Wednesday, March 2, 2016

Rivalry and Central Planning (Modern Technology and the Calculation Debate Part 3)

This is an excerpt from a paper presented at ASSC 2016. Full Paper available here.

Not only can the information relevant to economic calculation not be collected by any agent by any means, the information that can be collected and used for central planning makes calculation more difficult, not less. Mateusz Machaj[1] writes of the fundamental difference between centrally planned “prices” and prices which emerge from free exchange. The “planners” in a free market, he argues, are the various entrepreneurs who attempt to make plans using price signals as clues and who then subject these plans to the judgement of profit or loss. In this way, productive enterprises are allowed to persist while those which are unproductive, and, thus, waste resources, are forced to shut down. In a centrally planned scheme, however, prices do not control the planners; planners control the prices. So production will be driven in the direction of the planners’ preferences regardless of economic reality because the forces which would constrain entrepreneurs are themselves under the control of the planners.

This critique is made more fully by Don Lavoie[2] who emphasizes the role of rivalry between competing production plans in the formation of prices that allow for rational economic calculation. Lavoie recounts the Austrian critique specifically toward the more recent proposal of so-called “market socialism.” Later in the calculation debate, proponents of central planning like Lange and Lerner retreated from full socialism and essentially conceded half the argument to the Austrians by defending, instead, market socialism. This model entailed allowing markets to allocate consumer goods and using the information generated by that process to centrally plan the production side of the market. The Austrians would agree that allowing the price mechanism to work on the consumer side does solve the calculation problem for that side of the market (that is merely a concession of the Austrian thesis), but they further held that free prices are necessary for all orders of goods on both sides of the market for rational economic calculation to occur throughout the whole economy. As Lavoie demonstrates, centrally planned production still does not work under the market socialist model; free capital markets are indeed necessary in addition to free markets for consumer goods.

This point is precisely where the modern socialist arguments about the use of technology may appear to function best. Perhaps, as noted above, consumer preferences are of a nature that they cannot be assimilated into a central plan by any technological means, but surely the producer side of the market does not suffer from this same shortcoming. The argument might go that planners could simply take the information from freely fluctuating prices in markets for consumer goods as sufficient to centrally plan production of those goods which consumers value if they also have access to the wealth of information produced by radically interconnected technologies like the Internet of Things. Are not these two sets of data sufficient to establish a rational allocation of higher order goods? To go back to Hayek’s tin, why would one need market prices to adjust exchange ratios in response to changes in the availability of tin if a computer can provide the information even more quickly? This position once again fails on a fundamental level, as Lavoie emphasizes, because the information bearing properties of prices in a free market are the result of rivalry between various plans.

Because factors of production are scarce and have alternative uses, producers have to bid them away from alternative production plans. This rivalrous bidding process is what makes factor prices the bearers of economic information that can be used to engage in economic calculation. Rivalry means that each producer has his own ends in mind and will judge potential production decisions by his expectations of how they will achieve his ends. His use of scarce factors is then judged based on its ability to satisfy others’ preferences, and this information is communicated as either a profit or a loss. The producer can then use the understandable unit of money prices to engage in economic calculation and determine his preferred course of future action. But if there is central planning, then there is one goal of production not many competing goals. In that case, the allocation of capital is directed toward the goal of the planners. Even if the planners set up some sort of exchange ratio between factors, these “prices” will not carry with them the information necessary to economic calculation. The old dream of mandating that price equal marginal cost fails because marginal cost is not given, and it is not a characteristic of the inputs themselves. All costs are opportunity costs and the opportunity cost of using particular inputs is discovered by the process of bidding factors away from alternative uses. Centrally planned exchange ratios for factors of production will not have encoded within them information about the alternative uses of factors because they acquire that property from being bid away from alternative uses of which there are none under central planning.


The crucial fact about the flaws in even the market socialist thesis is that it is not a technical problem but a fundamental flaw in the idea of central planning. Proposing to solve the calculation problem with ever more advanced and connected computers is, therefore, to misdiagnose the problem. It is quite likely that very interesting and useful innovations will be produced by solving technical problems with the IoT, block chains, and related technologies, but to set these phenomena as solutions to the socialist calculation problem gives the right answer to the wrong question.

[1] Machaj, M. (2014). Market socialism and economic calculation. Argumenta Oeconomica, 1(32).
[2] Lavoie, D. (1985). Rivalry and central planning. Arlington, VA: Mercatus Center at George Mason University.

Tuesday, March 1, 2016

Central Planning and Consumer Valuation (Modern Technology and the Calculation Debate Part 2)

This is an excerpt from a paper presented at ASSC 2016. Full Paper available here.

The impossibility of economic calculation within socialism does not derive merely from the volume or complexity of information. As Hayek put it, the information necessary to calculation does not just happen to be dispersed among various individuals in a way that makes aggregating it difficult. Rather, information is “essentially dispersed.” [1]  The usefulness of information derives exactly from the fact that it is not in in the hands of a central planner, be it a person or computer, but in the hands of Hayek’s “man on the spot.” [2]

Even if all relevant information could be aggregated to a central computer in real time, there is still no way for an algorithm of any complexity to produce a superior order than that which emerges from the market process making use of the price mechanism. “Superior” is obviously a value laden term, but when its definition is carefully considered, the first fatal flaw in computer driven socialism is revealed: a system of pricing and allocating resources must be judged by the subjective preferences of those within the system. An algorithm may be able to set exchange ratios between goods which would resemble those generated by the price mechanism in a free market, but they must be directed toward an end which is designed by a minority of individuals or emerges from the program itself. The ends pursued by a computer program, therefore, are not based on the subjective preferences of all individuals in the economy, and this massive piece of data, by its very nature, can never be assimilated into an objective algorithm. As Mises puts it, “It is impossible that there should ever be unit of subjective use-value for goods. Marginal utility does not posit any unit of value. Judgements of value…do not measure; they merely establish grades and scales.”[3] The market prices of goods reflect not only how rare or abundant they are in absolute terms but also the subjective value of those goods in alternative uses. A good may be extremely rare but have a very low price if no one values it. The same good, however, may obtain a very high price if many individuals strongly prefer it to available alternatives. The process of bidding up the price of a good is the product of human action pursuing individual preferences, and no amount of data about the state of the world can allow one to accurately predict each person’s value scale prior to their action. As James Buchanan[4] put it, a central planning scheme, even when it possesses all available information, only works if we disregard the fact that humans make genuine choices. He writes,
The potential participants do not know until they enter the process what their own choices will be. From this it follows that it is logically impossible for an omniscient designer to know unless, of course, we are to preclude individual freedom of will. [Emphasis in original]
So a hyper-advanced computer or Internet system possessing all information about the state of all goods in real time still cannot account for the very engine that drives the emergence of a spontaneous order, namely human action. It must substitute some set of objective preferences for the numerous subjective valuations of each potential market participant, and this fact puts central planning at large disadvantage compared to the market price mechanism. The coordination facilitated by the price mechanism is not the result of objective information transmission only – that is, bare facts about the world – but the use of that information in exchanges which themselves rely upon the inversely ordered subjective preferences of acting individuals. In order to achieve a “price” under central planning which contains the same richness of information as a price set on the free market, the planner, be he man or machine, must possess the necessary data before making a determination. But the existence of that data depends not only on information about a good but also on information about individuals’ value scales which are revealed by action and, thus, cannot be known prior to the action. Therefore, the data necessary to make the determination of economically useful price via central planning does not exist to be known.

[1] Hayek, F., & Bartley, W. (1989). The fatal conceit: The errors of socialism (University of Chicago Press ed.). Chicago: University of Chicago Press.
[2] Hayek, F. (1945). The use of knowledge in society. Menlo Park, CA: Institute for Humane Studies.
[3] Mises, L. V. (1920). Economic calculation in the socialist commonwealth. Auburn, Ala.: Ludwig Von Mises Institute, Auburn University.
[4] Buchanan, J. (1983). Order defined in the process of its emergence.

Monday, February 29, 2016

Modern Technology and the Calculation Debate (Part 1)

This is an excerpt from a paper presented at ASSC 2016. Full Paper available here.

The socialist calculation debate is a major milestone in Austrian economics in which Mises, followed by Hayek and others, showed that socialism was untenable not just because of unfortunate incentives but because of defects inherent in the structure of the socialist proposal; there simply is no way, they argued, for a central plan to engage in rational economic calculation without freely fluctuating market prices for all orders of goods. One of the central aspects of the argument, emphasized particularly by Hayek, is the knowledge problem inherent in socialist planning. Because information is dispersed and specific to time and place, there is no way to centralize it in a way that would permit central planning to rival the free market. But recent developments in technology and the rise of the Internet have led some to question whether the Austrian position may need to be reexamined in the light of twenty first century advancements.

Leaps in Technology

Obviously technology has evolved in a way no one, including Austrian economists, could have foreseen. In particular, the rise of the Internet has dramatically reshaped the production process. Especially relevant to the calculation debate is the new and growing field called the Internet of Things (IoT). This term refers to the phenomenon of connecting everyday objects, not just specialized computers, to an international network. Watches, cars, refrigerators, lightbulbs, toothbrushes, and pretty much anything else you can think of are now being developed so their status can be viewed and controlled over the Internet. Agriculture is a good example of IoT implementation as it has been one its first major beneficiaries. Devices now exist which allow farmers to receive constant data about the status of individual plants, anticipate weather patterns, and adjust cultivation practices accordingly[1] (Lohr 2015). Other producers are able to make more informed production decisions as the ubiquity of sensors provides a wealth of data about consumer behavior and preferences. Certainly the nature of information has been revolutionized by the Internet, and some have taken this change as a reason to revisit and reject the Austrian position on the necessity of market prices in economic calculation.

Technology as a Solution to Socialism

The position that central planning could be a superior method of making production decisions if only technology were advanced enough goes back to the original calculation debate, but proposals have become more serious as computers became more powerful. Many writers from the early 1970s to now have proposed that Mises and Hayek may have been right back then, but we could eventually (and perhaps now do) have the technology to possess the knowledge necessary to plan the economy. Oskar Lange[2], conducted significant research into “cybernetic economics” in which computers would be used to facilitate central planning. This kind of planning was implemented in Chile in 1971 with project Cybersyn. While that project was abandoned in the midst of a military coup in 1973, some have proposed that the modern Internet can make central planning succeed where all other attempts have failed.
One optimist about the feasibility of socialism is activist Andy Pollack who writes,
The material possibility of socialism, as reckoned in the sheer productivity of industry and the availability of masses of goods and services, has existed for most of this century. Now the technical basis for the process of managing those things, i.e. for the process of socialism, has taken huge leaps forward with the advances in information technology of just the last few years.[3]
One can only assume that Pollack’s resolve has been strengthened by significantly greater technological advances in the past eighteen years. More recently, author and senior editor of The New Republic Evgeny Morozov connected fresh developments in Internet technology directly to overturning the result of the calculation debate in a 2015 interview.
The only way to beat the market… is by relying on cybernetics…. The unfortunate episode in the development of cybernetics is that… most… experiments in the socialist context never had the ability to work on the assumption of constant connectivity and interconnected feedback systems that can communicate in real-time at virtually no cost. If you think about the Soviet experience… it’s actually surprising that it carried on for so long given how poorly informed the planners were. And also how easy it was to cheat the system by submitting false data and so forth. Many of these problems can now be resolved thanks to the Internet of Things on the connectivity front and technologies like blockchains on the trust/security front (imagine: replacing the lying Soviet bureaucrats with a blockchain!). Where the neoliberals won the debate in the 1980s and the 1990s is in convincing all but hardcore believers in the communist project that socialism and even more broadly communism were practically impossible [due] to the implausibility of designing an adequate communication system that can be as effective as the market in allocating knowledge dispersed through the economy. I’m not sure that this argument is still valid today.[4]
As the Internet of Things becomes more ubiquitous, one must expect that Morozov’s position will seem increasingly plausible to socialists. They can admit that socialism was impossible in the past, but that now the world is ready; socialism can finally work!
One distinction must be made at the outset. The terms “prices” and “the price mechanism” as used by Mises and Hayek refer to the existence and use of genuine money prices which are the result of bidding for goods and services in a market. The term has been appropriated by others, like Lange and Taylor, to have a wider meaning, namely “terms on which alternatives are offered.”[5] This broad definition of prices, which may exist under socialism must be held separate from the term as used by Mises in the former sense.

Technical Flaws in Socialist Approach

Despite the high hopes of the above writers, it can truly be said that they all have missed the point. The Austrian critique of socialism is still valid today, and will still be valid regardless of the development of technology. To begin with, the plausibility of central planning even with advanced Internet and computing capabilities fails on a superficial, technical level. First, Morozov’s implication that the modern Internet allows for communication “in real-time at virtually no cost” is highly questionable on both counts. The speed of light is fast, but not negligible on a planet sized scale, and there are obviously large costs to building and maintaining Internet infrastructure. Second, As Jesús Huerta de Soto explains, the same technology that allows one to account for the collection and operationalization of more data also allows for the creation of a greater volume and complexity of data such that the information to be known will always run ahead of the ability to know it.[6] A great virtue of the price mechanism is that it does not, strictly speaking, convey all the information about the goods being priced but rather allows for the use of that information even by those who do not know it. As in Hayek’s example of tin, it does not matter why tin is more scarce; price fluctuations allow for appropriate adjustments in consumption and production without anyone knowing all the details. Through prices, information is encoded into a simple shorthand understood by everyone but designed by no one. It is through the price mechanism that production processes too complex to be contained in any consciousness are able to be realized, and eliminating market prices would eliminate that ability. In addition to these shortcomings, however, hope for a revival of socialism based on improved technology is flawed on a much more fundamental level.

[1] Lohr, S. (2015, August 3). The Internet of Things and the Future of Farming.
[2] Lange, O. (1970). Introduction to economic cybernetics. Warszawa: Polish Scientific.
[3] Pollack, A. (1997). Information technology and socialist self-management. Monthly Review. 49.
[4] Morozov, E. (2015). Internet as common or capture of collective intelligence. 18-19. Retrieved from
[5] Lange, O. & Taylor, F. M. (1938). On the economic theory of socialism. Minneapolis, MN: University of Minnesota Press.
[6] Soto, J. H. (2010). Socialism, economic calculation and entrepreneurship. Cheltenham, Glos, UK: Edward Elgar. 

Monday, November 16, 2015

State Governors on Refugees are Like the FDA on New Drugs

The incentive structure that the FDA faces in approving new drugs is well known to be skewed in such a way that slows down innovation implementation of potentially life saving treatments. It goes something like this: If the FDA does not approve a drug that would have saved thousands of lives, no one will know. If the FDA approves a drug that kills a few people, everyone will know. Therefore, the incentives are such that decisions will skew towards caution even if a different policy would have saved more lives. The combination of availability bias and costless risk aversion yields a system which is detrimental to those who most need help, and it is this same combination that now threatens Syrian refugees.

Today seems to be official “governors against refugees” day. In the past several hours the governors of the majority of U.S. states have specifically come out in opposition to or banned by executive order their state taking in more refugees from the war in Syria citing security concerns and an inability to background check new entrants.

There are several problems with this logic. First, it is not that hard for a state to run background checks on a few thousand people. Connecticut Governor Dan Malloy (one of only two governors to support refugee acceptance today, the other being Peter Shumlin of Vermont) says that his state plans to continue to accept around 1,600 Syrian refugees and can easily complete background checks before entry. Second, states don't have have the authority to stop resettlement of refugees and there is not really any way to prevent refugees from moving between states even if states could bar them initially. Third, and most interestingly, the extreme precautionary principle being applied in these cases ignores economics and is detrimental to both natives and refugees.

The economic argument for open immigration is iron clad; it simply is the case that immigrants improve and do not harm the domestic economy in the country to which they move. Given this fact, there should be a pretty high burden of proof on those who want to impose restrictions on visas to refugees as doing so harms not only those fleeing the monstrous conflict in the Middle East but also the domestic economy.

Surely these governors think they have a pretty good reason in the form of security concerns. They don’t want an event like the Paris attacks to happen their state. I do not doubt the purity of their motives, but the nature of incentives and unseen costs makes the seemingly obvious case for caution more complicated. In short, overly precautionary restrictions on immigration have opportunity costs. But because these costs are not as visible as the potential security threat from allowing in a few bad actors, there is incentive to place an irrationally high value on safety.

No one will miss the additional innovation and production that could be brought about by allowing in refugees who will buy goods, pay taxes, and maybe even settle down and start businesses. All the economic benefits of immigration apply to refugees as well, but it is difficult to mentally account for what might have happened.

Terrorism, on the other hand, is obvious to the eye. The images and stories from Paris in the past few days provide firm footing for a call to greater caution. If we admit Syrians to the U.S. and one act of terrorism occurs, everyone will know. If we do not admit Syrians to the U.S. when doing so would have saved many lives and economically benefited both parties, no one will know.

This is not just an academic triviality; there are real lives at stake. In the case of the FDA, policy makers are beginning to understand the perverse incentives involved, and the adoption of “right to try” laws as increased. Unfortunately the same is not true of the refugee situation. Republicans have often been the ones in favor of reducing FDA control over patients’ decisions, but they seem to forgo this logic in the refugee issue; today’s loudest voices against refugee admittance, including many of the governors listed above and Presidential candidates Carson, Cruz, and Paul, have been from the GOP. The events in Paris seem to have shocked the rationality out of decision making, and the fate of many refugees will now be decided by the fears of policymakers rather than by measured composure that could save lives.

Availability bias is always a danger in making balanced security policy, and, in this case, state executives are allowing it to mercilessly drag them around. The opportunity costs of keeping out immigrants of any kind are very real and very harmful, but in the case of Syrian refugees they are even higher. Keeping these refugees out condemns them to horrible situations, and even if you don’t want to help these people, we should at least not slam doors in their faces.

Friday, June 19, 2015

Backward Reasoning on IP Protectionism

The folks over at IP Watchdog recently responded to a question from a reader who asked for proof that innovation would not happen in the absence of “sufficient IP protections.” As is often the case with IP advocates, the Watchdog writer thinks the case is glaringly obvious but chose to respond anyway because it is a “message worth repeating.”

Apparently she also thinks the case for intellectual property regulation is so obvious that it is not worth giving sound evidence. The arguments put forward are amazingly unperceptive and do not hold up to critical analysis.

The article begins with the standard argument of “economic fundamentals;” high R&D costs plus low marginal cost of replication and production means that innovation will not happen in the absence of patents. The jump is then quickly made to a pharmaceutical example to show the importance of patents in general. This is a misleading example because the question of IP protection is always an empirical one. Are fixed costs of development actually high enough and are marginal costs of duplication actually low enough that there will be a net loss of innovation in the absence of IP protection? The argument of myself and others is that they are not.

Pharmaceuticals are one of the only conceivable realm in which there is a possibility of the balance being so out of whack that some kind of IP protection scheme may be desirable. (Parenthetically, this does not mean that the present system of US patents is the most desirable form of protection. It is even likely that some non-governmental solution is preferable to any centralized regulation.)

The particulars of pharmaceutical patents aside, their uniqueness makes them poor candidates for analogies to the rest of the IP system. There is conceivably a case for IP protection of new drugs, but that has almost no relation to whether a farmer should be allowed to modify his tractor, and it is quite different from saying that patents on off the shelf Wi-Fi equipment should be able to be owned by patent assertion entities and asserted against small end users. Trying to set up pharmaceuticals as a blanket justification for all patents and copyrights as currently conceived is misleading at best.

The main thrust of the article is to argue that a correlation between countries with strong IP regulations and those with a lot of innovation. Even ignoring the dubious proposition of calculating an innovation score for individual countries, this reasoning is backwards. Innovation does not result from IP laws; IP laws result from rent seeking after innovation occurs. Every businessman would like to have a monopoly on the good or service he produces, and this desire, while usually frowned upon, finds social acceptance when couched in terms “intellectual property.”

But, of course, there must be inventions before inventors (or other IP holders) can lobby for monopolies. It should not be surprising that innovative countries have strong IP regulations because where there is much innovation there is much incentive to monopolize one’s piece of it. The presence of strong IP laws in innovative countries does not indicate that the IP laws where the cause of innovation any more than the presence of sick people at a hospital indicates that the hospital is the cause of the sickness.

Wednesday, May 20, 2015

Two Charts on Film Piracy

What follows is an excerpt of the results of a longer paper on The Effect of Increased Availability of Online Piratable Copies of Films on Box Office Revenue. The availability of screener copies online almost immediately for films released late in the year provides an exception to the rule of normal windowing, and the paper attempts to exploit this anomaly to discover whether the immediate availability of high quality piratable copies of films still in theaters affects box office revenue.

The films were first broken into two groups by year of release: Group 1 (1990-2002) and Group 2 (2003-2015. The groups were chosen to delineate between periods of growth in Internet film piracy, specifically the development of the protocol BitTorrent in 2003 (Dahaner and Waldfogel 2012). Before BitTorrent, film piracy via the Internet was more difficult because the large file sizes made it inconveniently slow. The new protocol, however, allows for much faster transfer of large files making downloading movies more feasible. These groups were then subdivided by month and the mean worldwide box office revenue number for each month was calculated. The result of these calculations is seen in Chart 1.

Recall that the relationship sought is the difference in revenue for end of year movies as piracy became more prevalent. The data do indeed show a decrease in revenue from November to December, but a drop occurred during between those months in both time periods. The magnitude of the change is especially relevant to this analysis; the change for each time period is shown in the table below.