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August 19, 2009 – Comments (16)

Mises's paper (http://mises.org/pdf/econcalc.pdf) is rather long, so one cannot refute all of his objections in a single post. Still, it is worth trying becuase the erroneous postulates of Mises seem to hold sway over a substantial segment of the economist community. As a disclaimer, this is NOT intended an as apology of Marxism, which is yet another erroneous theory that has failed the reality test; having said that, it was still a mistake on Mises's part to attack Marx where Marx was right. Let us now look at Ch. 2, entitled "The nature of economic calculation in the socialist commonwealth".

In his opening salvo, Mises claims, correctly, that exact valuation of goods relative to one another is unfeasible except in the simplest situations. To quote Mises:

"But it is quite a different matter when the choice lies between the utilization of a water-course for the manufacture of electricity or the extension of a coal mine or the drawing up of plans for the better employment of the energies latent in raw coal."

To a religious mind, that should seem sufficient. Those with the analytical mindset, however, will not be so easily convinced. The fact that planning involves a margin of error does not by itself tell us anything. Indeed, margin of error is part of any human activity, but that does not mean that every endeavor is destined to fail. For example, Newtonian Mechanics has a margin of error, but that doesn't prevent us from using it. Instead of pointing out the obvious, the honest critic should answer the following questions: how big is the margin of error? Is it tolerable? How does it compare against the alternatives? Can it be reduced and how? This the ultimate test that one uses to distinuish an honest economist from a dilettante. Where the honest economist provides numerical estimates, the dilettante simply cites a mantra becuase he is unaware that the mantra must be supported by numbers. 

Unfortunately, Mises fails this test. He does, to be sure, mention what he feels are the advantages of capitalism:

"In an exchange economy the objective exchange value of commodities enters as the unit of economic calculation. This entails a threefold advantage. In the first place, it renders it possible to base the calculation upon the valuations of all participants in trade. The subjective use value of each is not immediately comparable as a purely individual phenomenon with the subjective use value of other men. It only becomes so in exchange value, which arises out of the interplay of the subjective valuations of all who take part in exchange. But in that case calculation by exchange value furnishes a control over the appropriate employment of goods. Anyone who wishes to make calculations in regard to a complicated process of production will immediately notice whether he has worked more economically than others or not; if he finds, from reference to the exchange relations obtaining in the market, that he will not be able to produce profitably, this shows that others understand how to make a better use of the goods of higher order in question. Lastly, calculation by exchange value makes it possible to refer values back to a unit. For this purpose, since goods are mutually substitutable in accordance with the exchange relations obtaining in the market, any possible good can be chosen. In a monetary economy it is money that is so chosen.

Alas, this attempt falls short because it is impossible to determine from it how important these advantages are to Mises. Meanwhile, upon a closer look, all 3 advantages prove mostly fictitious. In the first place, Mises is mistaken to assume that the sum of individual subjective valuations will somehow produce an objective valuation. If you ask a bunch of chimps how much is 2+2, and then average their answers, you certainly WON'T get 4. By dismissing the opinion of an individual chimp as subjective, you also dismiss the possibility of an objective valuation. By the way, if you are a believer in the wisdom of crowds, it won't work here. Know why? Because chimps don't have the concept of a negative number...their answers will range from 0 to +infinity...On the average, chimps believe that 2+2 is an infinite number.

The second advantage perceived by Mises is also a fiction. "Anyone who wishes to make calculations in regard to a complicated process of production will immediately notice whether he has worked more economically than others".  That Mises' "anyone" would be using a wrong standard that has nothing "objective" about it is only part of the problem. Even if that standard were accurate, it would still show only the situation at the current moment. There is no predictive power to it, and therefore it cannot be used as an accurate planning tool. We now have supercomputers and a hundred years of data at our disposal, and yet no one in the whole world will tell you how much oil is going to cost 6 months from today. As of this writing, the sum of subjective valuations is putting the price of oil at 67 dollars a barrel, but that doesn't tell you whether or not drilling the Arctic shelf will be justified by the future prices. "But oil companies are still making such decisions, don't they?" - you might ask. Yes, they do, and they do it by putting some arbitrary number into their computer, and then if their analyst's guess was not too far off, they make money, and if the analyst was wrong, they lose money, but in either case, their model was just as "objective" as a coin's toss. In the case of the most conservatively run companies, the practice is to base their model on a low price, then earn an extra profit if they are lucky. The state planning agency does exactly the same: plan conservatively and keep large reserves to handle any future accidents.

Finally, the last advantage that "calculation by exchange value makes it possible to refer values back to a unit " is just a trivial observation that it's nice to have some reference point. But if there is nothing special about exchange value that would make it "objective", this reference point will be as good as any other. For example, by the exchange value of the S&P index has just changed from 1500 to 666 and then back to 1000. Referring if back to the unit chosen by Mises gives us a margin of error that will make Gosplan's planning practises seem rational in comparison. And yet we are talking about the same index, the same companies, and the same economy whose GDP has only changed by a couple of percentage points.

The next page of Mises' essay offers a disappointing repetition of the points already made, so after skipping it, we arive to his next contention about socialism piggybacking on the success of its rival. Here I think he is wrong again, but let's leave it for another post.

16 Comments – Post Your Own

#1) On August 19, 2009 at 8:09 PM, Bludgeoner (< 20) wrote:

No soup for you

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#2) On August 19, 2009 at 8:27 PM, whereaminow (30.78) wrote:

zloj,

I'm glad you're reading this.

The objective criteria that will determine whether or not the producer is using his goods economically is the profit he derives from it. 

The subjective valuations that are made at the beginning of the endeavor are subjective because you can not predict
1. The future
2. What every person in the market place is thinking.

Yes, you can reduce error through the wise use of statistics, but in the end every human being must make a subjective decision.

I will use information security products as an example, since I am currently studying for the CISSP. 

A company needs to implement a new security plan for their corporate headquarters.  They will use two methods to guide their decision: 
1. Qualitative - this would be detailed analysis of the threats, the vulnerabilities of the system in question, the benefits of additional security, the disadvantages in productivity from increased security, and on and on.  This can be exhausting.
2. Quantitative - this is an attempt to add numerical, somewhat "objective" detail to the assessment.  Costs are estimated as well as projected savings from decreased exposure vs. the probability of attack/corruption of data, etc..  Yet, even the smartest CIO will tell you this is also somewhat subjective, as the inputs for the Quantitative measure must be entered by humans.  It is also error prone as no one knows for sure what threats will arise in the future.  No one can be certain that past data on savings from risk deterrence is repeatable or even accurate. 

In other words, experience, judgment and subjectivity play a huge role.  The CIO passes this guidance to the CEO, who in turn must make a final, subjective decision.  That's life.

Monkeys don't think like humans.  Though sometimes humans act like monkeys.  I'll just leave that one alone.

David in Qatar

 

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#3) On August 19, 2009 at 8:38 PM, starbucks4ever (98.92) wrote:

So we dismissed state planning as too subjective, only to find the same subjectivity everywhere else in the world. That was my point. 

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#4) On August 19, 2009 at 8:44 PM, whereaminow (30.78) wrote:

zloj,

No silly.  We dismissed state planning because it has no objective end.  No price = no profit = no way to know if you are properly using your goods economically.  Hence, you get a lot of military hardware (see USSR and USSA) and a shortage of corn.

David in Qatar 

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#5) On August 19, 2009 at 8:46 PM, whereaminow (30.78) wrote:

Oops

No voluntary exchange in the market = no price = no profit = no real economic feedback.

Price controls are not real prices, since they don't involve the interplay of subjective actors.  That is why they always fail.

Sorry.

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#6) On August 19, 2009 at 9:50 PM, starbucks4ever (98.92) wrote:

whereaminow,

Suppose for a moment that instead of getting fixated on some imaginary "correct" number which doesn't exist anyway, you set yourself a realistic goal of making the decisions with a 20% margin of error. Then it turns out that by listening to your gut, you can value things surprisingly well. For example, I may have no idea how much a dwelling unit would cost on an open market in the United States, but my gut still tells me that the number of units in a country of 307 mln people should be approximately 130 million. So without any market signals I can still order the right amount of bricks and constuction workers, give or take a few percent. Then I google the data and find that indeed, 130 million is just about how many homes they have in America. And I did not need to employ millions of realtors, fiancial officers, accountants, auditors, and structural finance specialists to figure this one out. Clearly, my resource allocation process will be more efficient than the market's because the market was so obscessed with efficiency that it became disfunctional.

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#7) On August 20, 2009 at 4:26 AM, whereaminow (30.78) wrote:

zloj,

A comment like this makes me wonder if you are just writing stuff and not even thinking about it.  It's 11am, and i've been up doing server babysitting and chatting with you for over 20 hours, and I wonder if I'm just going blind or you really just want to say the same thing over and over again.

What you've just described is subjective valuation with an emphasis on quantitave over qualitative measurements.  Congratulations.  Most entrepreneurs would probably laugh at you, but hey it's your subjective choice to go that route.  Now after you go through all that, you get this thing called a profit and loss statement.  It tells you how you did.  That's called economic feedback.  Then you know if you're using your goods productively or not.  

I'm sorry to be flip, maybe I'm just tired, but I'm not sure you even understand what Capitalism is.

I need to go to bed now. I hope when I wake up tomorrow you'll have figured out the difference between work you do now, and results you receive later.... but I'm losing faith.

David in Qatar

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#8) On August 20, 2009 at 5:09 AM, whereaminow (30.78) wrote:

What "objective standard" did you use to determine that listening to your gut was equal to "your guy" and your google research?  Or perhaps you're weighted your google research higher. Who knows?  What objective metric did you use for valuing these "market signals?"

I will wait for the light bulb to go off...... ...... ...... ..... ........................................................... ............................................  one day, perhaps.

David in Qatar

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#9) On August 20, 2009 at 9:43 AM, starbucks4ever (98.92) wrote:

Profit is a motivator in a capitalist system. Just that. Under a well-functioning capitalism, profit will be the objective and the 130 mln houses will be the side effect. Under a well-functioning central planning system, the 130 mln houses will be the objective, and profit will be mostly irrelevant. In the drive for profit, effficiency improvements may or may not materialize. Likewise, in the drive to fulfill the plan, you may or may not be able to realize economy of "funds" - materials and labor. If you use funds more efficiently and thus overfulfill the plan, you will be certain to get a bonus and a promotion. The central planning system can become corrupt and start promoting incompetent or crooked managers. The capitalist system can also become corrupt and start creating government-chartered cartels that privatize profits and socialize losses. Hope that answers your question.

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#10) On August 20, 2009 at 12:25 PM, whereaminow (30.78) wrote:

Ok, so how does that little rant against profit prove that Mises was wrong? 

See there is a difference between actually making an argument and just succumbing to the anticapitalist mentality that has been forced upon you your whole life.

Profit may be a horrible thing to you, but to this world it has been the most amazing invention.  The development of the objective standard of profit has allowed people that would have been hopelessly enslaved as peasants to have wonderful lives, like me!  I am thankful every day that humans developed the profit system.  You can be bitter and hateful about it all you want.  We couldn't communicate without it.

Mises said repeatedly that the device of profit isn't perfect, but until you can find a better method, socialism is just a web of fairy tales masquerading as an economic system.  So far, you have done nothing but prove Mises right.  When you get stuck, you unleash a tirade against profit instead of understanding that Socialism has no answer.  You should be upset at Socialists.  At least Mises was honest.  The Socialists promised you government angels on unicorns sprinkling fairy dust over the world.  Sorry that you believed them.

Sorry to have bothered.

David in Qatar

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#11) On August 20, 2009 at 1:02 PM, whereaminow (30.78) wrote:

zloj,

Shall we continue?  Let me know when you are tired of having your beliefs proven wrong.

It was all those evil unregulated capitalist home builders now?  LMAO, I have heard some really stupid explanations for the boom, but this might take the cake.  Congratulations. You win first prize.

Actually, in America, you have a system of central planning that created 130 million houses. Houses for everyone, remember?! It's called the Federal Reserve, a central planning of the supply of money and the interest rate.  Are you sure you want to deny the Fed's role in creating the housing boom?  Or Clinton's role? Or Bush's? Or Congress's role?  C'mon, even the dimmest American knows your argument is ridiculous.

Again, I don't know why I bother. 

David in Qatar

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#12) On August 20, 2009 at 3:51 PM, starbucks4ever (98.92) wrote:

whereaminow,

I am not against profit, let alone "unleashing tirades against profit". Leave that to vulgar socialists who haven't even read their own Marx. Profit motive can be a wonderful instrument, when used correctly. However, this doesn't mean that a) it can never be abused and b) this is the only instrument there is. Like any instrument, it has its own range of applicability where it works well and also some other applications where it doesn't work at all. 

 

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#13) On August 24, 2009 at 3:58 PM, JHenson04 (< 20) wrote:

David in Qatar,

I would not bother responding to the unteachable.  This dronish zlog will never understand the market economy because he is obstinately set against the free-market system. Liberals are first and foremost liberals, not analyst.  They do not bother to think through their economic policy, and to the extent that they do, their thinking finds total conclusion in their mind when it justifies socialism.  Like you, I do understand Mises' points and arguments.  You can take a horse to water - in this case, the horse took itself - but you cannot force it to drink.

No, zlog does not understand the nature of economy/economics, nor the indispensible role of private property.  Perhaps after he has been dispossessed of his own property and savings, he will understand the difficulty inherent in planning his own finances when their legal status is questionable.  (Does it belong to zlog, or the state?  What rights of consumption does zlog have over his property?  When can the state take it away?  What if it's in quasi-private legal status?  What happens if the state decides it knows better than zlog, and appropriates it?  These are question that zlog does not take seriously, yet any socialist must seek to answer.)   Zlog does not blink.

 

And he would not blink either if confronted with this question: he admits that people have their own subjective values of preference.  We know that the market economy molds itself around the aggregate input of market actors (i.e., their buying decisions' effect on business production decisions).  If this is true - I view this as self-evident - then how does dispossessing nearly all market actors from their inherent right to affect the market, and giving their purchasing decisions to a handful of bureaucrats not affect the useful productive output from society as a whole?  The supply structure will unfairly reflect the buying preferences of bureaucrats, by definition.

Hayek and Mises were right all along.  History has proved them right again and again and again.  Yet we still have neophytes, desperate liberals in fact, trying to disprove these master economists through their novice, pseudo-intellectual commentary.

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#14) On August 24, 2009 at 4:13 PM, starbucks4ever (98.92) wrote:

JHenson04,

I am glad that we don't have a uniform consensus on this issue, and I hope we never will. Competition of ideas is what drives progress, and I'd hate to see everybody agreeing with me.

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#15) On August 24, 2009 at 5:00 PM, JHenson04 (< 20) wrote:

On the contrary, these are issues we should both agree on because socialism is impossible.  You can conveniently deny objective truth, though, as your last defense.

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#16) On August 24, 2009 at 5:17 PM, JHenson04 (< 20) wrote:

The more I re-read the original post, the more I realize it's written by someone who has never taken the time to think about the free-market nor socialism.  It's written with ad hoc examples from unrelated fields (like those bizarre references to mathematical formulae).  And what on earth is this supposed to mean?

"On the average, chimps believe that 2+2 is an infinite number."

No, there's a reason why it's fruitless to speak to someone whose mind is made up of decisively left-of-center opinions, who additionally clings to these opinions despite logical refutation, demonstrable theoretical problems, and a huge number of historical examples that disprove socialism's feasibility, much less desirability.

I confess that it's very difficult for me to explain Mises, even to educated people who work in the financial industry.  They are too married to mathematical economics and political ideology.  Breaking their habitually poor thinking patterns, after years of indoctrination, might just require personal loss of wealth. The socialists, lamentably, will be more than willing to provide this experience.

Finally, I would encourage anyone genuinely interested in learning about the great debate to disregard zlog's post.

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