The Economic Calculation Problem

The Economic Calculation Problem

If you have ever tried to talking to one or more economists about a resource-based economy, you will likely hear about the economic calculation problem. The assertion is that a centrally planned system cannot possibly distribute resources efficiently without the unbounded wisdom of individual opinions. This argument stumped me the first time I had heard it, but I later realized that I simply had not understood it. Let's take a look at an example of this argument from the Ludwig von Mises Institute, an austrian economics think tank.[1][2]

Our writers offer little explanation of where this newfound abundance will come from, but they do say this: This view demonstrates either that the writers have never heard of the socialist-calculation debate or that they failed to learn its lessons.

One important note about the socialist-calculation debate is that it happened in the 1920s and 1930s. It was an age before computers, digital networking, and many other technologies that are important to production, logistics, economics, society, science, and the metadata on all of those things.

Ludwig von Mises showed that money prices are not arbitrary; it really means something when a firm suffers a loss. Specifically, when a firm loses money it means that customers are not willing to pay as much for the finished product (or service) as the firm had to spend acquiring inputs. Loosely speaking, then, a firm that loses money is one that takes valuable resources and turns them into something that society values less.
  1. First, lots of firms make money on things that society doesn't value, or that unequivocally harm society. Examples: Military-industrial complex, tobacco industry, coal industry, the private prison system, the TSA and its supporters, the spam industry, or criminals.

  2. Lots of firms lose money on things that society does value, is kept ignorant of, or that is important, but simply not profitable. Examples: The airline industry[3], the arts, non-pharmaceutical medicines[4][5], long-lasting products[6]

  3. There are lots of terrible choices on how resources should be distributed. Merril Matthews makes a very interesting point in her article:
Many very profitable firms spend far less on research and development, take much lower risks, and make as much or more money than even the most profitable drug companies.

Nabisco, for example, reported a 36 percent profit last year, according to Fortune. Coca-Cola, which produces a product that is competitively priced and very affordable, had higher profits than the drug industry median for most of the 1990s. [...]

When CBS ran the final segment of its hit program "Survivor," it charged $600,000 for a 30-second ad. At the time, that was the highest any network had charged for a slot in prime time, up from the previous high of $319,000.

This fall, however, the popular program "ER" will also command $600,000 for a 30-second ad. The networks are very clear that when they have a popular show, they charge as much as the market will bear.

Why is it that advertising has a better incentive than treating disease?[7] This kind of inversion is fairly common.
Making choices based on opinions or economics does not produce good results. Examples: Nuclear energy[8], climate change[9], coal energy[10][11], oil spills[12][13]

  1. There are many things that are not necessarily congruent with society's value of them simply because there is no other choice, or very limited choice, or the choices are being made by people not qualified to make them. Example: Universities[14], internships[15], teachers[16], insurance[17], and so on.
Mises put his finger on the fundamental problem with socialism. If the state owns all the resources, then there can be no market prices for the tractors, kilowatt-hours, barrels of oil, and other things necessary for production.1 Looking at the various productive enterprises in operation at any moment, the central planners won't have a common denominator for all of the different combinations of inputs going into each one.2 The planners won't know if a particular car factory "makes sense," because they will just have an enormous stream of data describing the various resources going into the factory, and the amount of finished cars coming out of the factory. These brute facts alone don't tell the planners if they are efficiently using the resources being consumed in the factory.3
  1. You should be spotting what this writer doesn't understand. They think an RBEM uses a human establishment to collect and centrally manage the resources. They think that a state owns all the resources, rather than no one owning the resources. Ownership is one of the biggest hurdles to efficient and equal distribution of resources; maintaining ownership creates tremendous industries around enforcing property rights, managing property rights, interpreting property rights, etc. The idea of the state is another huge hurdle: In order for society to truly equal, there cannot be a special subset of society that that is subordinate to another. What is the necessity of the state? It is extremely slow to adapt to anything, it makes far more bad decisions than good ones, it's a huge waste of resources, and it doesn't really create anything of its own.

  2. Except energy, which is required throughout all industrial processes and lacks a sensible valuation in the market model[18]. Externalities ensure that highly destructive processes remain popular, as there is often far more to be gained than lost with externalities.

  3. What is the basis for this? A factory that is optimal will have maximal efficiency in the usage of each resource that goes in. If I make cars, what configuration is there that is more efficient than using the least amount of metal, rubber, silicon, glass, and energy than using the least amount of each one? Further, how does the price mechanism solve this problem? Say a Nissan Teana takes $20,000 worth of materials to make. What does that tell you about the efficiency of a Nissan factory? Does it tell you how to use the resources more efficiently? The price says nothing. Price is, in fact, meaningless, because it not even well-defined. There is no way to get unambiguous information from the price of something. If I know that gas costs X amount of monies, what data can I get about the supply of gas? How about the demand? How about the transportation cost? How about the profit margin? I cannot determine or extrapolate these things without simply looking directly at the data about supply, demand, transportation, and company finances. So what utility did we just get out of the pricing mechanism?
Returning to the quotation above, our RBE writers don't realize that their world would still require the services of bankers, insurance agents, and advertising personnel. Whether conducted at the individual level, or by "society" through a group of representatives, people would still need to decide how much of their resources to save,1 and how much to invest in various enterprises.2 They would also need to decide how to deal with the possibility that key workers could drop dead of a heart attack, upsetting their production plans. Furthermore, even in the RBE utopia, there would still be constant product innovation. Citizens would need to be informed of the new options,3 so that production decisions could change to reflect the public's desires.4 Thus we see that even the RBE would require some form of bankers, advertisers, etc.
  1. And that can be done with computerized mathematics, by measuring the supply, as well as the difference between the rates of depletion and replenishment, you will get a tuple that tells you exactly whether you are in a scarce or abundant state, and the rate at which the resource is becoming more scarce or more abundant. Again, how does the pricing system solve this? People are actually really bad at saving[19].

  2. Why? Yes, resources need to go in to starting projects, but why would we need investors to tell us whether a project is worthwhile? Having investors implies some sort of ownership of the resources.

  3. There is a world of difference between information about a new product and advertising a product. Advertising is about manufacturing desire, in order to sell or upsell a product or service. McDonald's doesn't tell me it has mediocre, CTC factory-made, hastily-brewed, iced tea for a whole dollar. McDonald's tells me that I am (relatively) a genius for knowing that you can get a delicious McDonald's sweet tea for only a dollar. By the way, high-quality, specialty orange pekoe tea, bought in quantities for personal consumption (which I assume must mean large profit margins for the tea distributors) costs me 12-98 cents per cup[20], and it can be infused multiple times.

  4. You know, it wasn't long ago that stores had to supply themselves using nothing but guesswork, and an industry of lower-class stores emerged to pick up the slack of selling overstock at big discounts. Only recently has inventory management been mechanized and computerized enough to allow accurate, rapid supply rates.[21] Notice that it is not superior business practices, or higher profit margins, or better compensation, or some kind of market force that allows this. It is the technical design of storage and logistics, the automation. RFID technology, computers, and other technical changes made this difference. Furthermore, the public's desire should be subordinate to what the Earth can provide to them, not to how efficiently they can acquire imaginary value. We recently gave trillions of universal resource credits to banks for failing, that they then spent on themselves, which took everyone completely by surprise, to think that they would do that, they must be bad eggs. The thing with eggs, though, is that they all go bad eventually.

There are some items in this argument that remained unspoken by the LuvMI article, but they can be found on Wikipedia.

  1. Comparing heterogeneous goods: Not all goods are the same so central planners must make arbitrary decisions on which goods are the best.

  2. Relating utility to capital and consumption goods: Socialism has no way to measure customer satisfaction

    For one thing, the resource-based economic model (RBEM) is not centrally planned. Right there, the argument is moot, but I will continue. Goods are, and will continue to be, compared through testing. There will be multiple "competing" products, but the competition won't be the entire basis of the economy. I will give you an idea of how the decision between heterogeneous ideas might be obtained. Say someone designs a new laptop. A prototyping run would allocate a certain amount of resources to produce a number of prototypes, which can be tested at a building meant for prototypes and the one where laptops are normally available. This provides two different portions of the population, one that tests a lot of products, and one that normally uses laptops. The prototype laptops are then evaluated based on all the data collected during their testing. There are many possible data to look at, I'll list and describe a few that I can think of:

    1. Comparison to user baseline: Each tester will have a profile of their historical testing and usage data. New testing data can then be compared to the prototype data of the product the tester currently uses. There is no point in building something that doesn't even improve on the original. What this would include: Usage time, learning curve, emotions during use, usage profile, fatigue profile, and others. The "likability" of a product can certainly be measured in ways more accurate than the willingness to give money for it.
    2. Use of resources: The new product should use as little as possible. This would be measured in terms of the amount of utility provided per mass unit of each resource that went into it. This could also be compared to the prototype versions of the current products; one could also extrapolate to estimate the full-scale production efficiency and compare that with the current products. It would also include the amount of resources needed to distribute the new product, if it is accepted.
    3. Longevity: This could easily be considered part of use of resources, but I realized it is possible for something to have a shorter lifespan but still use fewer resources than the alternative. Not conceivable, as I cannot give an example, but possible. It may be possible that a product is in a field that is advancing extremely quickly, and so a shorter lifespan is not necessarily detrimental.
    4. Demand: Demand is still a factor, you crazy kids. In fact, demand is even more of a factor without the barrier to entry provided by money. People will want to use the best product, so the product that is in highest demand is likely the one with the greatest utility. And since different products won't be made by companies competing over resources, the designers don't have an incentive to get an inferior product to be accepted.

    Another factor that would make design decisions more objective is increasing standardization and modularity of products. Many people think, probably by heuristic, that increasing standardization makes products less diverse. Actually, the opposite is usually true. Linux is a highly standardized operating system kernel with an incredible diversity of end products, and it runs most of the computers in the world. Firefox is powerful because of its extension API, which allows modules to be built that increase its utility. These modules are produced, generally, according to their popularity, and they are "manufactured" (transferred

    The market solution for comparing heterogeneous goods is just as, if not more arbitrary. The reason central planners' decisions are said to be arbitrary is that the planners cannot possibly be perfectly informed in every subject and test everything. So take away the fact that knowing how to plan an economy is their job, give them a knowledge specialty like finance, making coffee, or writing iPhone apps, and they are now the planners of a market economy. Each person has a differing amount of knowledge on products, and most people don't know a lot about everything they buy, so we can say that it is likely that most consumer decisions are ill-informed. Then we have the fact that the majority of the population is poor, and now most consumer decisions are based on what is cheap plus some other arbitrary factor, like aesthetics or popularity. Then you have the individual ownership system, so all together, you have lots of highly intelligent decision-making. Like my roommate, who owns 2 race cars and one is his daily driver, but is now having financial trouble and cannot afford to race either of them. Or whatever guy that owns a 50-room mansion by himself and a summer home and 50 cars that all just sit there doing nothing. These are not arbitrary decisions? Are you sure about that, chief?

  3. Entrepreneurship: Entrepreneurs lack the profit motive to take risks under socialism, and so are far less likely to attempt to supply consumer demands.

    That doesn't seem to follow at all. How does the profit motive reduce risk aversion when capitalism has strong consequences for failing? Why is risky behavior a good thing when it causes stuff like oil spills[12]? Further, it is well-established that creativity does not need to be incentivized[22][23], and risk-taking is a prime characteristic of creativity. There is no real evidence that the profit motive is necessary for anything but manual labor. It is just used axiomatically to manufacture a need for the system.

  4. Coherent planning: The fourth condition for successful economic calculation is plan coordination among those who plan production.

    This is another case for standardized production. Rather than the price system somehow magically communicating a plan between heterogeneous companies, standards are developed for technologies, so that products can be changed more fluidly as design evolves. This allows emergent design, the use of individual, simple design processes resulting in an overall pattern of behavior. And, again, back in the 20s there were no computers and no internet. The internet is one of the best tools there is for coordination and planning.

  5. Financial markets: Economic efficiency depends heavily upon avoiding errors in capital investment.

    I don't even feel it's necessary to respond to this, since market economies do a terrible job of avoiding errors in capital investment.

Let me say something that other Zeitgeistmenschen and Venus Project members might feel is too strong of a statement: this future society we are talking about, whether it be a resource-based economy or not, but this future society of one world, collaborating, using science, is not exactly a "proposed alternative". It is what is going to happen in the future. To explain why I am making this statement, I am going to have you think of human history in terms of its speed of communication and memory. For a very long time, the only communication was verbal, so collective memory was only what was verbally passed down among groups. Later, we developed writing systems, and this allowed external memory to start collecting knowledge. We tamed animals to allow us to travel and therefore communicate more quickly. Later still we invented the printing press, and it tremendously increased the speed and ubiquity of communication. Long after that was the electric telegraph, which allowed nearly instant communication across vast distances, and later evolved into the telephone. The telephone has developed so much that most of the first world carries a phone with them all the time, allowing the possibility for instant communication with anyone. Much of the development of the phone was shared with its more sophisticated child, the internet. The internet, as well as magnetic storage, provides us with instant access to any kind of information you can find, of which there is likely over a zettabyte available. You can use it to order a product from the other side of the world. The surface web contains billions of pages[24] of information, commerce, video, images, and so on. It is a worldwide, shared, external memory, and a growing part of our population has individual, near-instant access to it.

If we follow this and other computing[25] and networking trends, and consider that one-way brain interfaces are already commercially available[26], it is more likely than not that computer access will, at some point, match the speed of thought. That is, you will be able to access a computer, and therefore, the internet, as quickly as you can think. At this point, what is the difference between thought and internet access? If we are all instantly connected in a global thought cloud, will we maintain our obsession for individuality? I really don't think so, because we will realize that collaboration is what increases our knowledge, not competition, and technology is what makes society work better, not money. Money is a technology, but its obsolescence, whether planned or not, happened a long time ago, and still we continue to use this destructive tool. We have a better way to obtain decisions now, it's called the scientific method.

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Author: Acumen | Date: 18 January 2012 | Version: 0.1 | Rights: Copyleft Acumen. All wrongs reserved.