Production, consumption and economic calculation
[This brief article is taken from Economics for Software Professionals: A strategy for civilization and also explains the Mises/Hayek argument for the impossibility of economic calculation under Socialist/Communist regimes]
The wealth that life/order needs can be attained by either force/theft/violence which diminishes the wealth/life of others and leads to life/order destroying retaliation, or by production and trade, which leads to the mutual benefit of both orders. Peace, in other words, the absence of force and violence as a means to acquire wealth, is what motivates and forces every mind/order to think about the needs of others in order to produce something of value and successfully engage in trade, inadvertently leading to the aforementioned division of knowledge and labor that makes civilization possible. As the great Ludwig von Mises reminds us: “Society has arisen out of the works of peace; the essence of society is peacemaking. Peace and not war is the father of all things.” As should become increasingly clear, peace and the freedom from coercion/violence it implies is what “turns on” the market process and is the key to socioeconomic prosperity. Most living things are not smart enough to engage in trade so they are left with the much simpler strategy of violence/predation. A strategy which was increasingly important the farther back we go in our evolution which helps further explain why the potential for violence and war is still so prevalent amongst us.
Since predation/theft is generally outlawed and peace encouraged, social orders (individuals or companies) are in cycles of production, trade, and consumption. If you are a freelancer you produce a product/service and trade it directly with society (customers) for money, and then trade the money back with society for the wealth you consume. If you work for a company, you produce your labor and trade it for money with your “employer” who combines it with the labor of others to produce a product/service which is then traded with society for the money from which your paycheck comes. Whether you are a freelancer, employee, or company, what is commonly referred to as sales revenue (your paycheck), is an estimate of the total amount of wealth produced. Costs, like employee wages which will be used by them to consume wealth, are an estimate of how much wealth is consumed from the economic pie. And profits, which are the difference between sales revenue (production) and costs (consumption) are an estimate of by how much additional wealth the economic pie has grown. A profitable order is an order (cell/person/company) that produces more than it consumes and is therefore self-sustaining/alive. The global economy or ‘Social Organism’ is really a vast collection of orders that are constantly trading with each other, each trade taking each participant/order from an inferior to a superior state of well-being from its perspective, otherwise the trade would not occur. When Carl trades a dollar for a hamburger he values the hamburger more than the dollar and the restaurant values the dollar more than the hamburger so the action of trading takes place, which like all action which is not coerced, takes each participant from an inferior to superior state of well-being.
Each entrepreneur/businessman/order is like a computer that is constantly using prices to acquire wealth or ‘factors of production’ and calculating how to reorder/transform them in the most profitable/wealth-increasing way. For example, a restaurant owner in Miami Beach(MB) on Nov. 13th 2016 sells a traditional Cuban dish called Picadillo consisting of ground beef, rice, plantains and black beans for $8. The very existence of this business/order and the $8/meal price gives us a tremendous amount of information. We know that the costs per meal, in other words, the total amount of consumption of wealth needed to produce each meal has to be at most $8/meal, otherwise the business would be losing money and eventually cease to exist. Some of the $8/meal, perhaps $1, might be profit, and $7 will be spent on costs or ‘factors of production’ like labor, real estate, equipment, energy, food, etc. We also know that there are enough customers nearby willing to trade with and thus sustain the restaurant at the $8/meal price. If the businessman sets prices too high, customers will choose other options, if prices are set too low, they might not cover costs and cause the business to consume more than it produces and thus go out of business.
Let’s assume there is another restaurant that sells a similar Picadillo dish in Corpus Christi, Texas for $6.50 and also makes a $1/meal profit. How could this be? The most likely reason is due to the crucial fact that costs are highly time and place specific, and in this particular scenario such costs in Corpus Christi are lower than in MB. Perhaps the proximity with Mexico means that many Mexican immigrants who might be willing to work for less, and thus consume less, can be employed. Rent/real estate is also cheaper in Corpus Christi than in trendy MB. Texas also has many oil refineries and the price/cost of energy might be lower than in MB where gasoline has to be transported hundreds of miles by truckers whose consumption must be taken into account. The bottom line is that it is vitally important to realize that the knowledge and costs associated with creating a profitable order, things like real estate, labor, energy, trust relationships and countless other factors, are highly time and place specific, and only those minds managing their respective businesses/orders in their corner of the world at a particular time are in a position to acquire such knowledge and properly set prices that will lead to a profitable order. Would it make sense to copy the $6.50/meal price that can sustain the business in Corpus Christy and make it the price of meals in MB? Of course not. We already know that given the abilities and knowledge of the businessman in MB, his costs were $7/meal, so setting the price to $6.50 would simply lead to loses, in other words, more wealth consumption than production to the tune of 50 cents per meal sold. This unavoidable time and place specificity of knowledge, and the fact that only the businessmen running their respective enterprises are in a position to acquire such knowledge is one of the main reasons why economic planning MUST BE DECENTRALIZED, thus rendering central planning ideologies like Socialism/Communism completely unworkable. No central planning bureaucracy could possibly acquire all the time and place specific knowledge needed to properly organize a business/order and set prices which properly account for local costs and customer desires and lead to a profitable and thus sustainable order. Nikita Khrushchev, who followed Stalin as head of the centrally planned (Socialist/Communist) Soviet Union, is credited with saying “When all the world is socialist, Switzerland will have to remain capitalist, so that it can tell us the price of everything”. The same point was made by the great economist Murray N. Rothbard in a talk[i] where he mentioned that “A noted British economist visited Poland in the 1950s …and the Polish communist economist admitted that they refer to the world market [for prices]” And according to Murray the British mentioned to the Pole “If socialism takes over the whole world which you are presumably in favor of, what would you do then? [to look for prices]” and the Pole replies “We’ll have to cross that bridge when we come to it” Unfortunately for Khrushchev and the billions who suffered economic chaos and an inevitable decline in production under Socialist/Communist regimes all over the world, prices in Switzerland (or anywhere else) embody information about the costs of those particular places at specific times and are no good elsewhere. This would be like setting the MB price of Picadillo dishes be the Corpus Christy price. Governments can always attempt to tax more or redistribute wealth to keep unprofitable enterprises/orders going, but this only leads to a continued shrinking of the economic pie and lower standards of living for all which is the inevitable hallmark of all centrally planned Socialist/Communist economies.
The rise of the Internet and supercomputers is causing the economically ignorant to believe that now central economic planning will work and perhaps some bureaucrats will fall for it and propose government force to get people to go along with yet another disastrous socialist experiment. For example, with the Internet local pricing information all over the world can perhaps be processed by central computers. Although this can help some entrepreneurs in numerous ways it will not out-compete freedom and decentralization as far as economy-wide planning because no computer/system can get in the brains of entrepreneurs to predict what products/businesses they will create and thus alter society, and similarly no computer can get in the mind of consumers and predict how they will choose to spend their money thus once again altering the social order’s numerous cycles of production and consumption. For example, Dave in Seattle invents a drug that cures cancer which causes him to borrow billions to bring it to market and then causes billions of people to sustain his business/order at the expense of others. How can a central planning computer get in Dave’s head to come up with or predict such and invention and also predict people’s desire for the drug at the expense of other alternatives? Again, impossible. Yes, Artificial Intelligence and countless other innovations will greatly help mankind, but not bring about Socialism in the foreseeable future.
Socialist/Communist countries and government in general also face an ‘incentive problem’. In free societies or the private sector in general, each mind/entrepreneur is incentivized to be as productive as possible and keep inefficiencies to a minimum since he owns/keeps the additional wealth or losses. On the other hand, the government employee or bureaucrat gets the same pay whether his department did a good job or not, and is also not risking his own wealth since that comes from the taxpayers/society. So 1) the impossibility of economic calculation under Socialism/Communism, coupled with 2) the unproductive/wasteful incentives in such regimes/government should help one understand why Socialist/Communist regimes were/are always in socioeconomic chaos.
