The Praxeology of the Knowledge Problem of Socialism

0:00So I'm going to be discussing the praxeology of the knowledge problem of socialism and the reason I wrote this is that I feel like lots of Rothbardians reject the knowledge problem completely and I want to put the knowledge problem within the praxeological Rothbardian framework and I heard somebody ask earlier today what is praxeology a few minutes ago So, praxeology is the study of human action. Just read any, read human action and you're studying praxeology. So, let me say something about the two problems because if somebody doesn't know what praxeology is, I should probably explain the calculation problem and the knowledge problem too. So, the calculation problem refers to the fact that under socialism, It is not possible to give any objective sense of profit and loss for any given production process because all costs and benefits are given in terms of units that cannot be compared objectively, cannot be added up like apples and oranges.

1:19If I am running a labor camp, some of my costs will be in terms of the labor of my slaves. Other costs will be given in terms of money for things that I bought for materials production. So my costs will be money costs plus labor costs, but since I never bought the labor, The labor is not given in terms of any price, so there isn't any way to say objectively whether the labor and money costs add up to something that is worth the benefits. So probably the slaves would say that it's not worth the benefits, whereas the slave owner would say, yes, it is worth the benefits.

2:08So that's the calculation problem. Because the knowledge problem refers to the fact that if you have a large organization, you have a multinational corporation or a large state, you have all sorts of subsidiary organizations everywhere that are supposed to be doing what you want, you have to gain and a knowledge of everything that's happening to all of your subsidiary organizations to tell them what to do, otherwise how are you going to tell? So I'm going to start with a quote from Rothbard, Man Economy and State. He's referring to a free market organization that has completely, vertically integrated the production and use of a given capital good.

3:06So he says, suppose there is no external market, i.e. that the Jones Company is the only producer of the intermediate good. It would have no way of knowing which stage was being conducted profitably and which was not. In that case, it would have no way of knowing which stage was being conducted properly and which was not. It would therefore have no way of knowing how to allocate factors of the various stages. There would be no way for it to estimate any implicit price or opportunity cost for the capital good at that particular stage. Any estimate would be completely arbitrary and have no meaningful relation to economic conditions. Not being able to calculate a price, a firm could not rationally allocate factors and resources from one stage to another. So I believe that Rothbard has made a mistake here.

3:54Now one of the arguments that is often used against the Hayekian position is that Hayek will say that prices communicate knowledge and they tell us, tell entrepreneurs what they should do. Well, that's actually incorrect because if you want to know what's going to be profitable tomorrow, the prices of today tell you nothing about that. You really need to know about what people's preference scales are. You need to actually learn about what people really want if you're going to produce things. So it's really preference scales that matter in terms of appraising a good. and on the free market it should be possible to appraise a good even if it's not being traded today, it might be traded tomorrow, if you know about people's preference scales that should be feasible in theory.

4:46So I think that the argument that is used against Hayek could really be used against Rothbard here as well. So, now here's sort of a diagram of a two-stage production process, and in the middle would be the vertically integrated capital good. I'm going to explain how we can appraise the vertically integrated capital good now. Basically, so I might have a choice of whether I want to invest more and get a second of of these capital goods, then I can produce more output, or whether it's more profitable just to produce the lower amount of output.

5:31So what I can do if I'm the manager of this company, the inputs are all on a market, so they have prices and I can appraise those just as I would with anything else. The outputs also have prices and I can appraise them like I would with anything else. So any kind of technological possibility for the intermediate vertically integrated capital good, I can just look at the overall profitability for the entire production process and figure out which use of this capital good is best. So do I want to invest more and rely more heavily on capital or do I want to stay how I am?

6:19And I can just look at the overall profitability of the entire production process. And this is really no different than what any entrepreneur does with a single production process. You're just looking at the optimal technological possibilities for a given, for the given process. It's just that in this case, there is a larger range of possibilities, there's just more or to consider. And you can even come up with a price for the intermediate capital good, even though there's no market. When you have the optimal production process, it must be that the intermediate good is in equilibrium with respect to the inputs and the outputs, necessarily.

7:12So you can assign it the price which equalizes the profitability of both stages of production. Now that is not a market price, so what does it mean? Well it has a very clear meaning on the market, and that is that I assign the intermediate capital good a price, now somebody else comes up to my business and says, you know, I will If I will buy this for a higher price than what I just calculated for, then I know that I should stop doing the second production process entirely and I should just focus on the first one and sell to the second guy, because it's more profitable just to focus on the first one. Or if somebody else starts producing this capital good for a lower price than what I've I've appraised it, then I know that I should specialize in the second production process and just focus on that and buy from him.

8:11So this appraised price has a real meaning even though it's not being traded on the market. Now let's consider, well first of all I think, notice that my argument does not rely on equilibrium assumptions, a limited number of inputs or stages of production, interpersonal comparisons is a value. It doesn't rely on anything that socialists like to sneak into their arguments to say that calculation under socialism is possible. There could be an infinite number of possible stages. There could be a lot more choices than the ones I've considered. I just listed two here, but there could be any number. But really, any entrepreneur has to contend with, hypothetically, an infinite number of possible technological choices.

9:04So there really isn't a difference here. Now, on the other hand, what if this intermediate capital good were not a free market good? Were not the case that I monopolize it just because I'm the best on the market, but because Because there's a monopoly and I'm granted a right from the state to say, you're the only one, nobody else is allowed to produce and use this good. Well then, although I can appraise the price for it that I mentioned earlier, then that price no longer has any economic meaning whatsoever because it could very well be that there are other people around who are perfectly willing to produce the good at a lower price or to by the good at a higher price and they can't do anything about it because they're prevented coercively so even though I can use this method to appraise a price on the free market and and allocate the good rationally in a coercive monopoly system the good would still be allocated incorrectly at least

10:18So I would say that what Rothbard was discussing in this part of Man Economy and State was not a calculation problem but a knowledge problem. It really depends on being able to think about two stages of production at the same time rather than just one. The issue is that if you had one manager managing the first stage of production and a different Management Manager managing the second stages of production, then they wouldn't know what to do. You would have to have one manager managing both stages of production, then he would be capable of appraising the good, the intermediate capital good, and arranging it correctly.

11:07So I will argue in my paper that there is not a calculation problem on the free market, Contra Rothbard. If there is potential for trade, there is a method to appraise goods and to allocate them rationally. There is only a calculation problem under socialism. So, okay, I was going to talk about... I talked about this part first. So here are some quotes from Mises from Bureaucracy, which is the book he wrote with the highest greatness density, in my opinion. And this, I think, the book Bureaucracy is really more about the knowledge problem than the calculation problem in a way because it really discusses a lot about how a socialist organization is going to get all of its subsidiary organizations to do what it wants.

12:20And this kind of explains the relationship between the calculation and knowledge problems under socialism. So under socialism there is a calculation problem because there is a coercion and this prevents goods from being appraised on the market. But what was I saying here? So what Mises says is that a free market firm is able to delegate authority because the subsidiary managers are able to measure profits and losses for their own individual parts Parts of the Production Process.

13:24Whereas a socialist organization, when they try to delegate authority, there is no such method that the subsidiary organizations are able to measure profit and loss. So whereas a free market organization can delegate authority and expect that the subsidiary Mises did not seem to take this argument to its logical extreme, but here I have a graph representing what is possible on the free market, but what would be necessary under socialism in order to find an optimum.

14:25So if you're a socialist and you're running an economy or attempting to, you can't expect any subsidiary organizations will do what you want. I mean, they might have sort of a guess, but there's no sense of any optimality that will will allow them to, that will give you any assurance that they're necessarily going to do what you want. So if you have perfect knowledge and you're able to look at the entire economy and just make all the decisions for yourself, that's what you will do. Whereas on the free market it is possible to have subsidiary organizations that will optimize their own profits and do what you want. Now obviously in real life this is not really feasible because people don't have perfect knowledge but what this shows is that there is a separate knowledge problem under socialism and it's caused by the calculation problem because there If there wasn't a calculation problem, you wouldn't really want to organize your economy in this way.

15:38But you can imagine an economy in which the knowledge problem has been solved, a socialist economy in which the knowledge problem has been solved, and compare it to one in which it has not been solved. And in my paper, I do this thought experiment, but I didn't really think I would have the time to go into all the details. So anyway, here's a summary. A bureaucratic organization can have no reason to expect that independent decisions made by subordinates will be beneficial to his overall plan. A free market organization need not centralize all knowledge and decisions, whereas a bureaucratic organization necessarily must if it wants to achieve any sort of optimum for its goals. The knowledge problem is caused by the calculation problem, but it's possible to compare socialist society, which has solved the knowledge problem, to one which has not.

16:38And here's the basic thesis of my paper. The calculation problem is a problem of evaluating a goal, the knowledge problem is the problem of actually achieving it. Now as I showed earlier, when you have a whole network of intermediate capital goods, if you can imagine the entire problem all at once, it is possible to allocate the capital goods according to your goal, but there won't be any overall idea of profit and loss. So if you do solve the knowledge problem, the ultimate problem of socialism is that the final goods that are produced will have no relation to people's preferences.

17:25But you wouldn't see problems like tractors rotting in the fields, huge piles of crops being produced that then just rot. So the Rothbardian interpretation, so Mises discussed the calculation and knowledge problems in his writings, but did not clearly distinguish them in points. The Rothbardian interpretation of Mises is characterized by failing to appreciate this distinction, and the Hayekian interpretation is characterized by not understanding the calculation problem at all because they only talk about knowledge.

18:12So here are some quotes from Mises to substantiate my position. The first step that would be necessary to form sections inside the socialist community to which the management of definite branches of business would be entrusted. The first step, which would be necessary, would be to form sections inside the socialist community to which the management of definite branches of business would be entrusted. As long as the industry of the socialist community is directed by one single authority, which makes all arrangements and bears all the responsibility, a solution of the problems is inconceivable because all the other workers are only acting instruments without independent delimited spheres of operation and consequently without any special responsibility.

19:00So I think this really illustrates my interpretation of the calculation problem because lots of times the emphasis is on not being able to allocate capital goods properly, but as I've tried to show, it is possible to allocate capital goods according to the central planner's There's goals if they solve the knowledge problem but there can be no intellectual division of labor under socialism. Now if you look at the examples that Mises gives of the calculation problem, they're all examples that try to abstract a part of the economy from the whole.

19:50He'll say, what if you try to build a house? Or what if the socialist planner wants to build a railroad? And the conclusion is always that this is impossible because there's no objective sense of profit and loss. There's no reason to believe that it's a good idea or a bad idea. But if you can think about everything happening in the entire economy all at once, then you are able to come up with an answer. Mises, because you can just compare the entire outcome from one to the other. And so, by conclusion, under socialism there can be no intellectual division of labor.

20:41And this is what is really impossible under socialism. It's not really the allocation of capital goods, but just the fact that there can be no intellectual division of labor. So here's a quote from Brian Kaplan, Why I'm Not an Austrian Economist. Does Trousseau's one-man socialism become impossible when Friday shows up? Hardly. What if a hundred people show up? One thousand. 2000, Mises' distinction between a modern economy and proofs of it and why the economic calculation argument applies only to the former, again shows that Mises has underlying quantitative assumptions in spite of his strictures against them. So I think that my interpretation of the calculations and knowledge problems explains this apparent paradox in the interpretation of Mises, because it shows that if you have an economy in which you can encompass in which you can imagine and think about everything all at once and it won't fall apart, you won't produce things that people want but that's why the two-person socialist economy will work and the large economy won't. So thank you very much.