the Marx-Lenin-Stalin-Lange-Lerner position, but that's only a very rough cut because:

(1.) The U.S. really isn't an example of the Hayek-Mises-Friedman-Kling-George-Mason position in aciton, and

(2.) To a large extent, the totalitarianism of the U.S.S.R. might even lead guys like Marx, Lange, and Lerner to say that that doesn't represent them (presumably Lenin and Stalin wouldn't hesitate to embrace it).

Why Kling thinks the Soviet Union can arbitrate between his position and mine I still don't think he adequately explains - and I think it's because he's stuck on this idea that we have some kind of mystical faith in experts and models.

Boettke on Climate Change

Peter Boettke has a good post on climate change this morning. Here is an excerpt:

"Even if you make an argument about a "global public good" it seems to me you still would need to worry about "demand-revealing" mechanisms, etc. In other words, if you grant many of the strongest arguments to the climate change alarmists, they would still have to worry about (a) identifying what the correct policy response would be, and (b) figuring out how to implement such a policy in a cost effective manner."

This sounded on-target in many ways, but had an odd flavor of assuming his own conclusions insofar as he did not apply the same concerns to his own position. First, of course interventionists have a demand revelation problem. The idea is to make carbon users bear the full cost of carbon, but the question is "what is that cost?". Where do we set a carbon tax? It's a big problem and there's no easy way to solve it.

But the thing is, the only reason why anyone is proposing a carbon tax in the first place is precisely because we are saying that there is a "demand revelation" problem in the market. There is an externality - people are using carbon without bearing all the costs of that use, and people are bearing costs of the use of carbon without compensation. There is no market for "comfortable climate" where people can trade-off costs and benefits, so those costs and benefits are externalized from the market transaction for carbon. The market has no way to reveal demand, in other words. So we say "well, it's not like we're not aware of the consequences as a society, so let's put a Pigovian tax on carbon that at least improves (albeit probably doesn't solve) the problem".

Demand revelation problems don't just go away, as I said. You still have to price carbon. But if you "grant many of the strongest arguments", as Boettke claims he does, presumably you're granting the argument that the market has a serious demand revelation problem in this case. That's the heart of the public goods/externalities argument, after all, so it would be hard to "grant many of the strongest arguments" without granting that argument. And if the market does have a demand revelation problem, then there's no reason to highlight the demand revelation problems of a government solution. Democratic government is not a perfect solution, but it has one major advantage when it comes to dealing with problems of externalized costs and benefits where there are no property rights, namely that people without property rights do have voting rights. Not a perfect solution, obviously - but if we assume the existence of externalities, it seems to me it's probably the better solution.

This all gets back to my old point that too often we talk past each other because we confuse "calculation problems" with "incentive problems". I have no disagreement at all with Boettke on the "calculation problem" facet of this issue. My disagreement comes in with the "incentive problem".

Some Swedish Stuff...

- Brad DeLong contrasts Knut Wicksell's Stockholm School view of general gluts with the views of Bagehot and Fisher. DeLong makes a point I heartily agree with and briefly referenced earlier today about the fact that many theories in economics don't conflict as much as people suggest they do. DeLong writes:

"Which of these three schools is correct? All of them--that is, any one of these
three financial-market excess demand configurations can trigger a depression. In
general, asset market prices and interest rates will react differently depending
on which disequilibrium is active."

- Don Boudreaux points out a misreading of Hayek by Paul Samuelson. Samuelson counters Hayek's critique of socialism with the example of Sweden and other Scandinavian countries. Boudreaux explains the problem with this example:

"Hayek said that “the planning against which all our criticism is directed is solely the planning against competition – the planning which is to be substituted for competition.” So because Scandinavian countries emphatically do not plan in this way, Samuelson was mistaken to say that their socialism is of the sort that Hayek believed paved the road to serfdom. Those countries have reasonably free trade, only light regulation of capital markets and business, and strong private property rights. In short, all Scandinavia retains what for Hayek was the most significant protection against serfdom: competitive economies."

He goes on to point out the fact that the welfare state was not inherently problematic for Hayek's primary point on market competition. This is an extremely important point and it gets back to an earlier series of posts on calculation problems vs. incentive problems. Hayek's point was that the market is more efficient at using knowledge and calculating solutions than socialist planners. His concern was with planning that interfered with the calculation process specifically - not planning that achieved some other end such as a desired social justice outcome. That's not to say he loved other sorts of planning (i.e. - for social justice). It's simply to say that his primary academic objection to planning was grounded in it's interference with competition and the market process. And the Scandanavian countries do quite well on this front (as does, I should add, the ideal-type of Keynesian "planning"). Don't read past the initial post into the comments. This more nuanced point of Hayek's isn't really discussed in the comment section - it's mostly just mud-slinging at Samuelson.

- The Urban Institute library still isn't completely packed up yet (they're shutting the library down). As I was walking through it to get a cup of coffee I noticed a book by Erik Lundberg, also of the Stockholm School, called "Instability and Economic Growth". It appears to be an underconsumptionist presentation of macroeconomics as opposed to a business cycle theory. Obviously that was interesting to me, as it is the foundation of the Keynesian approach. Lundberg also developed the "sequence approach" to markets. I'm hoping to finish a lot of Garrison on the plane to Paris (a week and a half!). Perhaps I'll read Lundberg next.

Ability to Pay and the Efficiency of the Market

Mattheus von Gutenberg has put a lot of time and effort into exchanging thoughts with me on subjective valuation, prices, and the profit motive in recent posts. We agree broadly on subjective valuation and on the efficiency of the price mechanism. I think it's fairest to say that we disagree on the extent to which there are exceptions to the efficiency of the price mechanism, rather than on the question of the efficiency of the mechanism itself. I see markets as succeeding at specific goals under specific circumstances, with these goals and circumstances holding close enough to true to in most circumstances to make markets applicable to a huge range of human action.

But there are limits and issues to be considered. In my series of posts on calculation vs. incentive problems, I highlight the importance of incomplete property rights regimes for considerations of when state action may be more efficient than market action. Contrary to the imputations of some commenters, I'm thinking of instances where the state can augment market investment and allocation, rather than substitute for it. I've also alluded to times where we think a prioritarian ethic might take precedence over a strict utilitarian ethic. Markets cannot satisfy prioritarian goals, because the price mechanism doesn't distinguish between the utilities of different persons.

I have been too busy to respond to detail to his most recent posts, but I wanted to highlight one thought I had in relation to this point that Mattheus makes:

"Certain types of allocation? The price system is the only tool EVER designed to allocate resources to any modicum of efficiency. It is a procedure that has unbelievably obvious success in meeting needs. If you are going to make a product or service to meet the needs of some people, and you do not use the price mechanism - what other recourse do you have? How can you possibly do it efficiently?"

As a side note, I would disagree with the Mattheus that the price mechanism is "designed", but that's another matter entirely. This point reminds me of a long-standing concern about markets that I've had, which I've never had the time to think through carefully. My question is simply: what about needs and demands that are correlated with a person's ability to pay?

We use examples about the relative demand for apples and oranges, and the way that the price mechanism coordinates the needs and demands of millions of people for apples and oranges, but we leave the question of income curiously vague. We act as if one person who subjectively values an apple more than another person will offer to pay more for that apple, but this of course isn't necessarily true at all. The prices we offer for goods is not only a function of our subjective valuation of that good. It's also a function of the income we have available to spend on that good. Writ large, this of course is an insight straight out of Keynes. But it also has important microeconomic consequences.

My family makes a fairly healthy income, and I feel no uncertainty at all that our standard of living will only improve over time. What I will be willing to pay for things is going to be informed by this. It's entirely plausible that I would be willing to pay twice as much for the same orange as a lower-income family standing next to me in the grocery store, despite the fact that I actually prefer apples to oranges (I'm getting a variety of produce), and in fact that other family values oranges more highly than I do. I haven't been able to think through the implications, but this would seem to throw a monkey-wrench into the efficiency of the price mechanism. How can the market communicate information about subjective valuation if those subjective valuations are mediated through a person's ability to pay? Prices are at the very least communicating information about both subjective valuation and ability to pay. Maximizing total subjective valuation is what we always like so much about the market - but what are the implications if we're actually maximizing a combination of subjective valuation and ability to pay?

From a general equilibrium perspective, of course, ability of pay is closely related to a worker's marginal productivity (how much they earn in the labor market). In that sense, it's not entirely disconcerting that the price mechanism in the product market is going to reach a general equilibrium with the price mechanism in the labor market (which is ultimately a major determinant of ability to pay). But it's not that simple. Ability to pay is also largely determined by the circumstances of birth, genetics, and the willingness of parents to make investments in their children.

Regardless, the importance of the ability to pay in mediating the willingness to pay is something that I don't think has been sufficiently considered by economists. The ultimate effect is that people who have a higher ability to pay will be treated by the price mechanism as if they have a higher subjective valuation of goods and services by virtue of their higher willingness to pay.

Cobb Dug Less Responds

One of the most frustrating things about having a small blog is the searing anonymity of it all. That's why it was so great to see an extensive response to my calculation problem vs. information problem posts on Cobb Dug Less this morning. It looks like Tom is going to respond to each of my posts, but I'll reproduce some of his first post here with thoughts. Tom writes:

"The information in market prices is awesome and they are a wonderful example of spontaneous order. The most important, relevant point is that interference in the markets' ability to freely set prices, unencumbered, has to be the very highest priority."

Agreed. Perhaps I'm guilty of framing it as the "socialist calculation debate," rather than the "socialist calculation debate," but Tom is right here. The point is, even if there were no such thing as socialism Hayek highlights the importance of the price mechanism as something more than one of the two coordinates of an equilibrium (the other being quantity). Price carry information, and even putting all the socialism stuff or even just the "government" stuff aside, that is a valuable insight. I would perhaps raise a question (I haven't entirely thought this through, so I'm not sure what my answer is) about whether this "very highest priority" that commands our attention is a price priority or a relative price priority. In other words, does this priority leave scope for macroeconomic policy? Just food for thought. He goes on:

"I do think that a large portion of the population does believe that government can allocate resources better than individuals. Not economists in general, but this is a widespread belief among a wide swath of the population"

Again, agreed. I think it's safe to say that just about any economist of any persuasion would agree that the general public could benefit from a course in supply and demand, market efficiency, and basic Econ 101 stuff. I'm assuming that anyone reading these posts at least has some understanding of these issues at a level that they don't believe the government can allocate resources better than the market, or if they do believe that they are aware of the oddity of their belief and have some counter-arguments ready (and in restricted circumstances I believe that odd belief as well, and I try to make sure I have counter-arguments ready). That's the assumption that I blog with, but Tom's point about the value of this insight for the general public certainly holds. And just look at my post about the Pew survey or about the recent EJW article... if you have any doubts about the economic illiteracy of the public, those two should dispel those doubts.

"Second, I would argue that while although no one would call Keynes a socialist, he did take an approach that diverged from the classical liberals who dominated economics prior to the Great Depression and placed a heavier emphasis on reliance on government intervention. In some way perhaps, Hayek's essays served to try to influence Keynes to place the priority of market prices higher rather than sacrificing some of their robustness in the pursuit of full employment."

Of course I have to comment on this.

1. Tom is wise enough to recognize Keynes is not a socialist, but the fact that he has to say "no one would call Keynes a socialist" demonstrates that deep down he knows some people do, in fact, call Keynes a socialist! But I've been over this before, Tom is right, and anyone who thinks Keynes is a socialist either doesn't understand (and dare I say, trivializes) socialism, doesn't understand Keynes, or both.

2. I would argue that the "classical liberals" before the Great Depression had different ideas than the classic "classical liberals". I would call Keynes a "classical liberal" in the older sense, albeit certainly with important departures from some of them. And of course he was not a "classical liberal" in the pre-GD sense. But since Tom acknowledged Keynes is not a socialist, I'll let that be for now :) For an understanding of how Keynes saw himself in relation to classical liberalism, I can't recommend enough his book The End of Laissez-Faire.

3. Keynes offered a theory of output that transcended the unsatisfactory "under-consumption theories" of earlier eras. Keynes was not remarkable for his full employment policies. He was remarkable for his theory of output. I think the issue of priorities is a difficult one. Would I have liked to see an economist that had both Hayek's vigorous treatment of prices and knowledge and Keynes's stunning insights into output? Of course I would prefer that. Would I sacrifice the best theory of output we have right now for the sake of further plumbing the depths of knowledge and prices? That is a much tougher question. So we can fault Keynes for this, but by the same token we can fault Hayek for what he neglects. Maybe someone like Ed Phelps is a worthy candidate for the guy that took knowledge, prices, and output seriously.

Generally speaking, though, I feel like Tom comes out in around the same place as me, albeit with different emphases and priorities. His framing of the problem is the same as mine, which gives me faith that I phrased it fairly clearly. Other good reviews from him:

"the framing of the efficient allocation argument has degenerated into a senseless disagreement because of confusion from both sides about calculation and incentives (if I am reading your term incentive problems correctly). Hayek was not writing about incentives in the SCD. The calculation problem exists even in the presence of the so-called benevolent dictator

[...]Unlike Boettke, I differentiate between market failures and information problems. They are overlapping sets, but do not share all elements. Strictly speaking, I think the term market failure is misused as many problems are attributed to market failures, but no market is without distortions. I have no reason to believe that a truly free market won't arbitrage away market failures, but show me a free market [here I'm a little confused about exactly what he's calling a "market failure"]. Information problems are another story. Information problems is one area in which I split with the Austrians. There is overwhelming evidence that information problems exist, even in the most transparent environments and, as the amount of information has exploded exponentially in the recent past, there is no way to sort through it all. At its most basic level, both buyers and sellers have the incentive to work in their own best interest, but it is much easier to hide information from each other now or mislead and both sides are usually at fault.

[...]Given that the state is fallible, we should not expect a solution, simply a Pareto improvement at best. I would also suggest that any "solution" is an intervention subject to the risk of the Theory of the Second Best. I also invoke Bastiat here: "There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen."

Also:

"What Daniel suggests is directly in line with my thinking about Pareto improvement. However, where we differ is how to deal with it. I am not entirely convinced that a small tax is better than doing nothing. A tax costs overall welfare, a tax on carbon emitters has enforcement costs, and a broadly applied tax has free rider problems. I would be in favor of tax cuts for carbon emitters and shift the burden of proof of reduction of carbon emissions to the companies if they want to take advantage of the tax cuts, vastly reducing enforcement costs."

This is all great stuff. I'm not involved in the environmental economics literature, so I don't know the best way to implement this. This tax cut idea is completely fine - I'm not picky about the implementation. My point is that there is a case for a correction of some sort.

I would push back a little on Tom's statement that "I am not entirely convinced that a small tax is better than doing nothing". I'll grant all his enforcement cost and dead weight loss points, but its important to recognize that right now, with no correction to this incentive problem, our liberty to breath clean air and live on a healthy planet is being imposed upon. The lack of property rights not only causes this problem - it also removes our ability to make a broadly recognized claim to a violation of liberty. It seems silly to say "my liberty to breath clean air is violated" because our conceptualization of liberty is so solidly grounded in property (for good reason, let me qualify). But let's not take that conceptualization too far. If we rely too heavily on that, liberty becomes a question of the luck of the institutional draw, and it loses its fundamental meaning and importance.

Hans-Hermann Hoppe and the Calculation vs. Incentive Problem Issue

I came across this article by Hans-Hermann Hoppe on the socialist calculation debate, and I found it quite interesting. Hoppe argues against the traditional Hayekian position in the calculation debate, which focuses on decentralized knowledge, and instead brings the focus back to property rights, which he contends is the focus of the Misesian position in the calculation debate (note that in earlier posts I collapsed Hayek and Mises into one "side" of the calculation debate, and I more or less explained it as Hoppe explains the Hayekian position here - I think this is how a lot of the literature summarizes the dispute, but Hoppe disputes the summary version).

In this passage, Hoppe practically takes the Lange-Lerner position on knowledge and prices:

"the knowledge conveyed by prices actually can be centralized. But if price information is public information and thus can be centralized, then, according to Hayek's thesis that socialism's problem stems from the inefficiency of trying to centralize genuinely uncentralizable private knowledge, it would follow that the absence of prices, and hence of private property, has nothing to do with the plight of socialism."

This presents Hayek's arguments in essentially the same terms as Oliver Williamson's theory of the firm. To a certain extent I would agree with that characterization of Hayek, although I wouldn't consider it to be as unsatisfactory as Hoppe apparently does. The "knowledge problem" version of the "calculation problem" does turn on the practical inefficiency of socialism, rather than the logical impossibility of socialism (I can agree with Hoppe on that). But the Hayekian argument loses none of its force for being an accusation of practical inefficiency, rather than logical impossibility (here I disagree with Hoppe).

Hoppe prefers what he contends is the Misesian version of the argument (I have to take his word on that - I've never read Mises on the calculation problem). Unfortunately, this essay is almost entirely taken up with Hoppe's critique of Hayek, so little is offered in elaborating this property-based position. This is all we really have in the essay in terms of an exposition of his own position:

"Mises's well-known calculation argument states this: If there is no private property in land and other production factors, then there can also be no market prices for them. Hence, economic calculation, i.e., the comparison, in light of current prices, of anticipated revenue, and expected cost expressed in terms of a common medium of exchange-money-(thus permitting cardinal accounting operations), is literally impossible. Therefore, socialism's fatal error is the absence of private property in land and production factors, and, by implication, the absence of economic calculation."

My impression is that he's identifying property as the stake that actors have in their economic action - that knowledge of the situation alone is not sufficient, but that the incentive to act on that knowledge is required. I would agree with this too, and simply say that socialism fails on both counts: the problem with socialism is that it lacks both the knowledge to optimize decisions about allocation and production, as well as the incentive to act on whatever knowledge it does have. For all Hoppe's belly-aching about Hayek, I imagine Hayek would agree with him on this point too.

My feeling is that none of this changes the distinction I've been making (here, here, and here) between calculation problems and incentive problems. The market (or really, free society in general) usually has a considerable advantage over the state because it has both the decentralized knowledge that Hayek highlights and the incentive to act on it that Hoppe highlights. However, when this incentive to act is absent, all the knowledge of the market is useless because, as I said before, the market then "efficiently targets a biased solution". The solution might be to adjust the institutions so that the market can act - create property rights, for example. But when such solutions are problematic, using the state becomes a very plausible possibility. The classic externality of greenhouses gases is the most obvious: it seems more reasonable to impose a carbon tax than it does to assign property rights to the air we breath to solve the incentive problem. Of course questions still remain about what the tax should be (or if it should be a tax at all - maybe it should be a subsidy if climate change is a good thing and we want more balmy winters). These questions don't just go away. But the point is the decentralized information of the market is no better positioned to answer these questions than the state because the property rights simply aren't there - there is no incentive to act on the information that people have. Because there are no property rights, doing nothing is as much an imposition on human liberty as imposing a carbon tax is.

.

As a post-script, generally speaking I find Hoppe's views extremely problematic, if not dangerous (and as readers know, that's not really an adjective I apply to thinkers, even those I disagree with). I don't genuinely recommend him, but the distinction he makes here was worth highlighting in light of the issues I've been writing about recently.

Cafe Hayek, Sen. Nelson, and Calculation Problems vs. Incentive Problems

In two previous posts I've differentiated between "calculation problems" and "incentive problems", and I've remarked that too often "incentive problems" get identified as being "calculation problems", muddying the waters of rational debate. I submitted that economists by and large agree on the classic socialist calculation problem; the debate between von Mises and Hayek (among others) and Lange and Lerner. The resounding conclusion has been that government cannot make allocation, production, and consumer choice decisions as efficiently as the market.

But that does not mean that institutional arrangements - property rights (or the lack thereof), externalities, asymmetric information, and paradoxical phenomena - can't distort the incentives and information that act as inputs into the otherwise efficient optimization process that is the free market. It also doesn't imply that the government can't improve outcomes by addressing these institutional distortions. They may fail. They may still not have enough information to improve outcomes. But the point is, the information that government is missing in this "incentive problem" is not information that would be available to agents in the market.

At Cafe Hayek, Don Boudreaux asserts that Sen. Bill Nelson (D-FL) is guilty of ignoring the calculation problem (Boudreaux calls it a "knowledge problem") in his claim that we should stop offshore drilling and move towards renewable energy.

I'm still working out whether I agree with Boudreaux or not. I know I at least partially disagree with him, but I'm not sure how much at this point. Given the framework that I've presented and the distinction between "calculation problems" and "incentive problems" (a distinction you may not even consider to be legitimate, granted), what are your thoughts on Sen. Nelson and on Boudreaux's response to Nelson? Is this a "calcualtion problem", and "incentive problem", a mix of the two, or something else entirely?

Greg Mankiw with more on calculation vs. incentive problems

Yesterday, I asserted that often what we argue about are "incentive problems", rather than "calculation problems", and that pretending they are disagreements over the classic calculation problem just muddies the waters.

Greg Mankiw has a post up on Pigovian taxes today that help reinforce this logic. Quoting Holman Jenkins, he writes:

"Even if you believe saving gasoline is a holy cause, subsidizing electric cars simply is not a substitute for politicians finding the courage to jack up gas prices. Think about it this way: You can double the fuel efficiency of any car by putting a second person in it. You can increase its fuel efficiency to infinity by refraining from frivolous trips.

These are the incentives that flow from a higher gas price. Exactly the opposite incentives flow from mandatory investment in higher-mileage vehicles. You paid a lot for a car that costs very little to operate—so why not operate it? Why bother to car pool? Why not drive across town for a jar of mayonnaise?"

Let's start with the second paragraph first. This illustrates perfectly my point that we're not talking about a calculation problem. Mankiw, Jenkins, and I are all assuming that Lange and Lerner were wrong on the calculation problem, and that individuals acting in the market on their decentralized knowledge is the only way to efficiently determine when and when not to drive and buy gas. The concern is to use a gas tax to try to fix distortions in the incentive structure (ie - the property rights regime), but not to calculate, optimize, or determine any sort of solution to the question of consumer choice or firm production. Why not? Because the government is really bad at answering those questions.

I take more issue with his first paragraph. It's a general equilibrium world, Prof. Mankiw. Certain types of energy are underutilized for precisely the same reason that other types of energy are over-utilized, and a subsidy is ultimately just a negative tax rate. So I take major issue with his first paragraph, but the logic of the second paragraph is sound and consistent with what I was saying yesterday.

That's not to say I think subsidizing electric cars is necessarily a good thing. Gasoline fueld cars run on gasoline and electric cars run on coal. From a climate/externality perspective they're not all that different. All the subsidy to electric cars really does is help American energy companies, and maybe positions us well for the day when the power grid is cleaner. But for right now, in terms of negative externalities, one is no better than the other.

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UPDATE: Jonathan Finegold Catalán blogs about private calculation and public regulation with respect to the oil spill at Economic Thought. I have a thought in the comment section there. I think he raises some good points, but I specifically criticize it from an externality-based and from a welfare-economics perspective. However, I would add here that Jonathan's point can also be criticized from an Austrian perspective. He seems to completely ignore Israel Kirzner's insights about the market as discovery process where the failure of poor choices directs the economy towards equilibrium positions as surely as the success of good choices. Jonathan tries to argue that self-regulation will lead to less oil spills. The market discovery process perspective would adamently disagree. More oil spills would be predicted to occur as entreprenuers discover the rightness or wrongness of their choices and calculations. This may be an market equilibrating process, but it is not a process for guaranteeing a reduction in oil spills, as Jonathan suggests it is.

Calculation Problems vs. Incentive Problems

I recently started listening to Bryan Caplan and Peter Boettke's debate on the Austrian School, and something dawned on me when Caplan started talking about the socialist calculation problem. I agreed with Boettke rather than Caplan on the question of the calculation problem in the Soviet Union (and on several other points, actually), but Caplan did raise the question of the centrality of the calculation problem to the Austrian School, and I think this is the source of a lot of unnecessary conflict with Keynesians.

As I alluded to in an earlier post on Hayek and Stiglitz, the "socialist calculation problem" has never really interested me that much. It just strikes me as so obvious, and I fully recognize that a lot of that is due to my age. As far as I can tell, von Mises and Hayek made comments about the possibility of socialism in the 1920s and 1930s that were not necessarily on everybody's radar, but weren't exactly controversial for economists either. The alternative view gained a modicum of respectability only when Oskar Lange and Abba Lerner in the 1930s provided an ex post justification of socialism that essentially dependend on a benevolent dictator orchestrating a traditional neoclassical economy. The "socialist calculation debate" seems to have only really taken off when Lange and Lerner provided Mises and Hayek with someone (serious) to argue with. Others of course joined Lange and Lerner. Lawrence Klein barely even tries to hide his socialist sympathies in his writing (although I respect his exposition of Keynes). My point is that as far as I can tell, this is a debate that only started raging after my primary influence (Keynes) had made his impression on the discipline, and wrapped itself up before I was even born and with all the modern economists that I admire coming down against Lange and Lerner. Moreover, none of the economists in the interim that I admire - Phelps, Friedman, Hicks, Modigliani, Minsky, Coase, Williamson - really succumbed to the Lange-Lerner infatuation with socialism. I can certainly understand why someone who grew up during the Cold War could maintain an interest in this skirmish even into the twenty-first century, but it doesn't hold any particular interest for me, because it seems so eminently obvious and conclusively decided.

Nevertheless, Austrians still regulalry point to decentralized knowledge and the calculation problem in their critiques. When I'm speaking with Austrians I often have to remind them that we have no difference of opinion on these questions (indeed, I think that most economists have no difference of opinion with them on these questions). One of the major impediments to good dialogue, I think, is that many people confuse "calculation problems" with what I will call (for lack of a better term) "incentive problems". Most of the disagreements today revolve around "incentive problems" and we're all on the same side when it comes to "calculation problems", but a lot of people argue as if the issue were still a calculation problem.

Take fiscal stimulus. The argument has never been (so far as I can tell - correct me if I'm wrong... certainly it's not the argument that I ever make) that the government can more efficiently allocate resources than free individuals. It has always been recognized that the market economy does this better. The concern is that incentive problems introduce stable biases to market outcomes. Asymmetric information isn't a challenge to the idea of decentralized knowledge and market calculation - it's a claim (in econometrics-speak) that decentralized information is going to efficiently target a biased solution. The same with the Keynesian theory of output, which can be stable at sub-optimal levels because output is jointly determined by loanable funds market equilibrium and liquidity preference equilibrium. As Keynes writes:

"To put the point concretely, I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use. There are, of course, errors of foresight; but these would not be avoided by centralising decisions. When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labour of these 9,000,000 men is misdirected. The complaint against the present system is not that these 9,000,000 men ought to be employed on different tasks, but that tasks should be available for the remaining 1,000,000 men. It is in determining the volume, not the direction, of actual employment that the existing system has broken down."

I think Peter Boettke makes this mistake of calling an incentive problem a calculation problem at minute 4:40 here when he tries to grapple with the idea of "market failures". To him, "market failures give rise to arbitrage opportunities", and so Stiglitz and Akerloff and guys like that (allegedly) completely miss the point of how markets clear. But this misunderstands the problem of market failures. Market failures occur precisely where arbitrage cannot solve problems. If arbitrage could solve the problem, the market wouldn't fail - it would succeed! What form of arbitrage can possibly solve a problem of negative externalities? The problem with a negative externality is not with the availability or use of knowledge, and it's not with the will to act on that knowledge in the pursuit of self-interest. The problem is precisely that entrepreneurs acting on their decentralized knowledge and seeking out arbitrage opportunities to satisfy their self-interests will converge on sub-optimal solutions as a result of the institutional structure in which they are operating.

There are two relevant questions, I think. First, is a "market failure" a genuine market failure or is it, as Boettke says, an opportunity for arbitrage? If it's just an opportunity for arbitrage then "market failure" is a misnomer. If it is a genuine market failure, we then of course have to ask ourselves what the best solution is. In some cases a public solution will be appropriate, and in some cases a private solution will be appropriate. It is the article of faith of no economist that I am aware of that a public solution is necessarily a good solution. The point for me is that none of these claims rest on the idea that Lange and Lerner were correct in the calculation problem debate. The underlying assumption is that they were wrong - the question is, does the admitted fallibility of the state preclude a public solution or doesn't it.

If the problem isn't a calculation problem at all, but an incentive problem, there may be certain areas where a public solution could be quite successful. For example, let's take the case of the negative externality of carbon emissions. Some cost-benefit analysis aficionado may think it's important to determine precisely what the social cost of carbon consumption is, but that's not really an economist's perspective. The economist simply understands that choice on the basis of decentralized knowledge would converge on the "true cost" of carbon if it had an incentive to, but that the lack of property rights to the air we breathe removes that incentive. The government doesn't have to know what the right solution is to move society in the direction of the right solution. If the property rights arrangements introduce a negative externality then a moderate correction in the direction of raising the cost of carbon will be an improvement, regardless of whether the government knows the true social cost of carbon. Of course, what constitutes a "moderate correction" is going to be a matter of debate, but if we're confident that what we're dealing with is a negative externality then doing nothing is certainly inferior to a small carbon tax.

The important thing to note here is that the carbon tax (a specific example of a "Pigovian Tax") absolutely relies on the assumption that Lange and Lerner were wrong on the socialist calculation debate. These sorts of market failure arguments are driven by the belief that free markets use decentralized information efficiently. They aren't correcting market soltuions, they're correcting institutional arrangements that distort the incentive structures that markets respond to.

There's obviously still considerable scope for disagreement here. People are going to come down all over the place on our certainty regarding market failures and on the two questions that I posed earlier that we have to ask ourselves when thinking about market failures. The point is, it's erroneous to think of this as a "calculation problem" debate. We are on the same side of that debate. It is an "incentive problem" disagreement, not a calcualtion problem disagreement.

UPDATE: Mario Rizzo has a great post on this aggravating tendancy to simply list cognitive biases (or market failures), and then take this myopic perspective that nothing must work right. My perspective is this: market failures and cognitive "biases" are very important, but (1.) a lot of them cancel each other out, (2.) a lot of them bias outcomes, but only minorly, (3.) we don't really notice these problems because we don't know what an "optimal" universe looks like, so things don't really appear that bad, and (4.) even if there is sub-optimality, a free society still progresses for the same reason that it progresses when we assume away all these biases and failures. So for me, these biases and failures are incredibly important for understanding the difference between where we're at and where we could have been - but they don't change the fact at all that generally speaking a free society is going to guarantee progress regardless of whether we could have been further along had these biases and failures not been around.