Second Best and Socialist Calculation
The socialist calculation debate of the 1920s and 1930s centred on whether a benevolent social planner could allocate resources in a planned economy to replicate the efficiencies of the market while remedying the ills of monopoly losses and profit-taking. Ludwig von Mises argued that without a market in consumer goods, one could never impute back prices to capital goods and consequently capital goods could never be allocated rationally in a planned economy. F.A. Hayek argued that the planning agency could never acquire the information necessary to form the optimal plan — most knowledge is held in decentralised form that can never be aggregated to any one body; only the price system can work to that end.
The calculation debate was framed entirely in the context of benevolent planners. And, when planners are benevolent, it’s very clear that planner inability to engage in economic calculation reduces welfare in a planned economy. But what if the planner isn’t benevolent? Would outcomes in the Soviet Union, China or Cambodia have been better if Stalin, Mao, or Pol Pot been able to solve the Mises and Hayek problems?
Andrew Farrant and I argue (working paper version) to the contrary: we rather argue that the calculation problem raised by Mises and Hayek can never worsen and will sometimes improve outcomes in the socialist state. Why? If planners are benevolent, they’ll retreat from planning when they see the problems raised by the calculation argument, as did Western Europe and Britain in the late 40s and 1950s. If planners are not benevolent and rather are seeking to operate as an Olson bandit, the calculation problem serves to limit their rapacity. In the limit, perfect ability to engage in socialist economic calculation transforms the planning bureau into a perfectly price discriminating monopolist in every market, extracting all surplus for the planner. While the calculation problem creates deadweight losses, it also ensures that at least some surplus is left for the hapless citizenry. Median citizen welfare improves even though total surplus is less than it would be absent the calculation problem.
Consequently, it is wrong to view economic calculation as the problem with planned economies. Yes, inability to engage in economic calculation ensures a fair bit of economic irrationality in socialist states. But, it also constrains non-benevolent dictators. As Bryan Caplan argues, incentives, not accounting, lay at the heart of socialist failure.