Monday, June 13, 2011

Ludwig Von Mises & The Economic Calculation Problem

Those who followed the news in the 1980's recall the widespread shortages and misallocation of resources in the Soviet Union and other socialist states. But, few people understand the underlying causes of these failures. This is not just an academic discussion, but one that should hold great importance for anyone who follows contemporary political and economic debates. In 1920, with tremendous foresight, Ludwing Von Mises predicted and explained the fundamental economic problems that economic planners in socialist states would face. The Economic Calculation Problem  argued that even the most adept central planners could not rationally allocate goods, services, capital and labor, because at best they only commanded a small portion of necessary information. Paradoxically, the only successful means to rationally allocate resources was a free market price system. Prices serve as vital signals, driven by supply and demand, that provide essential information that allowed for millions of producers and consumers to coordinate their activities. Not only do shifting prices provide invaluable information of consumer needs, but also vital incentives to satisfy them. The same can be said of wages, which also are singals of relative supply and demand for different skills, in different localities. Planners that sought to mandate prices and wages from above always created shortages of most goods and surpluses of others. This is not to say that entrepreneurs and whole industries do not commit calculation errors, but unlike their government counterparts, these must rapidly respond to market corrections or face dire consequences.

Adherents to the Austrian School of Economics and a growing number of economics argue that the Economic Calculation Problem is increasingly seen with the Federal Reserve's efforts at economic planning and intervention.Specifically, arbitrarily mandating the rise and fall of the interest rate, rather than allowing the forces of supply and demand to do so, have contributed to irrational booms and busts and harmful misallocations of capital (i.e. the housing bubble). And those who propose that the government becomes more activate in mandating that health care and other services are "affordable," should also take heed, because this too is an example of central planning and price control.

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