Economic Calculation Revisited

The use of words “economic calculation” are almost a mantra for vulgar internet advocates of Austrian economics. When criticisms are made of Austrian economic theory, the usual red herring response is some charge of having failed to understand “economic calculation.”

The last time I dealt with this issue it led to the following exchange:

Jonathan Finegold Catalán, Economic Miscalculation: A Reply, Economic Thought, 7 February, 2012.

Jonathan Finegold Catalán, Economic Miscalculation, Economic Thought, 6 February, 2012.

“Austrian Nonsense About Economic Calculation,” February 3, 2012.

“Economic Calculation Yet Again,” February 7, 2012.

“Economic Calculation, Part 3,” February 7, 2012.

The upshot of all this was Jonathan Finegold Catalán’s view of the Austrian business cycle theory (ABCT) as one theory within the broader Austrian theory of economic coordination and discoordination:

“To clear up any confusion amongst third party readers, what I call the “theory of intertemporal discoordination” is Austrian business cycle theory — I prefer my term, because I think it gets across what the theory is about much better than the conventional one. Furthermore, as I posited in my original post, the new term suggests that the theory is only one facet of many within the body of theory of economic coordination (and discoordination). More accurately, it describes an artificial tendency of discoordination between investment and societal time preference (the latter dictating the aggregate stock of savings at any given point in time).”

The ABCT is one of economic miscalculation and malinvestment. This overarching, broader Austrian theory of economic calculation is supposed to show how the market economy would work free from government distortions.

The fundamental part of this broad Austrian theory of economic coordination/discoordination is the role of prices in a market economy.

Supposedly government deficit spending, price controls, subsidies, income policies, and so on will impair economic calculation on the market by impairing prices, presumably in some disastrous destabilising way.

But it is not difficult to see how the Austrians have a view here that sees the market as ridiculously feeble. For example, does the existence of some minor government subsidies cause an Austrian trade cycle? Would they impair the ability of the private sector to engage in production of commodities with rising real output? Would they distort the market so badly that nobody could engage in “economic calculation”?

For example, the idea that the normal types of government spending cause some severe problems of “economic calculation” leading to market chaos is patent nonsense.

Whatever “distortion” government causes is no more or less severe than what the private sector itself imposes. For example, it is absurd to believe that the millions of agents offering goods and services get their prices right in terms of demand/supply dynamics. Many corporations and business are in fact price setters/administrators: they set their prices according to production costs and then a profit markup, then leave them unchanged for significant periods of time, even when demand changes, as even Ludwig Lachmann understood (Lachmann 1986). The prices are not fundamentally set by supply/demand dynamics at all: they are set by central planners in corporations. A market economy at any one moment has a vast number of “wrong” prices. But this does not mean that the market collapses: it still achieves investment, production and economic growth over long periods.

The alleged price “distortions,” either public or private, don’t destroy capitalist economies. They don’t prevent vast and successful private production of wealth and investment. In the case of price setting, the empirical literature suggests that it has benefits they outweigh costs: stability of profits and the prevention of disastrous price wars between businesses, for example.

And completely “unadulterated” prices in a free market would not necessarily be right prices in the sense imagined by neoclassical or Austrian economics at all. Many would be wrong, merely because producers/sellers aren’t perfect.

But the market system doesn’t require “right” prices in the standard economic sense of equilibrium prices to be successful and dynamic.

If we extend this analysis from price setting to profits, we can say that the existence of significant price setting in many markets by private businesses does not mean the economy is necessarily subject to some unsustainable and devastating “economic calculation” problems, because profits are, thereby, also made stable.

A consequence of price setting is a kind of profit “setting”: profits for the firm are made stable by price setting activities. Far from being a cause of intractable “economic calculation” problems, this profit stability is more likely a strong stabilising factor for modern businesses: for stable profits allow stable margins for internal financing of investment (Melmiès 2012).

The market system is far more robust than what Austrians think it is, with their feeble-minded obsession with price distortions.


UPDATE

I have added a quick update above on the role of profits in light of Jonathan Finegold Catalán’s reply to this post here:

Jonathan Finegold Catalán, “Irony; One Last Time,” Economic Thought, 29 July, 2012.

BIBLIOGRAPHY

Lachmann, L. M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford.

Melmiès, J. 2012. “Price Rigidity,” in J. E. King, The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 452–456.