Category Archives: Dynamics of the Mixed Economy

Knowledge vs. Computation Problem

I have described the socialist computation problem as consisting of two parts: first, to solve the system of linear equations (consisting of a vast number of entries and featuring numerous factors of production), generating shadow prices; second, to improve it while preserving and creating the knowledge of new prices.

I have concluded that this problem is utterly computationally intractable. Thus, the Mises' calculation argument against socialism can now, with the development of computer science, be put in highly precise terms and proven with maximal rigor.

What then is the "knowledge" problem as described by Hayek? Perhaps it's something that applies not just to socialism but specifically to interventionism. Mises assumes that "the crowd of experts and specialists which [the central planner] assembles in his offices provide him with perfect information and answer correctly all questions he may ask them. Their voluminous reports accumulate in huge piles on his desk." (HA, 696) Mises does so in order to grant his socialist opponent his best case.

But perhaps the assumption is extremely generous in itself. Is it really possible for any human being to obtain and digest all those data? Even in merely regulating rather than running the economy, the interventionist is faced with a formidable problem. Could Hayek be interpreted as saying that "regulators" don't and can't know what they are doing?

Austrian Foresight

Ikeda mentions 2 interesting examples that should vex the neoclassical economists.

1. Suppose, he says, "the state issues and strictly enforces a prohibition against commercial vehicles driving over 200-miles per hour." Since no truck right now on today's highways would even approach this speed, this policy, as far as a neoclassical would imagine, has no effect on the market. An Austrian economist, however, sees farther. What if a technology could exist that would allow such fast transportation in a safe manner? If it is discovered in the future, entrepreneurs, constrained by the law, would never invest into it, and this beneficial advance would never be commercialized. Even worse, the technology itself might never be invented in the first place, if the law would not permit a payoff from research and development in this area of science.

"In addition, too much investment [compared to what is optimal] would take place over time in technologies that depend on lower-speed travel. As in standard analysis, the current costs of commercial transport remain unaffected, yet a subtle though very real impediment to economic development now exists because of the regulation." (95-6)

2. Let the state "mandate that insurance companies cover a minimum of two days of post-partum care for women who give birth in hospitals." Both the neoclassical and the Austrian will point out that "this will... reduce the number of women covered by insurance (by the law of demand)." But only the Austrian will notice in addition that the bill will "also tend to discourage researchers from investigating new medicines and procedures that could in fact safely speed up the in-hospital post-partum recovery process." (164)

We can conclude that neoclassical economists are like little babes, unable to glean the more remote yet for all that crucial consequences of government interventions.

Pigovian Taxes

It is a tax levied on output producing which is alleged to generate negative externalities. Generally, we want the production of widgets to increase as long as their marginal benefits exceed the marginal costs. But the externality has a "social cost" to some group of strangers superadded onto the cost of the widget to the producer yet not taken into consideration by him. By taxing the widgets, the government reduces output and makes the marginal benefit equal to the combined marginal individual + social cost.

It's hard to believe that economists were so easily misled by this prospect of power to optimize production. There are 3 devastating problems with Pigovian taxes.

First, one can engage in calculation of costs and benefits only within the market. The externality is by its nature external to the market. As a result, the proper amount of the tax can only be politically determined. For example, the people can only register their preferences regarding the production / pollution trade-off in their capacity as voters not as consumers. It is true that an economist can come up with some function that links pollution and production. But then the choice would be between politician A who promises to cut pollution by 10% and production by 8%; B, by 20% and 18%; and C who would practice laissez-faire. How much pollution to allow is a political decision in this sense.

Second, there are millions of existing products out there. Each product may be accused of generating some negative externalities. Yet the tax on each product for the sake of improving economic efficiency has to be unique and proper to that product: say, 10% on bacon; 12% on wine; 4% on aluminum; and so on. We can see that no politician can aggregate these values into a platform on which to run for office.

Third, no entrepreneur would be free to introduce a new product to the market, as it could conceivably turn out to be produced "inefficiently." Any such product would have to be submitted to the government Externalities Bureau for evaluation of the correct tax to be imposed on it. Not only would an epic amount of money have to be given to this bureau to do its work, but this would effectively shut down all economic progress.

Pigovian taxes are a nonsensical attempt to recruit the government into improving economic outcomes. To the extent that there are unhappy externalities (such as on community B when residents of nearby community A dispose of their garbage by throwing it out the windows), they have to be addressed by other means.

Discoordination in the Market

Disequilibrating entrepreneurship banks on global ignorance not on human error. To be unaware of opportunities is something other than to err. Being blind is not the same as seeing illusions.

For example, having a blank canvas rather than a beautiful painting is not an evil. The painting is under no necessity to exist; it is not something that ought to be; therefore, its absence cannot be called evil. But creating a painting does improve the global state of affairs and is, therefore, good.

Similarly, it is not the case that various types of market knowledge ought to be had by men; therefore, ignorance is not an evil as error is an evil; though, again, discovery of truth is good.

Saying that entrepreneurial profits are made possible by errors in human actions condemns our entire civilization to be a gigantic mistake, because things can always be better. But that I am enjoying a cup of coffee does not seem to me to be a lamentable sin for which I should scold myself and resolve never to do likewise, just because in a decade, the quality of coffee will improve. (SAtK, I, 10)

At the same time, though there is no doubt certain beauty to the construction of the perfectly coordinated evenly rotating economy, this beauty is deceptive, because something still better can always be created. Beauty is a real if subjective property, unless one does not want to treat such imperfect knowledge equilibriums as containing an aspect of perfection.

A true final equilibrium, then, would be a "heavenly" society, where there cannot in principle be any improvement. It is next to impossible to imagine such a thing, but that is exactly the implication of Kirzner's (2000) strange artifice of treating even an ERE as still discoordinated, because it can develop further. This is paradoxical, for an inventor's action could be coordinative in Kirzner's sense with regard to a previous state of affairs but discoordinative with regard to some succeeding state.

As a result, the term "coordination" comes to mean "closeness to absolute perfection" which is entirely unhelpful. (I, 11)

Any introduction of a novel plan into the free market economy starts with an act of saving money with the goal of purchasing capital goods. When I save, I lower my demand for existing goods. Their producer, surprised by my behavior, may have to sell his existing inventory below costs, thereby incurring a loss. He will likely restore equilibrium in the next round of production. A smaller quantity will be produced and sold at a lower price.

Meanwhile, once I have accumulated some cash, I buy the factors of production. Unless I specifically ordered a custom-made good, there is an increase in the demand for these factors. There is now a temporary shortage of them, again remedied in the next round of their production. A greater quantity will come into existence at a higher price.

From my point of view, the factors were underpriced and will continue to be underpriced even after the factors' supply and demand are equilibrated. If I am right, then upon combining them and creating the final product, I will be able to sell it at a profit. This means that the consumers will lower their demand for existing goods in order to have the funds to buy my stuff. Once again disequilibrium is reinforced.

But my goods and my revenues are public. Every potential entrepreneur can observe me profiting without laboring. This is too fun and lucrative an opportunity for them to pass up. They help themselves to my profits by imitating my production process. In so doing they bid on the same factors, raising both my and their costs and try to compete with me on price, lowering their prices. The costs and revenues converge, eventually eliminating all my profits.

(Since my method of production is private, commencing imitation can take some time during which my profits will be more or less secure. This period will also give me a chance myself to improve my products so as to stay ahead of the imitators.)

Finally, new entrepreneurs enter the market and by the exact same process just described turn my now profit-less even rotation into losses. My business starts out with a bang, then grows old, and finally dies with a whimper, supplanted with firms producing superior goods.

Interventionist Dynamics

Capitalism habituates people to respect each other's (justly acquired) private property.

However, to the extent that "the state is that great fiction by which everyone tries to live at the expense of everyone else," as per Bastiat, as more people decide to enter the political game, looting each other through the machinery of state, each citizen's "moral restraint" against using the political means to wealth diminishes.

"Why should I remain the 'moral' loser?" each public chooser thinks. "I at least need to protect myself in the free-for-all political brouhaha, or even myself pillage and plunder something."

This beefs up the welfare state still more and and accelerates its growth.

Governmental Process?

Contra Sanford Ikeda, I am not sure there is such a thing.

Ikeda defines "process" as ordered change. That corresponds well enough to my own change-amidst-permanence or creative advance that leads from a more primitive and less coherent economy to one superior on both counts.

The market process on an abstract level is an interaction of innovation and imitation that, when woven together, bear fruit in the form of economic improvement.

But either the government is a gang of bandits who randomly prey on the populace with unpredictable raids, thereby being all crazy and destructive yang, pure chaos; or it operates according rules and regulations that are strict, ossified, inflexible, and indeed also very unprocess-like, being all unchanging yin, pure order.

Pure yang can also manifest itself through price controls which check basic equilibration, as well as in socialist planned chaos.

On their own and without their complement, both yang and yin are barren.

To be sure, bureaucrats, too, "spontaneously adjust to changing circumstances," (77) but only through political pressures, budget cuts, and major technological shifts. These pale in comparison with the glory of the market process.

Hayek on Security

Hayek writes in The Road to Serfdom:

With every grant of such security to one group the insecurity of the rest necessarily increases.

If you guarantee to some a fixed part of a variable cake, the share left to the rest is bound to fluctuate proportionally more than the size of the whole.

And the essential element of security which the competitive system offers, the great variety of opportunities, is more and more reduced.

He means, I speculate, that if 90 ounces of a 100-ounce cake is guaranteed to be given to the privileged, then if the size of the cake declines by 5 ounces, the share to the non-secured declines by 50% which is greater than 5%.

Hayek's observation that the "the great variety of opportunities" is the essence of security under laissez-faire capitalism is nothing short of eye-opening. So you lost your job? Your business has gone under? Find another way to make money! There are plenty of opportunities to outshine your competitors in some area of production.

However, the more people are protected from your competition, the smaller your range of action, and the less secure you are against your own competitors wherever you happen to be if you are not protected. If, however, everyone is protected, then we obtain Cuban-style socialism, certainly something highly undesirable.

Your security under free market is found in the insecurity of others.