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Cost and Choice: An Inquiry in Economic Theory; Buchanan, James M.
25 paragraphs found.

Similar views in theories of cost have been developed and expressed since the 1930s at the London School of Economics by scholars such as Lionel Robbins, F. A. Hayek, Ronald Coase, and Jack Wiseman. These theories, for systematic as well as personal reasons, have quite strong links to even older theories of the so-called Austrian economists. However, though acknowledging and supporting the Austrian contribution in the socialist calculation debate with arguments based on his own concept of cost, Buchanan distances himself somewhat from the Austrians. Avoiding what he regards as the "arrogance of the eccentric," Buchanan makes a serious effort to integrate his views into the orthodox classical and neoclassical framework. Therefore the discussion in Cost and Choice starts with Adam Smith's famous deer-beaver example. In the particularly simple "one-factor" setting of that example, subjective opportunity costs are themselves "explained" by objective transformation rates. Because everybody can transform two deer into one beaver and vice versa, any divergence between the transformation and the exchange rate should eventually be washed out by the choices that rational decision makers make in view of the opportunity costs of their decisions. But what about more complicated settings?


The basic sources of the modern London tradition are represented in papers by Robbins, Hayek, and Coase in the 1930's. These are followed up insistently by the much neglected writings of Thirlby which extend from 1946 through 1960. Additional papers in the tradition were published by Jack Wiseman in the 1950's. These published materials seem, however, to be only the now-visible residues of an extensive dialogue that must have been part-and-parcel of economic teaching at LSE over a span of some thirty years.


More specifically, I should here acknowledge the help of many students, colleagues, and fellow scholars. Students in 1965 and 1967 graduate seminars at the University of Virginia suffered with me during the critical periods when my confusions were at their peaks. In 1967 an early draft was circulated, and I was fortunate in securing much useful revision advice. In this respect, I appreciate the help provided by William Breit, R. H. Coase, F. A. Hayek, Mark Pauly, Roger Sherman, G. F. Thirlby, Gordon Tullock, Richard E. Wagner, Thomas Willett, and Jack Wiseman. Although they probably did not realize it, both Francesco Forte and S. H. Frankel provided encouragement in discussions at critical times when my own enthusiasm wavered.

Ch. 2, The Origins and Development of a London Tradition

Mises, Robbins, and Hayek on Calculation in a Socialist Economy


A modern reading of these early contributions by Mises suggests that some of the intuitive force of his argument stemmed from a more sophisticated conception of opportunity cost than he was able to make explicit at that time. Mises' attack on the possibility of socialist calculation is wholly consistent with the conception of opportunity cost that emerged more fully later, both at LSE and in his own writings. Although he did not center his early argument directly on the cost problem, per se, the general tenor of Mises' discussion is clearly and quite closely related to later developments in cost theory, and his contribution to that theory surely deserves recognition alongside those of Wicksteed and Knight. Quite apart from the importance of Mises' own works is his influence on the work of Lionel Robbins and F. A. Hayek, the transplanted Austrian who became one of the central figures of the LSE tradition.


In addition to writing the 1934 paper previously cited, Robbins also participated in the great debate over the possibility of socialist calculation. *27 An assessment of his contribution at this stage must be closely connected with the assessment made of Mises' work. Robbins' argument might well have been based on a more sophisticated notion of opportunity cost than that which is explicitly discussed, but one senses in a modern reading that, along with Mises and Hayek, he could have been much more effective if he had been able to make more articulate the distinction between objectively measurable cost and cost as an element of a decision process.


Hayek's specific contribution to the development of cost theory that is contained in his part of the debate on socialist calculation is a peculiarly mixed bag. In his "Introduction" to the famous collection of essays, *28 Hayek foreshadows his later and more explicit methodological emphasis on the necessity of distinguishing between the subjective apparent sense data of the person who chooses in the economic process and the objective data that are available to any external observer. As we shall see, this methodological step is essential to any genuine understanding of cost. It appears, however, that Hayek had not in 1935 incorporated this methodology fully into his own basic theory. In his essay, "The Present State of the Debate," included in the collection, he suggests clearly that cost of production becomes difficult to calculate in a socialist setting primarily because of the absence of the conditions of competitive equilibrium where "cost of production had indeed a very precise meaning." *29 This emphasis, which was also evident in Robbins' work, left the way open for Lerner's effective reply which argued simply for the adoption of a rule for setting prices at marginal opportunity costs, regardless of the state of the world. *30

Hayek, Mises, and Subjectivist Economics


F. A. Hayek was appointed Tooke Professor of Economic Science and Statistics at the London School of Economics in 1931 and held this chair until 1950. Along with Robbins, he must be credited with providing the source of much of the LSE tradition in cost theory, a tradition that seems to have emerged gradually over these two decades. As suggested above, Hayek's contribution was primarily that of providing the underlying methodological basis for the more explicit works on cost by others. He presented the methodology of subjectivist economics with convincing authority; his essays remain recommended reading almost thirty years after their initial publication. And economic theory, generally, should certainly have avoided some major modern confusions if Hayek's essays had been more widely read and understood.


A distinction must be made between the orthodox neoclassical economics which incorporates the subjective-value or marginal-utility revolution in value theory and the subjectivist economics of the latter-day Austrians, notably Mises and Hayek. The dependence of price (value) on marginal utility, subjectively determined, can be fully recognized, while essentially an objective theory of cost is retained. In Jevons' famous statement, marginal utility depends on supply which, in its turn, depends on cost of production. As stated, this theory is wholly objectivist in character, although, of course, the valuation of buyers and sellers is incorporated as a part of the objective data. Costs are objectively determinable, although the theory does not say that costs alone determine value. As contrasted with classical theory, one-way causality is missing, but not the objectivity of the explanation. It is this latter objectivity that is jettisoned, wholly and completely, by both Mises and Hayek. In this respect, they differ sharply with earlier Austrians, although they do not seem fully to sense the distinction. In many respects, they seem much closer to Wicksteed than to Wieser.


There seems no doubt that subjectivist economics was explicitly introduced at LSE by Hayek. In a paper of major importance, published in 1937, *31 he laid down the central features of the subjectivist methodology, features that he elaborated in considerably more detail in later works. *32 In his 1937 paper, Hayek gives credit to Mises for the latter's background work, *33 published in German in 1933, but made available only much later (1960) to English-language scholars. Hayek's initial paper provides, in one sense, the "classical" methodology of the subjectivists, a methodology which is central to a theory of cost that is related directly to choice and that is to be contrasted with the theory of cost embodied in neoclassical orthodoxy.


The subtle distinction between the economics of subjective value and the subjectivist economics espoused by Hayek and Mises was quite naturally obscured so long as the task of economic theory was largely limited to the explanation of market interactions. The famous Jevons statement about supply serves as an illustration. So long as individual producers, responding to the demands of consumers, are the actors whose behavior we seek to explain, there is really no need of inquiring as to whether the costs of production are subjective or objective. Costs are obstacles to the choices of producers, and economists can discuss "laws of cost" in this context without presuming that objective measurement is possible.


Only Hayek and Mises seemed to be completely aware of this problem and of its major importance, although many other economists seem to have been vaguely disturbed by it. Subjectivist economics, for Hayek and Mises, amounts to an explicit denial of the objectivity of the data that informs economic choice. The acting subject, the chooser, selects certain preferred alternatives according to his own criteria, and in the absence of external change he attains economic equilibrium. This personalized or Crusoe equilibrium is, however, wholly different from that which describes the interactions among many actors, many choosers. In the latter case, the actions of all others become necessary data for the choices of the single decision-maker. Equilibrium is described not in terms of objectively determined "conditions" or relationships among specific magnitudes, e.g., prices and costs, but in terms of the realization of mutually reinforcing and consistent expectations. The difference between these two approaches, the objectivist and the subjectivist, is profound, but it continues to be slurred over in the neoclassical concentration on the idealized market interaction process in which all individuals behave economically. In an unchanging economic environment populated by purely economic men, the two approaches become identical in a superficial sense. In a universe where all behavior is not purely economic, where genuine choice takes place, the important differences emerge with clarity.


At this juncture in the development of economic theory, we must, I think, ask why the convincing arguments of Hayek exerted so little weight. Without question, objectivist economics continues to carry the day, and few of its practitioners pause to examine critically its methodological foundations. There are, no doubt, several reasons for this failure, but undue attention paid to the definition of equilibrium, although of immense importance in itself, may have retarded acceptance of the more general subjectivist notions. Neutral readers of the impassioned debates on socialist calculation might have been led to think that the central issue was really one that involved the possibly erroneous derivation of policy criteria from stationary equilibrium settings. Indeed this is an issue, but the subjectivist critique is obscured here. As noted earlier, this concentration on equilibrium, of which Hayek, Robbins, and to a lesser extent Mises, all are guilty, left the way open for Lerner to drop all references to general equilibrium in his derivation of the policy rules that explicitly require the introduction of objectively measurable costs.


Alongside the more abstract and methodological contributions to cost theory made by Robbins, Hayek, and Mises, other elements of perhaps a more authentic LSE tradition emerged in the 1930's. These reflect the direct application of some of the basic Wicksteed notions to problems that confront the businessman. This "common sense" approach had its roots at LSE in the work of Cannan who continually insisted on starting with problems as they exist. Cannan does not seem to have made specific contributions to cost theory, although he accepted opportunity-cost notions readily. *34


Despite his major contribution toward clarifying the concept of opportunity cost in the context of the theory of the firm, Coase did not in his 1938 papers fully incorporate the "subjectivist economics" of Hayek and Mises into his analysis, nor did he draw the distinction between his concept and that embodied in neoclassical orthodoxy. *36


As I noted earlier, Ludwig von Mises was one of the chief sources for the subjectivist economics expounded at LSE by Hayek, and his work was an influence as well on both Robbins and Thirlby. Mises' earlier work on the possibility of socialist calculation has been mentioned; some reference must now be made to his treatise, Human Action,*42 published in English in 1949, but based on a work in German published in 1940. In this book, Mises does discuss cost explicitly, even if briefly, and his basic conception is similar to that London conception that is best represented in Thirlby's work. Generically, "costs are equal to the value attached to the satisfaction which one must forego in order to attain the end aimed at" (p. 97). "At the bottom of many efforts to determine nonmarket prices is the confused and contradictory notion of real costs. If costs were a real thing, i.e., a quantity independent of personal value judgments and objectively discernible and measureable, it would be possible for a disinterested arbiter to determine their height.... Costs are a phenomenon of valuation. Costs are the value attached to the most valuable want-satisfaction which remains unsatisfied" (p. 393).


At the London School of Economics, the ideas on cost developed by Robbins, Hayek, Coase, Thirlby, and others formed a part of a developing oral tradition which included many participants. Modern adherents to this tradition seem scarce, however, and only Jack Wiseman fully qualifies. In two basic papers published in the 1950's, Wiseman tried as others had earlier tried to apply LSE opportunity-cost logic to the long-discussed problems of marginal-cost pricing, applying this logic both as general criteria for organizing a collectivist economy and as the specific criterion for public-utility enterprise. *45

"Die Wirtschaftsrechnung im sozialistischen Gemeinwesen," Archiv für Sozialwissenschaften, XLVII (1920), reprinted as "Economic Calculation in the Socialist Commonwealth," in F. A. Hayek (ed.), Collectivist Economic Planning (London: Routledge, 1935).
F. A. Hayek (ed.), Collectivist Economic Planning, op. cit.
F. A. Hayek, "Economics and Knowledge," Economica, IV (1937), 33-54, reprinted in Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 33-56.
Ch. 3, Cost and Choice

In one sense it might be said that the neoclassical economist has succumbed to the temptation to make his whole theory more general than its methodology warrants. This temptation has been increased by the parallel, and equally confused, logical theory of economic choice, which itself is completely general but which lacks predictive content. This purely logical theory, sharply distinct from the classical in its predictive implications, finds its origins in the subjective-value theorists, but its more explicit sources are Wicksteed, the later Austrians, and the economists associated with the London School of Economics. In full flower, this is the "subjectivist" economics espoused by Hayek and Mises to which I earlier made reference. Some reconciliation between the genuinely scientific theory of economic behavior and the pure logic of choice is required. The achievement of this reconciliation is one of the major purposes of this exploratory study in which the notion of opportunity cost becomes the analytical coupling device.


The equilibrium concepts introduced in this section up to this point are those of the predictive neoclassical theory. This implies that descriptions of equilibrium take the form of objectively defined relationships among variables in nonutility dimensions. Prices must bear specific relationships to costs. If we are content to remain within a more general, but ultimately nonpredictive and purely logical theory of economic choice, the concept of equilibrium may be modified. The equilibrium of the "subjectivist economics" espoused by Hayek is described behaviorally. It is attained when the plans of participants in the economic interaction process are mutually satisfied. Although prices continue in this equilibrium to bear some relationship to costs, such costs carry no objective meaning and cannot, therefore, be employed as criteria for determining prices in some welfare or efficiency sense.

Ch. 6, Cost Without Markets

As Hayek emphasized, equilibrium in a market interaction is categorically different from the behavioral equilibrium of an individual participant in that interaction. In the latter, there must be an absence of gains-from-trade within the perceived choice range of the individual. In the former, there must be an absence of gains-from-trade, in total or at the margin, from action taken among all individuals, each one of whom perceives the prospects of trade with others as a part of his own choice set. In order for market equilibrium to be established, every participant must be in his own behavioral equilibrium, but the contrary need not be true. That is, each individual can attain behavioral equilibrium at the moment of choice, but unless the decisions of separate persons are in a unique relationship with one another, market equilibrium need not result. The failure of this equilibrium to emerge will set in motion changes in behavioral equilibria of individuals for subsequent choices.


The Austrians and pseudo-Austrians—Mises, Hayek, and Robbins—who were involved in disputing the possibility of socialist calculation in the great interwar debate were all contributors to the evolution of opportunity-cost theory and implicitly acknowledged the basic distinction emphasized here. This particular aspect of their argument tended to be obscured, however, by their relative overemphasis on the difficulties in calculation that prospective socialist decision-makers would face. These difficulties are, of course, extremely important, and the information problems that centralized economic planning confronts are indeed enormous, as experience has surely proved. Relatively speaking, however, the more significant criticism of socialist economic organization lies in the difficulties of choice-making. Even if the socialist state should somehow discover an oracle that would allow all calculations to be made perfectly, even if all preference functions are revealed, and even if all production functions are known with certainty, efficiency in allocation will emerge only if the effective decision-makers are converted into economic eunuchs. Only if such men can be motivated to behave, to make decisions in accordance with cost criteria that are different from their own, can this decision-structure become workable. This amounts to saying that even if the problems of calculation are totally disregarded, the socialist system will generate efficiency in results only if men can be trained to make choices that do not embody the opportunity costs that they, individually and personally, confront.