5. Don’t neglect the benefits of economic calculation:
As an exchange economy becomes more
complex, people are induced to engage more in indirect rather than direct
exchange. Thus, rather than exchanging eggs for horses, horses for watermelons,
watermelons for oranges, people realize that it is more efficient to just
exchange all these goods for a common medium of exchange known as money.
Historically, gold and silver became the most popular media of exchange due to
their durability, portability, relative scarcity, divisibility, and uniformity.
When these emerged as money, eggs, horses, watermelons, and oranges, and every
other exchangeable good in the economy, can be exchanged against money, and
then that money can be exchanged against all the other exchangeable goods, thus
greatly facilitating the process of exchange in a complex exchange economy.
But having all exchangeable goods
exchanged for money has, besides this, another very important effect that the
first users of money probably did not realize; it enables economic calculation.
With all exchangeable goods exchanged for money, money becomes the common
denominator of economic activities. With an economic common denominator, it
becomes possible to more effectively assess the successfulness of a particular
productive activity. Thus, if the owner of a bakery buys the bakery and its
equipment for 50 gold ounces, and calculates that he requires 5 gold ounces a
month for operating expenses and to maintain the bakery, he is in a position to
calculate, based on his revenue, if his investment was successful. Thus, if his
revenue is 10 gold ounces a month, he would probably determine that this was a
good investment, depending on how quickly he feels he needs to recover his
initial upfront investment, while if his revenue is 4 gold ounces a month, not
even covering his maintenance and operating expenses, he would know that this
was a bad investment and would adjust accordingly. From a societal point of
view, due to consumer’s sovereignty, a good investment means that scarce
factors of production have been employed in a way that satisfies more urgent
wants of the consumers, while a bad investment means that scarce factors of
production have been employed in a way that does not satisfy the consumers as
fully. Without a common economic denominator, success or failure would have to
be determined by a comparison of a series of heterogeneous inputs and
heterogeneous outputs. This is hard enough if only the producer’s valuations
are consulted; it becomes virtually impossible when producing for the consumers
and all of the millions of market exchange ratios must be known instantaneously
in the mind of the producer in order to calculate. Thus, the ability to calculate economically
is vital for producers to ascertain if what they are doing accords with the
demands of the consumers, and in a complex economy, money prices are necessary
for this.
The ability to calculate economically
is one of the great benefits of a free-market, or capitalist, system of
production. In a fully socialist economy, exchanges, let alone monetary
exchanges, have been banned, and hence there is no common denominator. The
planners will have no way of knowing how well their investments are doing
either from the standpoint of the consumers or even from the standpoint of
themselves. If the planners decide that they want to produce steel, without a
market for the producers’ goods necessary for producing steel, no money prices
are assigned to these goods based on their alternate uses in the economy, and
hence the planners will have no idea what the most economical way of achieving
even their own goals will be.
Even without full socialism though
where a monetary market does exist, as in the modern world, there are still
institutions that do not calculate economically. Government bureaucracies
generally do not try to make the most money possible with their activities, but
have other goals for the employment of the resources under their control. But
if they are not aiming at making monetary profit, they cannot employ economic
calculation properly, and hence end up stabbing in the dark (from the point of
view of consumer satisfaction as demonstrated through voluntary exchanges), taking actions without a market-based assessment
of the opportunity costs (any alternative uses of the resources) involved
because they cannot use economic calculation to do so as the profit-seeking
businessman can. For example, consider the decision of whether to turn a
section of a city street into a pedestrian-only street. If the street is owned
privately, economic calculation can help with the decision. Are the expected
revenues from pedestrian tolls or perhaps the expected benefits to stores on
the street enough to outweigh the lost revenues from car tolls or the lost
business of motorists at the stores? Because this decision is based on
expectations, a wrong decision could certainly be made, but at least there is a
standard for ascertaining that the decision was wrong (losses as opposed to
profits) and after a while, street entrepreneurs, based on these experiments,
will have a better idea of which portions to make pedestrian-only and which
not.
On the other hand, if the street is
owned by a government, unless the government just wants to make monopoly
profits, they will generally not charge at the revenue-optimization point in a
quest for profits, but will have other goals. The decision will be made based
on the personal feelings and hunches of the bureaucrats involved. Maybe the
government is a “pedestrian-friendly” or a “car-friendly” regime and will make
their decision this way? Perhaps the bureaucrat just thinks that “it would be
nice” if this section was pedestrian-only. In any case, the decision will tend
to be more arbitrary from the point of view of the consumers than the private
decision, due to the lack of economic calculation and the profit-and-loss
motive. The more bureaucracy extends across the economy, the more sections of
the economy cannot calculate economically and rationally allocate their
resources and the more the demands of bureaucrats tend to dominate rather than
the demands of the consumers.
All this is not to say that a social
thinker may not want the demands of bureaucrats to override the demands of the
consumers in certain special cases. It is, however, fallacious to propose plans
for socializing industries or adopting a fully socialist system without even
mentioning the great potential benefits that economic calculation provides by helping and encouraging profit-seeking businessmen to serve the consumers in an economical fashion.
6. Methodologically, choose individualism:
Another common mistake of social
scientists is to subscribe, knowingly or unknowingly, to methodological holism,
rather than methodological individualism. Methodological holism is when a
collective, rather than an individual human, is taken as the basic unit of
analysis, to which motivations and anthropomorphic characteristics are assigned. Thus, it is
said that ‘England’, or ‘the workers’, want to do this or that, for this or
that reason. But England is a term signifying a geographical region or a term
signifying a grouping of all the individuals currently living in that
geographical region. It cannot ‘go to war’ or ‘protect its interests’ or have a
‘national character’ because it is not an individual, acting human. Men living
in that geographical region can form associations that convince or compel
others to ‘go to war’ or engage in certain economic or cultural activities, but
these associations are always just the aggregate of its constituent individuals,
never an entity with its own mind that can be analyzed other than by analyzing
the individuals who make it up.The same thing applies with ‘the workers’, a term that in
this context tends to signify people that are paid a wage for performing manual
labour of some kind. ‘The workers’ cannot think, feel, or want, anything, only
individual workers can do this, and sometimes the interests of one worker and
the interests of another will clash.
Methodological individualism, by
contrast, recognizes that the only entities in society that can think, feel,
have a character, and act, are individual human beings. The methodological
individualist does not deny that individuals can form associations to pursue
common interests, or exercise hegemonic bonds over other individuals and compel
them to do certain things, but when studying these associations one must never
speak of them as individual humans, they are only aggregates, often temporary
aggregates, of individuals, and must be studied as such.
It's not bureaucrats that drive government decisions, I think for the more important things it is more often applying political calculation and pandering to special interest groups of voters (witness the cancelling of the powerplants in Ontario).
ReplyDeleteBut the point you are implying is that everything can be measured in money. Unfortunately, that is not true. I think the best example is pollution. It is not practical for businesses or consumers to pay for the pollution they indirectly cause, because the future harm is not completely known. We can know that there is harm, without knowing how to measure it exactly. In these cases perhaps the political calculation serves society better than the economic one?
I would say that the bureaucrats are a channel through which political decisions are implemented, driven mostly, as you say, by special interest groups, but that they are not always a direct channel, they will sometimes modify or influence policy-making in their own, often subtle ways. In any case though, whether it’s bureaucrats or special interest politics mainly driving the decisions is not vitally important to the argument, the point is that political decisions rather than profit-maximizing decisions are being made.
ReplyDeleteAs for the second point, my intent wasn’t to imply that everything can be measured in money, this is why I included the sentence: “All this is not to say that a social thinker may not want the demands of bureaucrats to override the demands of the consumers in certain special cases” in the final paragraph of tip #5. The main point I was trying to get across is that when things certainly can be measured primarily in monetary terms, this is a great advantage that must be considered before proposing any measures that would throw away or distort the ability to calculate monetarily, such as heavy government interventions or, in the most extreme case, full socialism.
Pollution is an interesting example of a case where a negative externality (harm imposed by the production choices of an economic actor, without consent, on people not involved in the economic transaction) is almost certainly created, but one that is difficult for the economic actors to internalize, as you say. I will discuss pollution and environmental concerns in more detail in a planned future post on environmentalism. Here, let it suffice to say that there are some institutional changes that could be made to make the negative externality of pollution enter more into the monetary calculations of actors, mainly through a greater recognition of private ownership of environmental resources such as air quality and bodies of water and greater protection of this ownership by the courts. As we will discuss later, full-fledged private ownership of these resources is somewhat impractical, but there are some feasible steps that could be taken in that direction which would be positive.
As for whether political calculations might sometimes serve society better than economic ones, it is certainly possible in some limited instances, and in the field of defense and law and order in particular, the main raison d’etre of government, I believe that political calculations will usually prove more conducive to the welfare of the individuals in a society than economic ones.
ReplyDeleteThe main problem with political calculations though is that through them, some groups in society are able to impose costs on others to pay for what the imposing groups deem to be benefits. If one thinks about it, in fact, this is the same type of situation that we confront in economic negative externality cases such as pollution, except government can potentially impose negative externalities on a much vaster scale, through its taxation and regulation apparatus, than a polluting factory owner ever could. For example, if an environmentalist movement captured a certain amount of political influence, they could make it politically attractive for the government to impose all kinds of restrictions on economic activity, which would entail great costs imposed on producers whose operations are curtailed and consumers who are faced with a less abundant supply of goods due to the restrictions. We have no idea whether these restrictions are justified due to the reduction of pollution that will result, and there is no reason to believe that there is a mysterious tendency for political calculations to result in some kind of ‘optimal’ policy in this regard. Thus, when we suspect that there are great economic externalities present that cannot be internalized into monetary calculations, a focused and limited government intervention may be a plausible option, but we must always keep in mind that actions based on political calculations, by their very nature, suffer many of the same kinds of externalities problems as a few economic activities do, perhaps even more so.