Friday, November 5, 2010

Underworld Economics, Cleaned up and Formalized

Peter Dorman has a great post up explaining why market economies have tendency towards underconsumptionism, a position which Keynes called "underworld" economics, but which he identified as being closely related to his own thinking.

Dorman talks specifically about the problems with Walrasian price setting, and suggests that in the real world firms set quantities and compete for customers on price. He loosense utility maximization assumptions about consumers as well and suggests that if consumers have loyalty to firms that satisfy their quality requirements, firms will invest in more production as way to maintain customers. Dorman writes "This fits with the literature in marketing, which stresses that a sale should always be seen as the opening to future sales and therefore worth a much greater investment than it would justify from a myopic perspective."

One of the most interesting points that Dorman makes is connecting this argument to the work of Janos Kornai. I first encountered Kornai in the way that I think most people did - as a critic of planned economies in a discussion of comparative economic systems. What a lot of people forget is exactly what Kornai's criticism of planned economies was - the idea was actually not that central planners regularly make disastrous "market process" calculation mistakes (to borrow an Austrian phrase) - it was that planners deliberately underpriced their goods. Central planners, Kornai argued, are price-setters whereas market economy firms are almost always quantity setters and price takers. The result was the socialist "shortage economy" - and the flip side is that the market economy is a "surplus economy". That's not that bad of a problem to have, of course! In all my concerns about demand deficiency, you never see me saying "man - we'd all just be better off under central planning", after all. But it does shed light on the economic problems we do face, which is overproductionism/underconsumptionism to put it crudely - and employment as a function of effective demand to put it a little more respectably.

And it is an interesting point that Kornai makes about central planners, isn't it? I don't even know if I would have been that radical before reading this post. If, as Hayek or Mises contends, the primary problem is a socialist calculation problem, then wouldn't we expect to see chronic oversupply - full warehouses and overflowing shelves - as often as chronic shortages in socialist economies? If it's just a miscalculation issue, why the observed bias towards shortages? The traditional SCD logic (in which I side with Mises and Hayek, don't get me wrong) doesn't seem to be able to explain this feature. Kornai can explain that, and can also explain the struggles of market economies.

A little while back, Jonathan Catalan blogged on overproductionism here.

Also, I suppose worth noting, H.P. Lovecraft and Bertrand Russell were fervent adherents to the idea of overproductionism - and I've found at least one letter of Lovecraft's and an essay of Russell's that specifically identifies underconsumptionism as a problem (usually you find that the overproductionist variant dominates in the lay literature - underconsumptionism is largely restricted to economists, I've found). I've gotten the impression that overproductionist concerns were very, very common in the early part of the twentieth century (Albert Einstein made the point at one time as well) - which is interesting because you really don't hear the idea voiced among non-economists these days at all.

9 comments:

  1. Daniel,

    The socialist calculation debate does explain why economic goods in Soviet economies tend to suffer mostly from shortages. It has to do with rising market prices, as a result of the collectivization of the means of production (see, for example, Austrian arguments concerning universal healthcare), and the need for central planners to place price ceilings to retain affordability.

    Any surpluses there may have been were probably economic goods provided by the state itself, which has no sense of profit or loss, and that produced a certain quantity of good X irregardless of its actual demand on the market (most of the time, these goods were for the benefit of the state, such as armaments).

    Does Kornai have a more specific criticism? Otherwise, it seems to be a bit incomplete. Although, when did he make that criticism? It's worth noting that the socialist calculation problem, as posed by Mises in the early 1920s, was largely incomplete, because Mises had not presented a complete theory on price formation on the free market. The complete socialist calculation problem was not really presented until the advent of Human Action, where the price system was explained.

    I have the advantage of interpreting Kornai's criticism at a time in which I make use of a fairly complete economic theory (relative to the topic, that is). I don't know the progression of the debate that well, so it may be that Kornai's criticism was apt for the time it was made (although, even then, as it's posed here, it still seems rather elementary).

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  2. Jonathan - you're basically putting forward the argument that I did above and that Kornai did - but this isn't a calculation issue. This is an institutional question.

    "Retaining affordability" as a policy goal of central planners is precisely what I'm pointing to - but I'm not sure what that has to do with the socialist calculation debate or the market process problems that Hayek and Mises raised.

    Think of it this way - if "affordability" (kind of a misnomer anyway) were not a goal of central planners at all, would the Hayek/Mises position in the SCD predict a shortage economy at all? No, it wouldn't. It would just predict lots of inefficiency.

    Kornai (1.) is usually well regarded by the Austrians, and (2.) was not engaging SCD specifically. I'm just looking at his shortage economy arguments and noting that it's a very important factor in socialist economies that (from what I know of Mises and Hayek on calculation problems) isn't really addressed directly in the SCD debate.

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  3. I'm not sure why you're saying it's elementary. It's just different. And I don't expect Kornai would disagree at all with us and with Mises and Hayek on the SCD. It's a different argument entirely that I'm noting has value.

    Kornai says that socialist producers are primarily price setters and market producers are primarily quantity setters for institutional reasons. That generally makes socialist economies supply constrained and market economies demand constrained. I don't want you to read me as saying that's a counter-argument to Mises and Hayek - I'm just saying it's a different and quite useful insight.

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  4. Daniel,

    "...but this isn't a calculation issue."

    What? Of course it is! It has everything to do with calculation in a market without a functioning anarchistic price mechanism.

    "...but I'm not sure what that has to do with the socialist calculation debate or the market process problems that Hayek and Mises raised."

    As implied above, it has everything to do, because price fixing makes irrelevant the price mechanism, which is a central tenet of the modern socialist calculation problem (it was always a tenet, but a major weakness of the argument was that there was no coherent explanation of the price mechanism until after the socialist calculation debate lost relevancy in the profession).

    "Kornai says that socialist producers are primarily price setters and market producers are primarily quantity setters for institutional reasons."

    Mises would disagree. Both suppliers and demanders are price setters in a market economy. This is an elementary premise of Mengerian price formation.

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  5. Are we simply defining everything that occurs when there is no price mechanism a "calculation problem" and attributing it's solution to Hayek and Mises?

    When I think of the SCD I think of the fact that planners have no ability to make use of decentralized information. Prices make use of that decentralized information and allow all agents to respond to that information.

    None of that has anything to do with the insight that an economy where firms set prices rather than quantities is liable to shortages. It's simply a different argument.

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  6. "Are we simply defining everything that occurs when there is no price mechanism a "calculation problem" and attributing it's solution to Hayek and Mises?"

    Mises's calculation problem is exactly that; by socializing the means of production there is no price mechanism by which to economize resources.

    "None of that has anything to do with the insight that an economy where firms set prices rather than quantities is liable to shortages. It's simply a different argument."

    No, it's actually the same argument. By fixing prices you are disallowing the price mechanism from transmitting information between sellers and buyers.

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  7. "Mises's calculation problem is exactly that; by socializing the means of production there is no price mechanism by which to economize resources."

    I understand that. Perhaps I'm being unclear. My question is how the price mechanism's role in economizing resources - which Mises detailed - tells us "price-setting producers have a tendancy towards shortages while quantity-setting producers have a tendancy towards surpluses". It seems to be a fundamentally different insight. Kornai's insight applies to sitautions both with and without the free market. It just happens to apply to common institutions put in place by central planners (namely - price-setting behavior in a socialist economy).

    "No, it's actually the same argument. By fixing prices you are disallowing the price mechanism from transmitting information between sellers and buyers."

    Right right right. And so allocation is less efficient and sub-optimal. I know. But preventing the transmission of that information doesn't tell you anything about whether the inefficiency will err on the side of surplus or shortage (BOTH are inefficient by definition).

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  8. And that's really what's so useful about Kornai's point for questions of overproducitonism - the ability to predict surplus or shortage given a departure from standard marginalist equilibrating dynamics.

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  9. I think the market is both a shortage and surplus economy. I think primarily in terms of disequilibrium, where every good is constantly subject to shortage and surplus. What a study of the price mechanism tells you is that these phenomenon, in conjunction with the price mechanism, tell entrepreneurs how to invest.

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