David R. Henderson  

Hayek and Central Planning

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As I've posted about earlier, to understand why socialism must fail, you need to understand Hayek's argument (which he drew from Ludwig von Mises and elaborated on) that the information that's most valuable is information held in the hands of millions of individual actors. A central planner simply cannot have the information needed to plan an economy well.

I had thought this was part and parcel of what pretty much every economist knew. But I've been reading the back and forth between Bryan Caplan and Brad DeLong and I realize that that's not true. DeLong wrote a brilliant review of James Scott's Seeing Like a State, a Hayekian book, and credited Hayek for Scott's insights in a way that Scott didn't credit. (Incidentally, I think this is one of the best things DeLong has ever written.) Yet, in this latest debate, DeLong shows none of that understanding. He seems to think that the way to get growth is to have more technology or more capital, and doesn't seem to think it matters whether that more technology and more capital exists in a free market or in a centrally planned economy. DeLong aggregates capital and labor in one function to yield output. Put aside the fact that capital and labor cannot be aggregated. The bigger problem is that central planners must think in aggregates, which doesn't allow for local knowledge.

Here's one of the key paragraphs in Hayek's Use of Knowledge (paragraph H.16):

This is, perhaps, also the point where I should briefly mention the fact that the sort of knowledge with which I have been concerned is knowledge of the kind which by its nature cannot enter into statistics and therefore cannot be conveyed to any central authority in statistical form. The statistics which such a central authority would have to use would have to be arrived at precisely by abstracting from minor differences between the things, by lumping together, as resources of one kind, items which differ as regards location, quality, and other particulars, in a way which may be very significant for the specific decision. It follows from this that central planning based on statistical information by its nature cannot take direct account of these circumstances of time and place and that the central planner will have to find some way or other in which the decisions depending on them can be left to the "man on the spot."
I think DeLong is right that this is the way the late Paul Samuelson was thinking in making his way-off predictions about economic growth in the Soviet Union. And that's the problem.


COMMENTS (14 to date)
Eric H writes:

The DeLong review is a real treat. Thanks David.

Carl The EconGuy writes:

Hayek's Use of Knowledge is one of the most transformative essays I've ever read. It taught me the informational compactness of market economies -- all you need are the marginal rates of substitution revealed in demand and supply prices in the market. Central planners, on the other hand, lack that critical information and must rely on complete knowledge of production and utility functions. That's why markets work, and engineering solutions don't.

Norman writes:

"Put aside the fact that capital and labor cannot be aggregated."

"The Fact"? Really? I think there are enough thoughtful, intelligent economists out there who would consider this claim ludicrous nonsense that calling it a "fact" seems a bit strong.

I think failing to keep in mind the issue of local knowledge (which most models don't account for, but certainly don't rule out either) is an excellent critique. Is a superfluous jab at anyone who works in macroeconomics really necessary? At the least it's not as courteous as I would expect from you.

Kurbla writes:

I think you have relatively good answer on that in your own Encyclopaedia, article on socialism.

SydB writes:

While I don't propose central planning--impossible from the get go--I think due consideration must be given to the centralization that has taken place in a company such as Walmart. In the past, central authorities couldn't have a clue what local markets wanted. Now central authorities know what local markets want today and what they'll probably want in three months.

Mr Kling seems to ignore it in his recent book and, in general, I think libertarians may ignore it due to their motivation to push--politically--for decentralization.

Ryan Vann writes:


Syd,

Perhaps you have a point, but is it through a central authority that Walmart can extract local information, or do they have a loose heirarchial structure?

SyB writes:

Ryan: They do it through the scanning at checkout and information processing--and of course the price mechanism. All I'm saying is that the local price mechanism (supply and demand) gives Walmart the information they need to command the movement of goods and services. Now one could argue that the price mechanism itself is moving the goods and walmart just created a means for that information to flow--and I'll basically agree with that. But Walmat has still created a centralized mechanism to take advantage of the price mechanism.

This does not in any way argue against Hayek's ideas nor his great paper on the topic. Hayek's right overall, but I think libertarians should not neglect the idea of emergence--in particular the emergence of central processing systems--whether it be brains, walmart, or governments.

Josh Weil writes:

@SydB

Walmart's use of database technology is not central planning in any sense of the traditional term. Walmart is a profit maximizing company that uses information to its advantage. State owned industries are not profit maximizers, and will never be as successful as a company like Walmart in efficiently responding to consumer demands.

SydB writes:

Josh: I think you miss my point. Information is much easier to come by these days. Hence everyone can use information to their advantage--including government. For Hayek, the only information that existed was the price. Today, we have much more information that can be considered.

Josh Weil writes:

@SydB

You're right I kind of missed your first point. However I still have something to say now that I think I understand where you were going.

The information sent through price signals transcends retail preferences.

Within a free market, individuals use their specialized knowledge along with price signals to guide their actions in the face of scarcity. The government’s inability to utilize price signals is its greatest weakness.

Central planning is about maximizing output. Governments don't run the same cost/benefit analysis that Walmart runs.

Government has no special powers to do things well. They are faced with the same task as the private market, but with worse information and distorted incentives.

liberty writes:

@SydB

I think I appreciate what you are saying, and do not entirely disagree -- so long as it is the narrow version of such a point: in other words, so long as you recognize the limitations to what you are saying.

Yes, new technology can allow the emergence of much greater information flow within a larger hierarchical structure than 100 years ago. Wal-Mart and other multinational corporations can use technology that harnesses local information -- they have scanners and all kinds of tools connected to databases, connecting all the stores, so they can immediately know total demand and its distribution, stores also use customers' cards to track how demand for different products are related to each other etc. -- however, their other great advantage is that they allow individual clerks to change prices locally at will based on this information, and change the amount of stock to order. This is part of how the information is used and how it becomes more and more useful. If the individual stores could not change price or stocks based on the information then it would not only be less useful but it would stop being true information: this is because the central command could not possibly respond as quickly as the local store--unless technology allowed them to converge as one mind, essentially.

It is all about a decentralized profit-seeking, that at the limit is perfect price flexibility, which leads to perfect customer satisfaction--if you like, its own kind of "perfect competition" that is nothing like the neoclassical model. When customers demand more, there is suddenly more, when they want a lower price, the price falls.

This is possible because Wal-Mart is within a market system, has profit as unifying motive, and loss as unifying constraint, and they have prices of all inputs and labor and of competitors so that they *can* profit maximize and avoid loss, and they have this decentralization ability--to change prices and stock of various products at any level of the hierarchy they desire. None of these things are possible if a store is nationalized, or if government is in charge of supply of something -- if these things were possible it would be a private firm.

Hence, it still comes down to the basic institutional structure. Profit and loss, prices and decentralized decision-making come from private ownership. They cannot exist with public ownership (except prices which can sometimes exist if only some things are publicly owned, but which still become distorted the more that is publicly run).

Greg Ransom writes:

In Hayek technological innovation sets in motion the entrepreneurial problem of re-coordinating existing heterogeneous production goods -- a job requiring all sorts of different people applying their local knowledge in the context of changing relative prices and local conditions.

This division of knowledge / production good coordination problem is the very heart of Hayek's case against socialism, as he explicitely says in his Collectivist Economic Planning essays.

Tracy W writes:

Sydb: I think due consideration must be given to the centralization that has taken place in a company such as Walmart. In the past, central authorities couldn't have a clue what local markets wanted. Now central authorities know what local markets want today and what they'll probably want in three months.

I think you need to be a bit more precise about this. Walmart knows what its clients prefer at a particular price and at a particular point of time, and it has a historical set of data about this. It doesn't know its customers' entire set of preferences. For example, if the price of apples rose suddenly relative to oranges, Walmart could estimate how its customers would redistribute their spending based on historical data of past customer reactions. But it couldn't *know* how customers will respond ahead of time, and the further a price change or product is from what has happened in the recent past the worse Walmart's estimates would likely be. (Eg, say that the prices of apples relative to oranges double. If the last time that happened was 1 year ago the Walmart estimate of customers' responses would likely be more reliable than if the last time that happened was 50 years ago, as customers' preferences have likely changed over the last 50 years).

but I think libertarians should not neglect the idea of emergence--in particular the emergence of central processing systems--whether it be brains, walmart, or governments

I agree that libertarians should not neglect the idea of emergence, although I get the impression that libertarians are one of the least likely ideological groups to neglect the idea of emergence, and saying that they should not neglect the idea of emergence is like saying that transport engineers should not neglect the influence of peak hour traffic.

Turning to your more specific point, that libertarians should not neglect the emergence of central processing systems (I'll call this the Walmart effect for brevity), how specifically do you think that the Walmart effect should be taken into account? You say that you don't think this changes Hayek's basic argument, so in that case why shouldn't libertarians neglect the Walmart effect? After all, there are far more ideas out there than any one can bear in mind simultaneously. What ideas do you think that libertarians currently pay attention to and should neglect in order to take the Walmart effect into account?

Or are you saying that the Walmart effect is a common objection to Hayekian arguments (like the evolution of the eye keeps coming up amongst creationists when they try to criticise evolution), and libertarians should cover it off? If you mean to argue this, I think you might well be right, although I also think there are some advantages to brevity.

Nicolaie Ionut writes:

Probably late to the discussion, but I have to say that this talk about the “Walmart effect” is idiotic. This “effect” has no leg to stand on for two reasons:

1. Central Walmart, just like the local store, has access only to information on the products it sells, which are mostly consumer products. It has no idea about the intermediate products: that is from the raw materials to the product on the shelf. It is the main point of the Mises’s article from 1920.
2. It is nothing more than a part of a glorified double-entry book, only faster. It is a faster accounting system. It is doubtful that the central Walmart didn’t have information about local stores before, now they just have it faster. Like everything technology does, it probably makes some local decision making redundant. It still just helps them to assess the profitability of a local market, but has little or nothing to do with the theory of price formation.

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