When socialism was a rampaging idea in the twentieth century, part of the intellectual war was the socialist calculation debate. This debate made the point that a socialist central planner could never have enough information to plan the economy. The basic reason is that you need to know people’s desires to do that, and the only way to know their desires is to set them free and see what choices they make.
Additionally, the engineering tradeoffs in the economy are immensely complicated. E.g., how much steel should we devote to building apartment buildings, how much to car production, how much to computer production, etc.? Only a decentralized mechanism – markets – has a prayer of dealing with those tradeoffs in a sane manner. A market economy is a practical solution to the information problem because each small unit – each firm or individual person – only has to wrestle with their own small piece of the economy. They don’t have to plan the whole thing.
Furthermore, markets have a crucial feature: Feedback. Business are punished for bad decisions by making losses. A central planner, in a world without profit and loss, wouldn’t even know about his mistakes, let alone have any incentive to correct them.
Socialists being socialists, they got their asses thoroughly kicked in this debate, then declared victory. (Plus ca change…)
A while ago Slate Star Codex had a post reviewing a book, Red Plenty, in which these issues arose. In the comments the socialist calculation debate flared to life.
One commenter says of the planners’ problem compared to the market problem, “This fails a simple sanity check. I refuse to believe that [individual] humans are able to calculate those equations…”
This fails to get a large number of relevant points. To mention just two:
(1) The individuals aren’t solving the same problem the planner does. They have prices to do a large amount of the computational work for them. Market prices convey information; more on this below.
(2) Another problem, of course, is that the information the planner would need about people’s preferences is in the people’s heads, so the planner would have to read people’s minds. The people, in contrast, are not faced with the problem of reading their own minds.
Returning to (1), prices sum up the scarcity of something relative to the demand for it. Here’s economist Friedrich Hayek, in a famous passage (http://www.econlib.org/library/Essays/hykKnw1.html, paragraphing added for ease of reading):
Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose-and it is very significant that it does not matter-which of these two causes has made tin more scarce [relative to the demand for it].
All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply.
Hayek notes that if information is decentralized, and everyone just deals with their own small piece, the problem is manageable. He continues:
If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes… and so on; and all this without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes.
Tin’s price could have gone up due to a decrease in the supply… and a very large number of things could cause such a decrease. It also could have gone up due to an increase in demand… and a very large number of things could cause such an increase. The people making choices affected by that price don’t need to know why it went up— it is a summary statistic that only conveys what they need to know— but the planner does have to know. To plan efficiently, the planner has to know whether tin’s price rose due to an increase in demand for it, and what and where that specific demand was… or due to a decrease in supply, and what the particular decrease was. Otherwise the planning problem can’t be solved. E.g., maybe someone has discovered a new industrial use for tin, a new technological development. The planner, in contrast to market participants, must know this to come up with a new optimal plan – the planner can’t optimize without even knowing the engineering tradeoffs in the economy!
Now the “sanity check” radar of the commenter mentioned above may be pinging. “Why,” he might ask, “does the planner need to know something the market participants don’t need to know? Why can’t the planner just replicate whatever info-processing mechanism makes this work in a market economy?”
Answer: Because the mechanism that makes it work is decentralization.
Memo to socialists: You can’t have a goal of central planning, then whine because your goal involves centralization.
(Socialists in the 20th century often said the planners could use prices. This assumes an answer to the question that is being debated. Where do the prices come from? Who sets them? What gives them any connection to real-world supply and demand?)
Alternatively, you could embrace decentralization – and I hope you do – but then you’re basically just replicating the market. (In the context of a basically market economy, conventional deviations from pure market, like taxes and welfare programs, are of second-order importance compared to the complete informational chaos that would attend an attempt at central planning.)
This is what the commenter meant, though he didn’t know it, when he wrote,
“What really happens is that those humans don’t really calculate all those equations, but use some simplified version. But then, why does the computer need to use the 1,001,000 equations instead of using similar simplifications, or approximations, or better algorithms…”
The simplifying trick those humans use is decentralization.
This is, indeed, the dilemma upon which all socialist notions must founder: Either you depart radically from the market, in which case you can’t solve the information problem and all is chaos, or you simply replicate the market outcome, in which case why bother?
One more point: If you’re trying to enlist me in your violent revolution that’s going to kill tens of millions of people to replace the market, you’ll have to provide an argument a lot more concrete than, “There must be some way to do it.”