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Hayek at least partially answered Schumpeter in the last paragraphs of "The Use of Knowledge in Society", didn't he.

Note well that when Hayek presented this paper to Schumpeter's Harvard seminar, Hayek out of courtesy left out these paragraphs. (Hayek seems to have taken Schumpeter seriously in his economic claims.)

Paul Samuelson, who was in attendance, therefore missed Hayek's answer to Schumpeter.

Samuelson, of course, closely folled Schumpeter in methodology, fully accepting Schumpeter's Machian positivism and operationalism.

Here's Hayek:

A recent statement by Professor Joseph Schumpeter in his Capitalism, Socialism, and Democracy provides a clear illustration of one of the methodological differences which I have in mind. Its author is pre-eminent among those economists who approach economic phenomena in the light of a certain branch of positivism. To him these phenomena accordingly appear as objectively given quantities of commodities impinging directly upon each other, almost, it would seem, without any intervention of human minds. Only against this background can I account for the following (to me startling) pronouncement. Professor Schumpeter argues that the possibility of a rational calculation in the absence of markets for the factors of production follows for the theorist "from the elementary proposition that consumers in evaluating ('demanding') consumers' goods ipso facto also evaluate the means of production which enter into the production of these goods."*1
H.29

Taken literally, this statement is simply untrue. The consumers do nothing of the kind. What Professor Schumpeter's "ipso facto" presumably means is that the valuation of the factors of production is implied in, or follows necessarily from, the valuation of consumers' goods. But this, too, is not correct. Implication is a logical relationship which can be meaningfully asserted only of propositions simultaneously present to one and the same mind. It is evident, however, that the values of the factors of production do not depend solely on the valuation of the consumers' goods but also on the conditions of supply of the various factors of production. Only to a mind to which all these facts were simultaneously known would the answer necessarily follow from the facts given to it. The practical problem, however, arises precisely because these facts are never so given to a single mind, and because, in consequence, it is necessary that in the solution of the problem knowledge should be used that is dispersed among many people.
H.30

The problem is thus in no way solved if we can show that all the facts, if they were known to a single mind (as we hypothetically assume them to be given to the observing economist), would uniquely determine the solution; instead we must show how a solution is produced by the interactions of people each of whom possesses only partial knowledge. To assume all the knowledge to be given to a single mind in the same manner in which we assume it to be given to us as the explaining economists is to assume the problem away and to disregard everything that is important and significant in the real world.
H.31

That an economist of Professor Schumpeter's standing should thus have fallen into a trap which the ambiguity of the term "datum" sets to the unwary can hardly be explained as a simple error. It suggests rather that there is something fundamentally wrong with an approach which habitually disregards an essential part of the phenomena with which we have to deal: the unavoidable imperfection of man's knowledge and the consequent need for a process by which knowledge is constantly communicated and acquired. Any approach, such as that of much of mathematical economics with its simultaneous equations, which in effect starts from the assumption that people's knowledge corresponds with the objective facts of the situation, systematically leaves out what is our main task to explain. I am far from denying that in our system equilibrium analysis has a useful function to perform. But when it comes to the point where it misleads some of our leading thinkers into believing that the situation which it describes has direct relevance to the solution of practical problems, it is high time that we remember that it does not deal with the social process at all and that it is no more than a useful preliminary to the study of the main problem.

Notes for this chapter

1.
J. Schumpeter, Capitalism, Socialism, and Democracy (New York; Harper, 1942), p. 175. Professor Schumpeter is, I believe, also the original author of the myth that Pareto and Barone have "solved" the problem of socialist calculation. What they, and many others, did was merely to state the conditions which a rational allocation of resources would have to satisfy and to point out that these were essentially the same as the conditions of equilibrium of a competitive market. This is something altogether different from knowing how the allocation of resources satisfying these conditions can be found in practice. Pareto himself (from whom Barone has taken practically everything he has to say), far from claiming to have solved the practical problem, in fact explicitly denies that it can be solved without the help of the market. See his Manuel d'économie pure (2d ed., 1927), pp. 233-34. The relevant passage is quoted in an English translation at the beginning of my article on "Socialist Calculation: The Competitive 'Solution,' " in Economica, New Series, Vol. VIII, No. 26 (May, 1940), p. 125.

greg,

either your time management is terrific, or you have some difficulties with the concept of dimishing returns. Don't be mad. I just wonder.

Ah, mechanism design theory again.

You and I had a lengthy private discussion of this, and I furthermore researched it at great length, and still have no idea what the hell it's all about.

amv -- your remarks are cryptic. What do you mean, e.g. what is the point of your "diminishing returns" remark. I don't get it.

And I'd prefer it if folks who won't identify themselves will restrain themselves from making personal remarks about people who do identify themselves.

There's a genuinely perverse asymmetry at work in such situations.

I you want to engage personalities rather than ideas, we really need to know who is making the personal remark.

I see your point. you are right. not identifying oneself is not the most heroic thing to do. the only problem: if potential employees google my name, I do not want blog comments to be the first things to come up. not that I do not stand for what I say, it just looks bad, I guess.

so just forget about it. As I sad: I just wondered. You are so quick to answer, have so many worlds to say, and you have often multiple comments within one post. I was just curious. To ask you about diminishing returns meant: don't you have more productive things to do? But obviously this is not my business. so excuse me.

correction: not 'employees' but 'employers'

amv -- I have serious lower back pain and read blogs and comment while icing my back. I do the same often when eating meals. This really doesn't take much of my time.

Breakfast with "The Austrian Economists" -- almost as good as "Breakfast with the Beetles" (a weekend LA radio show).

the more I feel bad about my comment.

Samuelson also took Schumpeter seriously on the socialism debate -- and concluded by the 1980s that Schumpeter should have sided with Hayek:

""Schumpeter's final logic ought to have predisposed him to accord to Hayek the final victory over Lerner and Lange in the debate over whether a socialist state could play the game of
parametric pricing. To find new _cost_ technologies and husband scarce knowledge as it is forever newly arriving, the letter of
Walrasian equations achievable by Lerner-Lange auctioneers and bureaucrates serves as nothing compared to what Hayek's real life speculators and profit receivers are led by the invisible hand of market competition to contribute. I don't remember Schumpeter as pronouncing on this point, but on my reading it should be congenial to his _Weltanschauung_."

In other words, by the 1980s Samuelson came to the conclusion that Hayek got the better the argument in Hayek's counter to Schumpeter in his "The Use of Knowledge in Society".

The "Schumpeterian irony" claim is made by Jerry Z. Mueller in "The Mind and the Market." His argument seemed quite persuasive to me: given the popularity of socialism among intellectuals in the 1940s, the only way to present a case for capitalism was to demonstrate its virtues while conceding the inevitability of capitalism. Also, Mueller argues that Schumpeter examplifies a typically Viennese type of humor - pessimistic irony - that is curiously absent from the writings of Mises or Hayek. Anyway, Mueller's chapter on Schumpeter is well worth reading.

Anything that happens in California is suspect. This conference is no exception.

Greg-

Excellent note! I think the point you raise from Hayek is extremely important. It also suggests a fundamental shared assumption shared by behavioral economists when they reason.

Maybe McCraw is talking up Schumpeter because he has written a book on him. Perhaps if he'd written a book on Hayek he would be singing a different tune.

If "The Road to Serfdom" is polemic then I don't know what isn't.

A point I made in the discussion Pete is referencing is that it is not true that "socialism cannot work." Actually existing Soviet socialism in its later years did provide food, housing, clothing, and so on to people, even though prices were not set at efficient market levels. The problem was that it did not work as well as market capitalism, with the real signs of this being the lousy quality of goods and more importantly, the technological stagnation over time that left it behind its capitalist competitors.

Indeed, this last point is both Schumpeterian and Misesian. The technological stagnation was due to the lack of incentives, and the absence of entrepreneurs, ultimately leading to a lack of creative destruction. Soviet socialism did not die of catastrophic collapse (which came after the system was ended), but of boredom.

That the worst has not always materialized in socialist nations is only because they were not purely socialist. Even Soviet Russia and Nazi Germany “were not isolated socialist systems. They were operating in an environment in which the price system still worked. They could resort to economic calculation on the ground of…prices established abroad. Without the aid of these prices their actions would have been aimless and planless. Only because they were able to refer to these foreign prices were they able to calculate…keep books, and prepare their much talked about plans.” Ludwig von Mises

But under a world-wide and completely socialist regime, things would be different. The only hope for mankind then would be the discovery of life, capitalist life, on Mars.

But a lot of their internal prices were different from world ones. They simply did not use prices to allocate in general. Where they did, and where they had to use world prices, was when they exported and imported.

Barkely,

You wrote,

"They simply did not use prices to allocate in general."

That's why they were very poor "in general."

I don't know how you know that they didn't "use prices to allocate in general." The fact is that they they they could have used them, and, as you yourself concede, had to do so in foreign trade, which had to affect to spill over into their domestic trade. That wasn't everything, but it was enough to explain why they didn't completely starve to death. And there was more than that. They didn't eliminate market activity completely, but even allowed some of that. They had to. For without it, they were starving to death.

What more do you need to change your mind, beside a mind open to change?


to foreibut the fact is that they had foreign prices to refer to,

There were certainly significant departures from pure Communism in the USSR.

This was particularly the case for agriculture. I found a book on google books that goes into some detail on this. "Private Agriculture in the Soviet Union" by Stefan Hedlund.

It says that in 1985 the private plots allocated to peasants produced 60% of the potato output, 29% of vegatables, 28% of meat, 29% of milk, 28% of eggs and 26% of wool. Also, as he writes, the private output provided signs to the state farming planners on what good were in demand.

The same sort of thing is true in some other areas too. In Aircraft design, for example, there were a set of competing "design bureaus". This was done to ensure that Soviet aircraft could compete with NATO ones.

I must chime in on this point at well. The most pure socialism ever implemented has always produced the most vast famine and horror, for example: the "war communism" period in Russia, collectivization and the Stalinist period pf planning, Mao's Great Leap Forward, and Cambodia, where money was eliminated.

When socialism has left loopholes, stolen from market countries, legalized certain market relationships, and so on, it has functioned far better--but still very poorly compared to markets.

In Russia, during the whole period except during collectivization, the production and distribution of food did depend greatly upon markets: if I remember correctly, even when only 3% of arable land was privately owned (private plots) this land produced the majority of certain items of food (e.g., eggs, potatoes), and a third overall of all produce. Plus you had: black, gray, brown and pink markets, legalized artisan and services markets (single-hire), etc.

Second, Russia did depend on global prices! Prices were used throughout the planning process, and global prices were often used during the calculation. There is an excellent quote of Stalin that might shed some light on this, c 1951, describing the problem of price setting:

"Here is one of many examples. Some time ago it was decided to adjust the prices of cotton and grain in the interest of cotton growing, to establish more accurate prices for grain sold to the cotton growers, and to raise the prices of cotton delivered to the state.

Our business executives and planners submitted a proposal on this score which could not but astound the members of the Central Committee, since it suggested fixing the price of a ton of grain at practically the same level as a ton of cotton, and, moreover, the price of a ton of grain was taken as equivalent to that of a ton of baked bread.

In reply to the remarks of members of the Central Committee that the price of a ton of bread must be higher than that of a ton of grain, because of the additional expense of milling and baking, and that cotton was generally much dearer than grain, as was also borne out by their prices in the world market, the authors of the proposal could find nothing coherent to say."

Note that last bit: as born out on the world market. They were constantly aware of world market prices, and frequently referenced them to sanity-check their own choices.

I can look it up, but I think the best source for how often world prices were used is probably Paul Gregory and Mark Harrison's work using the archives, but it was known before that and is documented for the Stalin period elsewhere.

The actually existing Soviet economy was a very complicated system and it changed quite a bit over time. Someone writing under Stalin's name in 1951 did declare that the "law of value" operated in that economy, and there was a certain accounting coherence to prices, more related to adding up input costs rather than reflecting demand or indicating how resource allocation should be carried out. Although they were not labeled as such, "profit" and "interest" existed, but, again, did not generally operate as allocative determining devices.

Private ag markets, which existed in the 20s were allowed again after Stalin died. Over time it varied as to which goods were controlled totally from the center, which were controlled on more regional or local bases, and which were actually run by markets.

Oh, and I do not need to "change my mind" to comment on these matters (and commenting has not changed my mind, as I already knew this stuff).

A couple things-

"Someone writing under Stalin's name in 1951"

I'm not sure what you mean by "someone writing under Stalin's name" as this was discussed in central committee meetings and there are several speeches by Stalin on the matter--and Economic Problems of the USSR is one of Stalin's most famous late works.

Anyway, its epitomizes Stalin's theoretical framework--he argued that the law of value under socialism operated because socialist firms made exchanges, but that it had a different purpose under socialism than under capitalism, due to the different relations of production, and was bound by historical circumstances of the transition--so it would dissolve away once the transition to communism was complete.

"and there was a certain accounting coherence to prices, more related to adding up input costs rather than reflecting demand or indicating how resource allocation should be carried out."

There was not much accounting coherence to prices--in fact very little. They were centrally set, not set by the market. Not only did they not reflect demand (how could they?) or accurately reflect costs (once one is wrong, the rest based upon it become wrong, etc) but they were often self-contradictory as well.

I have dozens of quotes from officials, economists, planners, reformers, historians, etc on this point. Here is one:

"... so far no rational and workable pricing system has been devised. Prices do not fully reflect factor costs, as rent and interest are not necessarily fully accounted for in them, and furthermore different criteria for price-setting are used for different categories of products. As a result, prices do not, and cannot, perform a rational allocative function. The irrationality of prices in this sense in fact makes the whole system of economic decision-making largely arbitrary-- as Tindenberg puts it, 'optimization of what?'"

- Wilczynski (1977) p. 212

As to profit and interest -- during the 1965 reforms profit indicators (by the name) were introduced. However because of the uselessness of prices, and the distortion by other targets and by planned supply and by shortage, they did not do very much. Interest was also introduced (under the name "capital charge") but in practice it was often negative in real terms (especially once hidden inflation is taken account of, but even before that through various soft budget mechanisms).

liberty,

Regarding authorship, you have already answered your own question. Do you think that Stalin had to discuss things with the Central Committee before writing them? In 1951 the Central Committee and the Politburo totally kissed his behind. It is well known that this book was basically written by a committee, with the final approval of Stalin.

Look, the system was complicated and how prices were set was all over the place. Some were arbitrary and ridiculous, some were actually determined by markets, others had vague links to markets, with all this varying over time. Also, there was an accounting framework and system, even if it was easily criticizable, and it did reflect an adding up of costs, with your remarks saying essentially that many of those costs did not reflect real economic realities due to the arbitrariness of the prices. Of course, and you should note my weasel word "certain coherence," which implies that it is somewhat odd. But the framework had this semi-coherence in that it became the basis for the turnover tax that funded the State. The system may have been deeply flawed and seriously incoherent, but it held together in this very practical sense.

So when are you moving to North Korea?

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