The Seed Theory Problem with Central Planning

Many Austrians have cited a core problem with using the perfectly competitive market model—market self-correction is based on the market being out of equilibrium. How can we be sure that the economy will ever reach the perfectly competitive state if the ability to be out of equilibrium is denied to the market actors? It is for this reason that cost-savings and innovation produced by market competition may be lost in planned systems which try to mimic large-scale, low-cost enterprises seen in markets, without actually allowing market competition (as Hayek first described when debating Oskar Lange and Austrians well know; for my contribution, see Nell 2010b).

Although his model is based on this static Walrasian model, Lange (1938) did suggest trial and error. Assuming that his model was to be interpreted in a dynamic fashion, we can still see why it would be impossible for the central planner to adjust prices to allow for market-like correction: a single bad price, or “seed,” would destroy his “trial and error” process, which is based upon seeing shortages and surpluses at the end of some plan period and then adjusting prices on their basis. Any plan period that allows the accumulation of surpluses or the creation of a shortage will be long enough to allow the seed to grow and destroy the logic of the system, as will be shown.

As Kirzner describes, within the market system the circumstance of being “out of equilibrium” creates forces which direct resources toward correction of individual errors. This is true despite imperfect information. The ability for firms and entrepreneurs to respond to localized knowledge with price adjustments at the time of discovery is what makes this possible. This is not possible under Lange’s market socialism or under any form of central planning. This is because the market is not free to self-correct, so rigidities reflect and multiply any errors. Axel Leijonhufvud’s description of the corridor is useful: while a free market can self-correct and “home in on the ideal path,” a market with severe rigidities will respond as if outside of this corridor, the system’s homeostatic mechanisms unable to function, and in fact “multiplier tendencies” will kick in, enhancing the effects of each distortion, as one bad price infects those around it (Leijonhufvud 1973).²

The reason that correction is not possible under Lange’s market socialism (or any planned system)—and that in fact the attempt to correct distorts the system further—is clear when considering a particular example. Imagine that shortages and surpluses are to be used to determine if prices are too low or too high (as Lange suggests), and in fact the price that planners have for a certain input such as plastic is wrong, it is too high. Lange assumes that this will show at the end of the period in the form of a surplus of the good, unused because the price is high. In reality, the producer firms may use a large number of inputs required for any given product using plastic, and (especially if prices start out as “totally random” as Lange suggests) the other inputs may also be mispriced. If firms have a budget and a plan, rather than demanding less of that one particular input, producer firms will demand less of a bundle of inputs, some of which may be priced too high, others too low. If planners use shortage and surplus to determine which price is too high, even if they realize that the final product is in shortage (not enough produced) and even if they recognize that this is because input prices may be too high (rather than that they underestimated demand), they would not know which input is causing this outcome. This affects real production, not just prices, and once this production has been altered, final prices and quantities of many more goods will be affected—fewer plastics mean reduced demand for machinery and hence steel, etc.

This is all true in a market economy too—however, in a market economy adjustments will be made to input prices as firms’ profit-drive helps to immediately correct the error, just as Kirzner describes and even Lange recognized. As Lange (1938) writes, “the competition of the buyers and sellers will alter the prices.” This is precisely Kirzner’s argument as well—he assumes that entrepreneurs will adjust prices almost immediately. Indeed, in a free market, actors are able to respond continuously. If a firm has a high price and yet can continue to make a profit (because elasticity is low), an entrepreneur will tend to enter the market, just as Kirzner argues. Even if entry takes time, the price signal is recognized immediately and some action is taken; information is not lost. Either the existing firms or new firms will begin to take action, based on local information (in this case visible profit) which will ultimately adjust prices to reflect information about the most efficient use of resources.

This is not true in a market socialist system like Lange’s (and like many other proposals from more recent neoclassical market socialists and Marxists who would like to control prices), where the planner—from his central perch—is unable to see all of the individual reactions that occur throughout the market. All he or she sees is the static state at the end of the period, whatever length that might be. The planner sees only n goods in shortage and n goods in surplus. How can she sort through it all and find the culprit? The chaos at the end of the period cannot be traced to the offending price—the seed of the calculation problem.

But this isn’t the end; in the next period when the planners make bad adjustments, the inaccurate prices carry over and infect additional prices and production, never knowing if it was due to transportation problems (e.g., from too high a price for some intermediate good) or due to lack of a complement product, or a cheap substitute. This is how the seed grows, over time, into a tangled and gnarled tree. In every period, in real-world planned economies (see Nell 2010a, 2014) as well as for Lange’s proposed central planning bureau, planners have less information about demand, supply, and costs, as shortages and surpluses are indicative of more and more intertwined factors.