Tuesday, March 13, 2012

An Introduction to Austrian Economics - Calculations in Kind in an Advanced Economy

An Introduction to Austrian Economics
Thomas C. Taylor

Social Cooperation and Resource Allocation

Calculations in Kind in an Advanced Economy

Over the centuries an alternative to economic self-sufficiency has evolved to deal with the problem of scarcity. This alternative is social cooperation, the basis of what is called society. Virtually all people have chosen society over self-sufficiency. The enormous increase in productivity resulting from specialization and the division of labor gradually undermined the process of self-sufficient provisioning. Yet despite the comparative abundance of products and services emanating from the process of social cooperation, the economic problem remains: Wants continue to exceed the means or resources for their attainment. The persistence of the problem of scarcity means that even in a modern, highly developed, and productive society decisions have to be made regarding how the various scarce resources should be directed to the satisfaction of the more urgently felt wants of society's members.
These decisions are not as simple to make in an advanced society as they are in a primitive state of economic self-sufficiency. The resources cannot be as easily scrutinized for possible uses. The great enhancement of productivity arising from specialization and the division of labor considerably increases the flexibility of resource utilization. The fruits of social cooperation permit the devotion of a major portion of original resources, land, and labor, to the direct production of what may be called producer's goods, or intermediate products, which ultimately will give rise to consumer's goods when combined with additional increments of land and labor. Herein lies a crucial distinction between economic self-sufficiency and social cooperation: The complexity and intricacy of resource employment in a modern economy require far more complicated decisions than those that Robinson Crusoe had to make.
The increased complexity of economic decisions is partly attributable to the immense variety of consumer's goods and services that a high-level economy is capable of generating. Choices have to be made as to which ones should be produced and in what quantity; the larger the number of alternatives, the more difficult these decisions. However, decisions concerning ends are not the only vital decisions that must be made. As did Robinson Crusoe, people in society must make choices that relate resources to ends. How are the resources to be used? What makes this question hard to answer is that the economic resources in an advanced economy are extremely versatile and diversified. Their versatility can be traced to the wide range of uses to which they can be adapted as a result of advances in technology and productive skills, results that include the beneficial effects of the division of labor and specialization. And these numerous adaptations entail the conversion of original factors of production into a diversity of produced resources, thereby creating countless types of particular resources.
It is clear that with such an infinite array of steps that can be taken toward the production of finished products and services, the most economical or fruitful choices cannot be made simply by reviewing calculations in kind. The very abundance of resources makes it impossible rationally to assign and direct original factors of production to yield more refined means of production without some basis for comparison of the results. For example, iron can be used in the manufacture of locomotives, farm tractor equipment, textile spinning and weaving machinery, building frames, oil drilling equipment, and thousands of other items. And the problem is compounded when one remembers that for many uses other resources offer effective substitutes. Thus copper, tin, and aluminum can be used in place of iron or steel for certain items. The problem widens as the full range of alternatives is considered. Decisions concerning resource utilization would be a matter of immense confusion if calculations in kind were the only calculations. The allocation of scarce resources would be chaotic and seriously imprecise.
Once the shackles of self-sufficiency are removed and production for exchange is assumed, the epitome of which is a full-fledged market society, the need emerges for more precise calculations regarding the past and is met by the very factor that permits widespread exchanges to occur: money, the economy's medium of exchange. Monetary calculation provides an indispensable means by which a modern economy can translate the myriad of physically different resources and output into a common denominator. It is this monetary common denominator that provides the basis for an input-output calculus, a capital-income calculus that is crucial to the allocation of scarce resources. This calculus is necessary because the scarcity of means requires the careful comparison of costs and benefits, of inflows and outflows in the production process.
It is generally agreed that in a modern economy calculations in kind are not the proper basis for resource allocation. A brief look at how certain leading advocates of socialism came to recognize the inadequacy of calculations in kind reveals that even the most enthusiastic opponents of the market economy now recognize the need for a common denominator for the purpose of rational resource allocation.
In 1920 Ludwig von Mises challenged the theory of socialism when he contended that socialism is unworkable in an advanced economy because of the inadequacies of calculations in kind. [1] He accused the socialist theorists of having ignored the critical task of resource allocation in a modern economy. They had assumed away this problem in their ecstatic belief that socialism is inevitable and thus naturally feasible. Not one eminent spokesman for the cause of socialism had bothered to explain just how rational decisions would be reached concerning the employment of scarce resources. Now they were forced to face the issue; faith in inexorable laws of history has no place in the realm of scientific discussion and inquiry. The socialist thinkers were challenged to resolve theoretically the problem of calculation.
Leading socialist theorists subsequently agreed that their theory was in need of elaboration on this point. They then began to explain how they believed that the process of allocation could be directed by central planners in the absence of competitively established market prices. What this explanation amounted to was the recognition that the planning authorities would require some method of calculating in common terms the effects of alternative economic actions. [2] They agreed that Mises was right in pointing out that they had failed to confront this matter in all of their previous works. They had been convinced that calculations in kind are insufficient in the management of a modern economy. Their replies largely culminated in the contention that the central planning authorities could establish prices through trial and error, guided by the existence of surpluses and shortages for each particular good. And these prices, stated in terms of the economy's medium of exchange, would serve as beacons in the task of resource allocation. Shortages called for upward adjustments in the prices of those items; surpluses signaled for price reductions. These price adjustments would lead to proper production adjustments--price increases would induce supply increases while price decreases would effect supply decreases--so that eventually equilibrating prices would be set, thereby removing various shortages and surpluses in both intermediate and finished goods. Resources would be employed rationally through the monetary guides issued by the central pricing and planning authorities. The socialist position now is that a socialist economy is not doomed to calculations in kind, and that, thanks to Mises, they had been spurred to demonstrate this point. [3]

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