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Summary of History of Economics part 2
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Full summary of History of Economics part 1&2
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Part 2Lecture 5
Capitalism and socialism: what is at stake?
The dynamics of the Western economic system – from capitalism to socialism?
Theoretical arguments for or against socialism. They formulated very important
theoretical ideas: better understanding of how markets and the economy work.
Government intervention and the role of markets.
Key ideas of the 20th century economics along the way: do the changes we witness
amount to the radical transformation of the whole system? Rethinking capitalism.
Capitalism Socialism
Private ownership of most of Collective/government ownership:
resources. this is the major difference.
Individualism (ethical, wellbeing of Community interests, social
the individual is very important). preferences (not preferences of
Competition and liberty. society, but other regarding
Resource allocation: Decentralized preferences pro-social).
free decision-making on markets. Cooperation and democracy (in
Agents decide themselves what and theory).
where to produce. Resource allocation: Planning
First developed historically and then (someone decides how much and
as a theoretical construct. where there is production).
Changed throughout the 20th First developed in theory and then (at
century and incorporated elements the global scale) attempted in real
of socialism. societies.
Changed dramatically over the 1980s.
Joseph Schumpeter (1883-1950), Capitalism, Socialism, and Democracy (1942) book
posted in the midst of the second world war.
Socialism will replace capitalism, not because capitalism will fail (as Marx thought), but
because it will succeed! It will fade away, due to its success.
The opening up of new markets, foreign or domestic, and the organizational development
[...] illustrate the process of industrial mutation (evolutionary language) that incessantly (= in
a non-stop way) revolutionizes the economic structure from within, incessantly destroying
the old one, incessantly creating a new one. This process of Creative Destruction is the
essential fact about capitalism. It is what capitalism consists in and what every capitalist
concern has got to live in.
Instead of entrepreneurs managers of large corporations. Small entrepreneurs
who compete leave their space for managers of large cooperations.
Large corporations, together with critical intellectuals, will remove the political
support of capitalism. The new form: society governed by large companies.
Is socialism possible? The answer of economic theory
Vilfredo Pareto: the notion of the optimum of the economy.
(since the 1930s the notion of the optimum was taken up in the concept of a social
welfare function plan what is good for the entirety of the economy/society)
, General competitive equilibrium is possible (Walras!); why not enact it through
planning? We can achieve an optimum
Enrico Barone (1908): ‘ministry of production‘ just sets the prices = minimum costs,
and the welfare is maximized
The first critique: Ludwig von Mises (1881-1973)
Economic Calculation in the Socialist Commonwealth (1920)
How to define the monetary value of goods if they are not subjects to exchange (in other
words: if there are no markets)?
No independent owners of the production factors no factor markets (no one is selling
factors, capital and labor, on markets) no prices!
No single man can ever master all the possibilities of production, innumerable as they are, as
to be in a position to make straightway evident judgments of value without the aid of some
system of computation (= it is the idea of apples and oranges, how can you compare them.
When you talk about optimalization, you base your reasoning on monetary value).
There would be no means of determining what was rational, and hence it is obvious that
production could never be directed by economic considerations [...] How will [the
administration] be able to decide whether this or that method of production is the more
profitable?
Where there is no free market, there is no pricing mechanism; without a pricing mechanism,
there is no economic calculation ( no rationality). Socialism as economic policy is not
possible.
But what if the state itself becomes an economist?
Fred Taylor (1929): The task is to compute the equilibrium price vector and to take
the functions of the market upon the socialist state (state that owns the resources
and wants to spend them in the most rational way), armed with economic theory.
General outcome on all the markets: prices.
Method = trial-and-error adjustment process!
if the economic authorities of a socialist state would recognize equality between cost of
production on the one hand and the demand price of the buyer on the other as being the
adequate and the only adequate proof that the commodity in question ought to be produced,
they could [...] perform their duties [...] with well-founded confidence that they would never
make any other than the right use of the economic resources placed at their disposal (Taylor,
The Guidance of Production in a Socialist State, 1929)
Counter-critique: Oskar Lange (1904-1965) and ‘market socialism‘
Economic Theory of Socialism (1936)
Mises was wrong to claim that no prices are possible in socialism. Why: because the prices
are indicators of scarcity. There is no need for a market here.
The economic problem is a problem of (optimal) choice between different alternatives. To
solve the problem three data are needed:
(1) a preference scale which guides the activity of choice (we call it now the utility function
what do we actually want?), how do you formalize preferences? Utility function. These are
given as numbers.
(2) knowledge of the " terms on which alternatives are offered,“ [prices!] and, finally,
,(3) knowledge of the number of resources available (budget constraint). This is based on
income, what do you get given the prices of goods and the income? the budget constraint.
Those three data given; the problem of choice is soluble. You know your optimal resource
allocation. Constrained optimization is giving the solution for the whole economy (social
welfare function).
The function of market – allocating resources by trial and error – is taken by the
‘Central Planning Board‘.
Consumer goods and services of labor are sold at a genuine market.
Capital goods and other productive resources are not traded.
The Central Planning Board performs the functions of the market. It establishes the rules for
combining factors of production and choosing the scale of output of a plant, for determining
the output of an industry, [and] for the allocation of resources [...] Finally, it fixes the prices so
as to balance the quantity supplied and demanded of each commodity.
In this model we have the state instead of capitalists, which has the best theory of markets
and just applies it for planning and no more the best outcome. This is the idea of market
socialism.
The critique on Lange by Friedrich Hayek (1899-1992): The Use of Knowledge in Society
(1945)
Okay, optimal allocation of resources under socialism is possible in theory, but
impossible in practice! Why? Because knowledge is dispersed and often also tacit
to rationally plan we need to know things, but this knowledge is not given and cannot
be retrieved by the central planning board. Dispersed: it does not exist in just one
place. Tacit: you cannot put all the knowledge in the world on paper practical
knowledge.
- [T]he "data" from which 'the economic calculus starts are never for the whole
society "given" to a single mind which could work out the implications and can
never be so given.
- Lots of important information is created by the market interaction itself! If you
prohibit trade, this information is never revealed.
Thus, the economic problem is something different: how to secure the best use of
resources known to any of the members of society, for ends whose relative
importance only these individuals know. Or [...] it is a problem of the utilization of
knowledge which is not given to anyone in its totality. Central planning based on
statistical information by its nature cannot take direct account of these circumstances
of time and place.
Hayek‘s theoretical perspective
Prices collect and communicate information and thus register the changes in the
interconnected economy. Prices work as efficient information processors.
In a system in which the knowledge of the relevant facts is dispersed among many people,
prices can act to co-ordinate (coordination comes from the markets in a decentralized and
interconnected way) the separate actions of different people in the same way as subjective
values help the individual to co-ordinate the parts of his plan.
The smallest change in one place in the network changes everything.
, Hayek’s dynamic view of economy and competition (The Meaning of Competition, 1948)
Competitive process as an act of discovery: knowledge revealed only in the process of
competition! In competition you discover new things, the outcome of the
competition is much less certain than portraited in the models.
Critique of the static idea of competitive equilibrium and ‘perfect’ competition, open-
endedness.
Competition is [...] a process of the formation of opinion: by spreading information, it creates
that unity and coherence of the economic system which we presuppose when we think of it
as one market. It creates the views people have about what is best and cheapest, and it is
because of it that people know at least as much about possibilities and opportunities as they
in fact do. It is thus a process which involves a continuous change in the data and whose
significance must therefore be completely missed by any theory which treats these data as
constant.
For Hayek, perfectly competitive model (Walras) is a nonsense. Why? Because it does not
correspond to what is actually happening during competition!
it is worth recalling that, according to Dr. Johnson, competition is "the action of endeavoring
to gain what other endeavors to gain at the same time.“
Now, how many of the devices adopted in ordinary life to that end would still be open to a
seller in a market in which so-called “perfect competition” prevails? I believe that the answer
is exactly none. Advertising, undercutting, and improving (“differentiating”) the goods or
services produced are all excluded by definition—“perfect” competition means indeed the
absence of all competitive activities.
Theoretical and political challenges
Equilibrium – disequilibrium – equilibration: most contemporary models still don‘t
demonstrates how agents arrive at some mutually consistent plans of action. We do
not have a theory of how an economy is arriving at a general equilibrium. This idea is
always somehow assumed.
The role of information and communication on markets, especially in the age of Big
Data. What if with better technology we can create an optimum equilibrium?
- How are prices set today? They are set by algorithms.
- What information do they transmit?
What is the role of planning in contemporary economy?
- ‘mechanism design’ as a response to Hayek (if we know how perfect markets work,
why don’t we change existing markets to this state? The idea of designing the social
state in an optimal way, the markets give us this information).
- bigger corporations (recall Schumpeter!) always increasing due to technology.
Capitalism vs. socialism
- Inequality? Capitalist systems are known for the increasing inequality. They thought
inequality would end by the invisible hand, but it did not.
- Efficiency? If we move to socialism, so everything is common property, how do we
keep individual incentives?
- Incentives? See efficiency.
- How can we compare? Real socialism has never been implemented anywhere, so
how can we compare its effects to capitalism?
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