Economic Calculation

I've argued a lot that the exchange causes a variety of problems, from being unable to address factors of poverty, to creating more wealth inequality, to the need for continual growth, to overlooking essential work as "non-economic" or "non-productive" in some manner, to creating tension in workplaces and creating tension between markets and governments, to requiring a host of extra work in terms of regulation, tax collection, and legal systems. And I've also started to argue that the solutions we implement to resolve these problems - or, at least, the most successful solutions - are solutions where we implement non-reciprocal gifting. So, to me, the next natural question becomes: why not just use non-reciprocal gifting?

I think the answer is that we should, and I start to build up this answer in a later section. But just before I do, I think there are a couple of other things to touch on, including why the exchange is the dominant way of doing things currently. The first thing to consider is the academic argument about economic calculation.

What is economic calculation?

"Economic calculation" refers to the way in which the economy "figures out" how to rationally allocate resources to the places where they are needed. The computation could be done by a single person, a team of people, a computer, or by the economy itself acting as a giant computer that organises itself. In fact, a common argument, called the "economic calculation problem", argues that this last option - the economy computing itself - is the only viable way in which rational allocation can occur.

The argument goes something like this: the economy is made up of a lot of different resources that can be used for a lot of different things, and it is also made up of a lot of different people who want and need a lot of different things, and if you were to put all that information into a computer there would be too many details for it to be able to calculate where everything would need to go. It does not matter if that computer is a machine with chips and processors or a group of people who deliberate together; because we are dealing with many, many subjective evaluations of things, there is no way for a calculation to be done that can possibly encapsulate all those subjective evaluations. This is, in part, because people are making new subjective evaluations all the time as new information and new contexts come their way, and no computer can be responsive enough to take in this information at the speed needed.

The argument is primarily one against central planning, and the criticism is that no centralised computation (whether by a computer or a bureaucracy) can solve all the implicit equations required to come to a rational outcome. The result of trying to centrally plan, goes the argument, is irrational allocation.

Markets, goes the argument, don't have this problem. They have a clever way around it. Instead of trying to centrally figure out what goes where, markets instead are decentralised. They are made up of lots of people making individual and subjective evaluations all day, every day. And as long as there is a way for these individuals to make a rational individual decision about their resource management, and as long as there is a way for information about this rational allocation to interact with other people making other individual decisions, the overall consequence should be a collectively (or aggregated) rationality to the entire system.

Markets have a mechanism for doing this: the exchange. The exchange requires private ownership, money, and prices. And these three ingredients allow individuals to make individual rational decisions, and to have information about those decisions communicated to other people when they make their rational decisions. It works like this: an individual only has so much exchange capacity. Therefore, there is only so much that they can exchange, and only so many resources that they can have allocated to them through exchanges. Because of this, they need to think very carefully about which resources they want, because their finite exchange capacity means they probably can't get everything they desire. Therefore, they need to think about their preferences, and how much they value one thing over another thing.

Now this is all a little bit nebulous, but the introduction of money makes the whole thing easier. With money we now have a unit of account, a way of comparing the value of any two things. Moreover, a person can calculate their exchange capacity in terms of money (for example, how many dollars they can spend), and can start to rationally consider which resources they want to have allocated to them (which ones are within their budget) and which ones they will miss out on. So they might prefer to spend money on food rather than books, because food keeps them alive. They can also look at the options for food, and decide to buy the cheapest, saving up more money for other things (like shelter and warmth and medicine). This decision is a rational one.

The use of money and exchanges can set prices that give information about supply and demand. For example, if a lot of people want something that there is very little of, a shopkeeper can raise prices until the number of people who still want it matches the amount that there is available. The shopkeeper doesn't do this because they are interested in overall economic calculation, but because they have a motivation to accrue exchange capacity and are trying to gain the most profit possible. But now when someone looks at the price and sees that it is expensive (at least, in their subjective evaluation), they know to try and find an alternative or to put that need or want aside for the moment. And others, looking at how much money the shopkeeper is making and wanting more money themselves, might now start to produce and sell the same thing, increasing the supply. And if they can't move their stock - let's say that everyone who can pay a higher price is already buying from the original shopkeeper - they can lower their price until they get customers. Now that there is more supply to match demand, the price goes down.

Conversely, if there's a lot of something but not many people want it, the price will drop. This means that, even if the product is the most preferred product for the job, people will innovate to find a way to use these resources because they are cheaper than the alternative. If the price is too low - especially if it is lower than the cost of the product to make - no one will want to make it.

Exchanges with money require prices, and prices signal information about supply and demand, indicating to people in the economy when it is time to make more of something or make less of something, indicating to people when there is lots of a resource spare to work with and when there is little and it is time to find alternatives. And the whole process is done without any centralisation, but rather through the aggregation of many individual rational decisions.

But does that argument really hold up? There are a few things to consider.

What does exchange-value cover?

Exhange-value, as I mentioned earlier, is the amount that something can be exchanged for. It differs from cost-value (the amount of labour and materials required to make something) and use-value (how much utility someone gets from something). Because exchanges need a medium of exchange, like money, and because a medium of exchange is going to be a useful unit of account, this means that exchange-value can have a number placed on it more easily than use-value.

Pretty much anything can be exchanged. You can exchange material things, labour, the rights to something, ideas, and so on. You can make exchanges that guarantee intangible things, like being entertained, being happy, being scared, social standing, and the like. Exchange-value therefore covers a broad range of the economy.

But there are some omissions if we focus on exchange-value. For example, think about cooking for a child, helping an elderly relative about the house, or cleaning up a local waterway. These are things that could be paid jobs. Someone could pay for a person to cook their child's food or help their elderly mother about the house. But they are often cases where the recipient of the resources (food, labour) has no way of paying. When we think of someone being paid to cook food for a child, we think of the parent's paying for this service, not the child. The child (except in exceptional circumstances, I guess), can't pay.

This means that there are lot of cases of resource transfer out there that are not exchanges (and cannot be exchanges), and therefore don't have an exchange-value associated with them. So when the economic calculation argument poses that exchange-values (that is, prices) are the way in which information is communicated throughout the market, it is worth noting that this framing leaves a lot of economic contexts out of consideration because they are not part of the market (they are often considered part of the "household").

Another scenario is a person who gets acre in the emergency room of a hospital and where the services are paid for by the government. What is the exchange-value here? Well, the exchange-value doesn't reflect what the individual valued the care at, but what the government valued the care at. And if hte government decision is based on democratic or bureaucratic data (that is, people think it is a moral good to save lives, or saving lives is good for a prosperous society), then we're not seeing the individual subjective value of the exchange. Some die-hard Austrian school economists, who believe that markets work best and all government action is distortive interference, would definitely complain about this state of affairs - but it is also logically impossible to care for all emergency patients using the exchange.

There are some responses to this that are worth thinking about. One is that these rational allocation decisions are still embedded within the market and prices - a parent who buys food for their child needs to consider the price of the food, and they need to consider the opportunity-cost of cooking it themselves (that is, could their time have been used more valuably getting someone else to do it?) Another is, of course, the "household" argument, that children and the ill and the elderly and other dependents are sort of "appendages" of rational economic actors who can go and get jobs, and not worth considering within the framework of the economy. But in both cases what is happening is that the argument is only comprehensive if it selectively excludes various things, turning it into rather circular logic.

What do price signals tell us?

Even if we limit ourselves to economic activity that falls within the scope of the exchange, there are still some problems. The logic of the economic calculation argument is that a price will indicate to individuals and businesses what resources are scarce and what are abundant. But the other implication of the argument is that a seller can decide how to prioritise who to tell to by seeing who will pay the highest price.

In the earlier example, the shopkeeper raised prices until the number of people still willing to pay matched the amount of product. That is, where there was too much demand and not enough supply, the shopkeeper had to determine a way to prioritise allocating the supply to only a portion of demand. In an exchange economy the logical way to do this was to raise prices so that the shopkeeper could benefit from the exchange as much as possible. Similarly, if the shop were selling a product and two different people came and bid on the product, the shopkeeper would most likely prioritise allocating the product to the person who offered to pay the most.

This means that the logic of prioritising resource allocation of scarce resources is to whomever can pay the most. The assumption is that allocating resources to whoever can pay the most is the most rational way of allocating resources. To some extent, it makes sense. If two people had the same amount of money, and one bid higher on a product, it is suggestive that they want it more, because they would forego other things in order to have it. That indicates something about subjective evaluation, at the very least. However, if two people have significantly different amounts of money, then the situation is different. It is no longer reflective of who wants it more. Does the bigger offer indicate a greater desire, or a greater capacity?

So price signals don't necessarily tell us much about rationality, unless we believe that having more money makes someone more rational. That could certainly be an argument if everyone started on equal footing, but inheritance and the lottery of birth mean that this definitely isn't the case.

The reality is that rich people can out-signal poor people. This is why rich people can have banquets on their mega-yachts and throw away uneaten food, while poor people sometimes have to choose between food and shelter. Under this scenario the price-signals indicated that the rational allocation was to feed the rich a banquet and let the poor starve. To what extent is this representative of some social evaluation of where goods need to go? What happens in an exchange system is that goods are primarily allocated to where rich people want them to go, not where some abstract aggregation of individual subjective wants and needs would rationally direct them to go.

Are price signals sufficiently "correct"?

Can price signals be "wrong"? The price indicates the exchange-value of a good - what someone would exchange for it. But why do people want the good at all? A primary reason for most goods is because of the use-value. So a person, as much as possible, doesn't want to pay an exchange-value that is higher than the use-value: they would be giving away more than they were getting, which goes against fundamental motivations in an exchange economy. So a price can be "wrong" if the exchange-value is higher than the use-value.

The only real way to see whether exchange-value matches use-value is if it changes over time, and the context of that change. If the exchange-value stays relatively steady, it might mean that it is close to the use-value. If it drops dramatically it might be because the utility has been displaced by another, innovative product, and if it spikes it might be because there is a sudden need for this type of product. If, however, the exchange-value regularly increases and then dramatically drops, this could be a sign that the exchange-value was much higher than the use-value. This often happens when bubbles pop, but it can also happen on a smaller scale.

When this happens the outcome can be devastating: poverty, joblessness, homelessness, as in the 2008 Global Financial Crisis. But when this happens it is also called a market "correction", the implication being that the price was above the actual value of the product and then "corrected" downwards towards the actual price.

If price-signalling were a robust system to rationally allocate goods, then price-signal failures would not regularly occur and cause a crisis.

What is rational allocation?

The economic calculation argument proposes that we can devise an economic system that allocates resources rationally. It proposes that this cannot be done with any centralisation - the information is too subjective, too dispersed, and updated too often for any system to centrally compute it. How, then, can we determine whether the economic outcomes we are seeing are rational or not? There are a few different ways to tackle this, resulting in a few different answers.

One answer is that we can't. For the same reason that no bureaucracy or computer can calculate the information and know where to allocate resources, there is no person or team of people who can perform the calculation to determine whether the allocation was rational or not. If we take this approach, the economic calculation argument is self-defeating.

On the other hand, we could potentially assess those outcomes after the fact and determine whether a rational allocation had occurred. That is, we might not be able to compute things in real time to know how to allocate them right now, but we might be able to compute things sufficiently well to review past performance. In that case we should be able to look at various examples and make a determination about the rationality of the allocation.

There are at least two options here: to look at the process of past performance, and to look at the outcomes of past performance. the idea of looking at the process comes from two of the original advocates of the economic calculation problem: Mises and Hayek. They tend to agree with the position that we, as humans and economists, cannot process the required information to come up with an answer, so the best we can do is assess the rationality of the process. If the process is rational, they claim, then the outcome must be rational as well. So, for example, if everyone has the ability to make rational decisions about preferences using money and prices (noting that these two thinkers believe money and prices are essential for making such a preference-decision), then the outcome of those aggregate decisions must also be rational.

I think this is a weak argument. It argues that the outcome of the aggregation of individual rational decisions must also be rational. There is not much to support this implication. It is not necessarily true, given that the basis of rationality in the argument is subjective evaluation. There is no way to empirically assess it, because there are no other given metrics to assess it against, such as poverty levels or wealth inequality or waste. It is less an argument and more a definition.

That said, Mises and Hayek did make observations about the success of markets compared to the central planning of places like the USSR, so there were some metrics that they seemed to think relevant to use, such as poverty, waste and overall productivity. So this leads to option two: there is a way to assess the outcomes of past performances. Mises and Hayek use this to conclude that liberal market economies performed better. And while I don't think their overall argument makes a lot of sense, given that it excludes a lot of economic activity and assumes that more wealth means more rationality, the idea of measuring economic outcomes does make a lot of sense. I wrote a bit about this earlier when I discussed what defines a healthy economy.

So the economic calculation problem in its weak form argues that central planning is less rational than markets with prices, and in its strong form argues that markets are the best and possibly only way to allocate rationally. But the layout of the argument doesn't really give us a way to check if this is true - especially the strong form.

Are prices the only way?

So, even if prices don't provide perfect signalling information, do they at least provide better signalling information than other methods? If the economic calculation argument is correct, then we can't create a better system than markets and prices to help us allocate rationally, even if the results are sometimes less than we would have desired. Following this line of thinking, if poverty and wealth inequality occur, they are probably the best outcomes we could hope for given the economic context at the time.

While we can sometimes compare two economies, there are usually quite a few differing variables between them that can make it hard to make any clear counterfactual statements: if this economy had done this thing differently, things would have turned out better. What would the USSR have looked like if it had had market prices? What would the US have looked like if it had had a centralised command economy?

But what we can do is look at some of the consequences of an exchange economy and then look at how people have responded to those consequences. One of the main consequences is that there are going to be groups of people who cannot satisfy their basic needs from the market. And one of the most common responses to that consequence is to democratically create policies that gift those people with resources that do satisfy their needs. Debate tends to go back and forth abuot exactly how many resources they need, in the same manner that prices can tend to fluctuate around a particular point, but the general principle is quite clear.

What we are seeing in these cases are people evaluating the rationality of the allocation of resources, assessing that the market has misallocated them, and then, using the aggregating process of democracy, demanding that this misallocation be at least partly corrected. It is, like the argument about the market, an aggregation of subjective evaluation and it is, given that governments have budgets, a rational decision by voters to choose between preferences. That is, prices are not the only way to determine rational allocation, because economies routinely produce welfare policies that fill market gaps, which means that they identify the needs of people without utilising prices and the satisfy those needs without using prices.

One way to save the economic calculation argument is to claim that these instances of poverty would not exist except for some interfering factor, but hopefully I have established that needs going unmet is a structural issue for the exchange that can't be resolved by the exchange. Another way to save the argument is by claiming that all identifications of poverty are problematic and attempts to redirect resources to ameliorate them through non-exchange means is irrational. I do not think this is a tenable claim about rationality. A final way to save the argument is by claiming that exchanges and prices do a good job most of the time but that it is okay to complement them with some non-exchange activities in various circumstances. While Hayek might not agree with this, I suspect that many current mainstream economists would agree to something of the sort. The issue here, as I see it, is that it excludes all the contrary data from the set of evidence to come to its conclusion. That is, if we exclude all the times that exchanges and prices clearly don't work and we are forced to use another method, then the data we have left is just times when exchanges and prices do work, and so our conclusion is that they work.

This conclusion isn't very satisfying either. First, there is a lot of debate about the need for wealth taxes, land taxes, more government infrastructure, and so on - it is clearly not settled where that line might be between where the exchange is effective and where it is not. Second, where the exchange does work, it often does so only because some other economic transfer like non-reciprocal gifting provides a foundation upon which it can work, such as ensuring a healthy labour pool. Third, the fact that some things have to be excluded illustrates that the fundamentals of the argument are lacking, which makes it questionable that they could apply elsewhere.

There are other ways

In these first few sections I've done my best to outline what the liberal market economy looks like, how it's built on the concept of the exchange, how this concept causes a host of problems, how they are solved with non-reciprocal gifting, and how the arguments that the exchange can do something that non-reciprocal gifting cannot is not very sound. In a later section, I'll build up a model of the economy based solely on non-reciprocal gifting and think the model through.