The socialist calculation debate

The great debate in political economy isn't between Friedrich Hayek and John Maynard Keynes, but between Friedrich Hayek and Oskar Lange.

This debate began in the 1920s and focussed on whether it was theoretically possible for a socialist country to plan its economy, as advocates of socialism suggested.

Could a socialist planner allocate scarce resources efficiently?  How would they decide whether to send rubber to Tyre Factory 12 or Hose Factory 7?  In a market economy, the factory that needed the rubber most would be willing to pay the highest price.  But there is no natural price system in socialism -- consumer prices are decided by the planner, and rubber allocated according to their diktat.

Hayek thought socialist planning was practically impossible -- the information to choose without prices was too hard to get.  His mentor, Ludwig von Mises, also believed planning was theoretically impossible -- without market prices, the necessary information simply wouldn't exist.

On the other side was a group of socialist economists, led by the Polish Oskar Lange.  Lange argued all the information buried in prices would be accessible to socialist planners:  they could carefully watch inventories to ascertain supply and demand and therefore where goods should be allocated.  Lange's views firmed in later life as he recognised the power of computers, writing just before his death in 1965 the market process was just ''a computing device of the pre-electronic age'' and therefore ''old-fashioned''.  Computers could do everything a market does, and do it fairer.

Such was the theoretical debate.  Lange and his contemporaries lost twice:  first with the fall of the Soviet Empire, and second with the left's apparent embrace of the market.  The same Australian Labor Party that damned Hayek during the global financial crisis can't stop praising the virtues of market pricing when talking about its emissions trading scheme.

But both sides of the socialist calculation debate spoke in ideal terms.  Lange and his contemporaries imagined a unified and purposeful socialist commonwealth.  And, however critical they were, Hayek and Mises assumed the same.  The question was whether socialism could work in theory -- not whether socialism worked.

Actually existing socialism was nothing like Lange's ideal model.  In a 2004 book, The Political Economy of Stalinism, the economic historian Paul R Gregory dug through the Russian archives to see how socialist planning worked in practice.

It was chaotic.  At best, resources were allocated throughout the Soviet Union ''by feel and intuition''.  Stalin had an enormous bureaucracy at his command but there was little delegation.  Even the smallest economic decisions were pushed up to the Politburo, and to the dictator himself.  Should the state buy an oil tanker?  Should they sell 200 trucks to Mongolia?  Should steel pipes be imported or produced domestically?  It was not disinterested planners working towards efficiency, but Stalin and his senior colleagues who decided such things.

This extreme centralisation was not some Stalinist aberration, as Gregory points out.  Any political order that wishes to plan for national uniformity inevitably has to concentrate power.  Stalin was not overworked because he was a totalitarian leader, but because he was a socialist one.

There was a great irony in Oskar Lange's faith in the power of computers to resolve the calculation problem.  The development of a Soviet computer was itself a case study in the inability of socialism to efficiently produce and innovate.  While the West had pushed ahead with the development of computers after the Second World War, the Soviet hierarchy apparently saw little need to do so until the mid-1960s.

When a native computer was finally mass-produced, it was so poorly built it was virtually worthless.  And the central plan called for the production of lots of computers, not for them to be well maintained or integrated.  The USSR was never able to implement the technocratic ideal.  It was constitutionally unable to do so.

Central planning failed not because it was logically impossible, but because it couldn't deal with the ignorance and self-interest that characterises all human activity.

This is still the basic problem in public policy.  Governments no longer comprehensively ''plan'' their economies.  Yet they now try to supervise them.  We are often told the debate between Hayek and Keynes is the great question in political economy.  But whether governments can spend their way out of recessions is just one element of the larger debate about the coordinating power of markets.

Lange believed economic calculation was just a matter of throwing enough computing power at the problem.  Today's regulators believe the same thing -- extensive risk models purport to give regulators enough information to manage the private sector.  The global financial crisis demonstrated that those models are elaborate fictions.  Yet the response from regulators has been to double down and insist on greater powers and more complex models.

The calculation problem is endemic in highly regulated sectors like health, where it is not the price system that coordinates resources, but bureaucrats and politicians.  Every government proposes to reform health but the sector will remain unreformable until this basic problem is recognised.  In the meantime health will continue to be dominated by rent-seekers and rife with inefficiency.

And the calculation problem shapes the debate over tax and spending.  Social democrats claim in certain circumstances governments can spend money more rationally, more efficiently than taxpayers could.  But this claim relies on a belief that bureaucracies have enough knowledge to do so, and can surmount the political and commercial interests which flock to the centres of power.

Much has changed since the 1920s but the basic problem in political economy has not -- ignorance.  We should not be talking about Hayek versus Keynes, but Hayek versus Lange.

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