Oskar Lange, "On the Economic Theory of Socialism". Reprinted in Benjamin E. Lippincott, editor, On the Economic Theory of Socialism Volume 2: Government Control of the Economic Order. Minneapolis, Minn.: University of Minnesota Press. 1948. Original article in Review of Economic Studies, Volume IV, Nos. 1 and 2, October 1936 and November 1937. Used copies available from Amazon.com starting at $1.34.
I've had this article on the back of my back burner for roughly 30 years and I was inspired to read it, first, by Professor Danthine my microeconomics professor at Columbia Business School who reminded me of it in 1986 and second by Nicolai Foss's blog that I blogged about two weeks ago.
This is the article in which Lange writes that a statue should be erected to Ludwig von Mises in the hall of the ministry of socialism for his arguments about the impossibility of price in a socialist economy. Lange claims that he has disproven von Mises's arguments based on elementary economics (the second section of the article is a review of microeconomic theory) but history has proven von Mises right and Lange wrong. The socialist economy of the Soviet Union fell because of the very kind of pricing inefficiency that von Mises identified. Hence, a statue might be erected to Lange in the hall of failed academic theories.
Lange's argument is elegant but there are several flaws that stand out and should have stood out even prior to the passage of the historical record.
First the part that Lange could not have known in advance. Lange overlooks the realities of bureaucratic and political decision making in organizations. He assumes that central planners are rational actors who will equilibrate marginal cost and price. History did not prove him right. Central planning was largely political, and political actors are influenced, as were the Soviet planners of Gosplan, by political considerations rather than considerations of pure rationality. Thus, the history of Soviet socialism is riddled with examples of price-setting on the basis of political concerns. For instance, bread was priced at a low level because the citizenry expected cheap bread. However, farmers had earlier supply-chain access to the bread than did retailers, and because the bread was set at a price that was cheaper than animal feed, they would purchase the bread from the distributers and feed it to their cattle while there were bread shortages in the cities. There were many examples of this type as Berliner's book Soviet Socialism from Stalin to Gorbachev illustrates.
Second and related to the first point, much of Lange's argument is based on the theory that economic planners will be able to reach optimal, market clearing prices through trial and error. He assumes away Hayek's argument that it is impossible to acquire the necessary information for the myriad products in an economy. However, Hayek was right. The trial and error process is too difficult to accomplish because product variations are too complex for planners to anticipate. No amount of theorizing about the possibility of equating marginal cost and price will change the transactions cost impediments to doing so.
Third, there were several points that should have stood out as far fetched even in the 1930s. Many of Lange's arguments make assumptions that have a tautological quality. That is, to prove pricing is possible he assumes that price information is available, and then deduces that pricing is possible because the information is available. His argument begins with a model in which socialist firms have the ability to determine price and production levels, but this is the very problem that impeded socialist central planning. Central planners want to determine price and production levels centrally and so cannot make use of imbalances between supply and demand in each region and firm. For instance, Lange writes (p. 71):
"If demand and supply are not equal for each commmodity, prices change again and we have another set of prices, which again serves as a basis for individual rearranging of choices."
But this assumes either local price determination or the ability of the central planning authority to flexibly change price. It is precisely the absence of such flexibility that caused socialist planning to fail. Trial and error are impossible because the information constraints are too severe and because the political and bureaucratic processes are too inflexible.
The tautological quality of Lange's argument is especially seen on page 75 where he writes that:
"The decisions of the managers of production are no longer guided by the aim of maximization of profit. Instead, certain rules are imposed on them by the Central Planning Board which aim at satisfying consumers' preferences in the best way possible."
But it is the absence of price that inhibits the Central Planning Board from figuring out consumers' preferences. The entire problem is that the central planners do not know consumer preferences. This is related to their inability to judge product quality because of transactions costs constraints. The complex and subtle art of quality management could not be done by a central planning board. Even competitive American firms have had trouble in this area.
Similarly, on page 76 Lange argues that the central planners can combine factors:
"in such proportion that the marginal productivity of that amount of each factor which is worth a unit of money is the same for all factors".
The problem, though, is that determination of productivity is not independent of understanding consumer demand. You cannot know the productivity of the factors unless you know whether customers view the outputs as desirable in comparison with competitive products.
Perhaps most importantly, Lange's model omits one of the key assumptions of perfect competition: ease of entry. Because there is no flexibility as to competition to the governmentally controlled firms, they can all reflect arbitrary or bureaucratic decision criteria and fail to evolve or experiment simply because consumers are forced to purchase their product, which, to put it politely, will be garbage.
It is entirely possible that the central planning board produces garbage and since there is no entry of entrepreneurial firms, there are no competitors to produce alternative products. As it turned out, this was the rule in the Soviet economy, a rule which Lange's argument simply assumes away. If all existing firms produce garbage and there is no ease of entry, then consumers are forced to choose among an array of undesirable products and prices can be set by the trial and error method that Lange outlines but they will be market clearing prices for garbage.
Lange also omits the importants of dynamic change. Without entrepreneurship there is no process for quality improvement. Hence, he outlines a static economy that can produce garbage where, if there are no transactions costs, firms can disobey the central planners at risk of their necks and experiment to find optimal prices.
Price and marginal productivity are then equilibrated, but customers remain unsatisfied. Nor could the firms that produce the garbage be closed because doing so would be too complicated politically. You would have to shut down the entire economy.
It is puzzling that Lange's argument had any influence in the first place. Now that history has proven him wrong, let us resell our copy of this book for $.85.
Wednesday, June 4, 2008
Tuesday, June 3, 2008
Media Deception About Inflation
About two years ago I veered from my focus on higher education into the subject of inflation. The reason is that, based on my recollection of the 1970s, when an inflation begins there is considerable media distortion about the reason. The cause of inflation is monetary. The reason for the media distortion is that inflation has two effects. One is to boost the stock market, the other is to boost consumer prices. The media has a vested interest in an increasing stock market, and so tends to lie about the reason. Inflation and the stock market are caused by monetary expansion.
Monetary expansion boosts the stock market for this reason. Interest is the price of money. The stock market computes future earnings with an implicit discount rate. By printing money, the Fed lowers the discount rate. Thus, when the Fed "reduces the interest rates" (prints money) it increases the stock market valuation.
Now, who benefits from the boost that monetary inflation gives to the stock market? The answer, of course, is corporate executives who hold stock options, Wall Street stock jobbers, asset holders in general, home owners and debtors. Who is harmed by inflation? People who work for a living, who are thrifty, who do not have debt and have to pay for necessities with the dollars that the Fed has devalued.
The largest debtors are big businesses. Media companies are corporate enterprises just like any other, and they hold debt. Therefore, their executives benefit from inflation. Therefore, there is considerable pressure on media outlets to lie about the reasons for inflation.
Not surprisingly, my concern about potential lying in the media have materialized recently in response to Congressional testimony by Michael Masters. First, on Fox Business News, there was a panel discussion that included much verbiage about how commodity speculators are causing inflation. Second, when I opened the New York Sun, Liz Peek's article "Time to Intervene in Commodities Markets" likewise omits the underlying monetary cause of price inflation. Price inflation is a monetary phenomenon, a fact that Fox as well as Peek omit. Instead, Peek, like Fox, attributes inflation to speculators. The media lying circus has begun.
Fox and the Sun are two of the few "Republican" sources, which is why I am loyal to them. It is a testimony to Wall Street's and corporate power that superstition is presented as news when the few "conservative" sources discuss inflation much like the New York Times.
As my good friend Howard S. Katz has put it, when reading about the economy, assume anything that the mass media says is the opposite of the truth. If the media says that high interest rates are hurting you, conclude that they are helping you. If the media says that there is a "sub-prime crisis", conclude that the bloated house prices that have been causing middle class bankruptcies for the past two decades are moderating. If the media says that inflation is caused by commodity speculation, assume that it is caused by monetary expansion. If the media says that a depression is near, assume that the stock market is about to go up.
Smart men have become rich in this way.
I have responded to Ms. Peek's and Fox's "news" pieces with the following letter:
>"Thanks for your article 'Time to Intervene in Commodities Markets'. I disagree with Mr. Masters's argument. Neither he nor anyone else is smart enough to know when to intervene in markets. The S&P 500 is up 1500% since January 1970. Is that a reason to cap stock prices? If not, then why is a 183% increase in commodity prices, 12.2% of the 38 year stock price increase, a reason to cap commodity prices? If pension funds wish to hold commodities as a hedge against inflation, should the federal government tell plan participants that they must suffer from inflation?
"Given that the global supply of dollars has increased by 8% a year for the past 2 1/2 decades and the Greenspan/Bernanke Fed have been on a money printing spree since 2000, why attribute rising commodity prices to speculation? Why not the money supply? Does Mr. Masters have a theory as to why printing money does not cause inflation? And is he a relative of Jimmy Carter?
"Perhaps a more useful story would be on the reason the M-3 monetary statistic is no longer published and what the growth in the quantity of M-3 has looked like since 1983. And might there be a connection between money supply and inflation? I mean, duh."
Monetary expansion boosts the stock market for this reason. Interest is the price of money. The stock market computes future earnings with an implicit discount rate. By printing money, the Fed lowers the discount rate. Thus, when the Fed "reduces the interest rates" (prints money) it increases the stock market valuation.
Now, who benefits from the boost that monetary inflation gives to the stock market? The answer, of course, is corporate executives who hold stock options, Wall Street stock jobbers, asset holders in general, home owners and debtors. Who is harmed by inflation? People who work for a living, who are thrifty, who do not have debt and have to pay for necessities with the dollars that the Fed has devalued.
The largest debtors are big businesses. Media companies are corporate enterprises just like any other, and they hold debt. Therefore, their executives benefit from inflation. Therefore, there is considerable pressure on media outlets to lie about the reasons for inflation.
Not surprisingly, my concern about potential lying in the media have materialized recently in response to Congressional testimony by Michael Masters. First, on Fox Business News, there was a panel discussion that included much verbiage about how commodity speculators are causing inflation. Second, when I opened the New York Sun, Liz Peek's article "Time to Intervene in Commodities Markets" likewise omits the underlying monetary cause of price inflation. Price inflation is a monetary phenomenon, a fact that Fox as well as Peek omit. Instead, Peek, like Fox, attributes inflation to speculators. The media lying circus has begun.
Fox and the Sun are two of the few "Republican" sources, which is why I am loyal to them. It is a testimony to Wall Street's and corporate power that superstition is presented as news when the few "conservative" sources discuss inflation much like the New York Times.
As my good friend Howard S. Katz has put it, when reading about the economy, assume anything that the mass media says is the opposite of the truth. If the media says that high interest rates are hurting you, conclude that they are helping you. If the media says that there is a "sub-prime crisis", conclude that the bloated house prices that have been causing middle class bankruptcies for the past two decades are moderating. If the media says that inflation is caused by commodity speculation, assume that it is caused by monetary expansion. If the media says that a depression is near, assume that the stock market is about to go up.
Smart men have become rich in this way.
I have responded to Ms. Peek's and Fox's "news" pieces with the following letter:
>"Thanks for your article 'Time to Intervene in Commodities Markets'. I disagree with Mr. Masters's argument. Neither he nor anyone else is smart enough to know when to intervene in markets. The S&P 500 is up 1500% since January 1970. Is that a reason to cap stock prices? If not, then why is a 183% increase in commodity prices, 12.2% of the 38 year stock price increase, a reason to cap commodity prices? If pension funds wish to hold commodities as a hedge against inflation, should the federal government tell plan participants that they must suffer from inflation?
"Given that the global supply of dollars has increased by 8% a year for the past 2 1/2 decades and the Greenspan/Bernanke Fed have been on a money printing spree since 2000, why attribute rising commodity prices to speculation? Why not the money supply? Does Mr. Masters have a theory as to why printing money does not cause inflation? And is he a relative of Jimmy Carter?
"Perhaps a more useful story would be on the reason the M-3 monetary statistic is no longer published and what the growth in the quantity of M-3 has looked like since 1983. And might there be a connection between money supply and inflation? I mean, duh."
Hugo Chavez's Blood Libel
Gateway Pundit (hat tip Larwyn) reports yet another anti-Semitic campaign in Venezuela:
>On December 1, 2007, Venezuelan police raided a Jewish community center in Caracas. The raid by drug and terrorism police occurred just hours before Venezuelans went to the polls to vote on constitutional changes proposed by President Hugo Chavez. The Jewish community is routinely the target of verbal intimidation in the Chavez government-sponsored media- ADL.org.
>Today Hugo Chavez, the "brother" of Iranian president Mahmoud Ahmadinejad, opened a new media campaign against the Jews...
The stridency of Chavez's anti-Semitism is not, as the ADL claims, "inexplicable". Chavez is a national socialist in the same tradition as Hitler and Stalin. His storm troopers have attacked Jews before and will so again.
>On December 1, 2007, Venezuelan police raided a Jewish community center in Caracas. The raid by drug and terrorism police occurred just hours before Venezuelans went to the polls to vote on constitutional changes proposed by President Hugo Chavez. The Jewish community is routinely the target of verbal intimidation in the Chavez government-sponsored media- ADL.org.
>Today Hugo Chavez, the "brother" of Iranian president Mahmoud Ahmadinejad, opened a new media campaign against the Jews...
The stridency of Chavez's anti-Semitism is not, as the ADL claims, "inexplicable". Chavez is a national socialist in the same tradition as Hitler and Stalin. His storm troopers have attacked Jews before and will so again.
Media Silence on Iraqi War Success
The Belmont Club (hat tip Larwyn) notes that:
"The sudden and precipitous drop-off in the media coverage of Iraq is largely due to the reluctance among pundits to advertise the fact that they were wrong. Iraq is unmentionable because things are going well. Well for Iraq means not so well for pundits who staked their reputations on failure. Abe Greenwald at Commentary Magazine writes: "After years of telling us the war on terror was creating more terrorists, the mainstream media has mysteriously woken up to the fact that Islamic extremism is on the wane. Newsweek is the latest publication to run a support-for-jihad-is-fading piece.". The Washington Post has quietly and recently done so as well. Better to concede past mistakes in judgment quietly the better to deliver more judgements of the same quality in the future. But it comes at the price of clinging to the same false premises and ignoring the most glaring lessons. Greenwald writes:
"'there is an important omission in the sudden coverage of moderate Muslims: No one talks about the effect of the Iraq War. The MSM can dodge the issue all they like, but the fact remains that the Coalition’s toppling of Saddam facilitated the first organized rejection of fanatical Islam in the Middle East. Back in November 2005, while everyone stateside was crying fiasco, a group of Sunnis in Anbar province joined forces with a clutch of U.S. Marines and began to wrest their country back from al-Qaeda and its sympathizers.'"
In 1921 Walter Lippmann enumerated the reasons why the press could not be expected to provide reliable information needed for public deliberation. One is the need to sell newspapers. However, he was mildly sanguine about the technical ability of the media at that time to execute its news-providing mission competently. Things have turned out worse than Lippmann expected. Groupthink and political correctness dominate the media. The progressives of Lippmann's time had varying philosophies. Some were more or less socialist or conservative. The post-Depression New Deal liberalism resulted in two philosophies: (1) a moderately conservative progressivism that has mirrored social democracy and (2) social democracy. However, the media are almost all in the latter camp. One of the characteristics of social democrats is the inability to tolerate dissent and deliberation. Even in areas where their qualifications are weak, such as military strategy and foreign policy, the left looks to leadership from a few elite newspaper analysts. The result is a policy debate that is emotionally driven but poorly conceived.
Let us celebrate that things are going well in Iraq. General David Petraeus's fourth generation warfare strategy has worked. Rather than discuss why and begin to think about ways to improve it, the media react stupidly and public policy debate continues to be inarticulate and foolish.
"The sudden and precipitous drop-off in the media coverage of Iraq is largely due to the reluctance among pundits to advertise the fact that they were wrong. Iraq is unmentionable because things are going well. Well for Iraq means not so well for pundits who staked their reputations on failure. Abe Greenwald at Commentary Magazine writes: "After years of telling us the war on terror was creating more terrorists, the mainstream media has mysteriously woken up to the fact that Islamic extremism is on the wane. Newsweek is the latest publication to run a support-for-jihad-is-fading piece.". The Washington Post has quietly and recently done so as well. Better to concede past mistakes in judgment quietly the better to deliver more judgements of the same quality in the future. But it comes at the price of clinging to the same false premises and ignoring the most glaring lessons. Greenwald writes:
"'there is an important omission in the sudden coverage of moderate Muslims: No one talks about the effect of the Iraq War. The MSM can dodge the issue all they like, but the fact remains that the Coalition’s toppling of Saddam facilitated the first organized rejection of fanatical Islam in the Middle East. Back in November 2005, while everyone stateside was crying fiasco, a group of Sunnis in Anbar province joined forces with a clutch of U.S. Marines and began to wrest their country back from al-Qaeda and its sympathizers.'"
In 1921 Walter Lippmann enumerated the reasons why the press could not be expected to provide reliable information needed for public deliberation. One is the need to sell newspapers. However, he was mildly sanguine about the technical ability of the media at that time to execute its news-providing mission competently. Things have turned out worse than Lippmann expected. Groupthink and political correctness dominate the media. The progressives of Lippmann's time had varying philosophies. Some were more or less socialist or conservative. The post-Depression New Deal liberalism resulted in two philosophies: (1) a moderately conservative progressivism that has mirrored social democracy and (2) social democracy. However, the media are almost all in the latter camp. One of the characteristics of social democrats is the inability to tolerate dissent and deliberation. Even in areas where their qualifications are weak, such as military strategy and foreign policy, the left looks to leadership from a few elite newspaper analysts. The result is a policy debate that is emotionally driven but poorly conceived.
Let us celebrate that things are going well in Iraq. General David Petraeus's fourth generation warfare strategy has worked. Rather than discuss why and begin to think about ways to improve it, the media react stupidly and public policy debate continues to be inarticulate and foolish.
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