Central Planning is the Root Cause of Economic Chaos

LAW & ECONOMICS, MONEY / Sunday, March 8th, 2020

History tells us that central planning is the true harbinger of chaos.

Two potheads who love central planning.

By Brian Balfour on Fee.org

All economies are planned.

From communist Russia and corporatism in Italy under Mussolini to a Rothbardian anarcho-capitalist free market, all economic systems involve planning. This is not in dispute.

The intellectual battle gripping the planet for hundreds of years, however, is who gets to do the planning?

As Friedrich Hayek wrote in his 1948 book Individualism and the Economic Order:

“This is not a dispute about whether planning is to be done or not. It is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system, or is to be divided among many individuals.”

The key question when analyzing the efficacy of economic systems is how they deal with the issue of scarcity.

All economic goods are, by definition, scarce. By this, economists mean that resources such as raw materials, capital goods, and labor have many alternative possible uses but can only fulfill a very finite number of ends. For instance, a single steel beam can be used in a skyscraper or a bridge, but not both.

How scarce resources are arranged and for what purpose will largely determine the living standards of society. If producers utilize the resources in a manner that satisfies the most urgent needs of society, human flourishing will follow. If resources are instead squandered on less urgent needs, poverty and squalor will result.

So, the question of who gets to make these determinations is paramount to our well-being.

The free market is often ridiculed as “chaos” because the activities of market participants are not controlled or planned by any central governing body or manager. Market results do not come about as the product of some specific design.

In reality, however, free markets that allow individuals to pursue their own plans without interference from the state achieve a beautiful order based on voluntary cooperation. Leonard Read’s essay “I, Pencil” wonderfully articulates how hundreds of strangers across the globe unknowingly collaborate with each other in the stunningly complex process of producing a simple writing utensil.

What holds this order together?

The values of inputs used to create finished products are derived from the demand for the finished product for which they are used. And because scarce economic goods have alternative uses, manufacturers of various finished products are in competition with each other for these inputs.

Take the example of wood—a nonspecific good that can be used for many different purposes—and just two potential finished products: housing and books. How are manufacturers to determine which combination of these two options will best satisfy society’s demand for shelter and reading?

Only prices that emerge from the voluntary exchange of privately-owned resources can tell us where nonspecific, scarce goods are most urgently needed. Many different bidders for wood will cause price movements that convey vital information about the relative scarcity of wood and the relative value of the alternative final goods for which the wood could potentially be used.

Without prices, scarce resources like wood could be employed in such a way as to leave more urgent needs unsatisfied. For instance, the market would be flooded with books, while many would-be home buyers remain without shelter.  

As the late George Mason University economist Don Lavoie wrote in his 1985 book Central Economic Planning: What is Left?:

“In other words, if a rival outbids me for a factor of production by pushing its price so high that I can no longer afford to use this factor in my own project, he is not only frustrating my purpose, but is also informing me. He is sending a signal that this factor of production has a more urgently valued use than the one to which I was planning to use it.”

Now multiply this bidding process across thousands of potential users of scarce resources, and the process creates prices that all but ensure that productive resources are directed away from less important uses.

The price system, Lavoie continued, “permits decision-makers to take account of conditions beyond their immediate locality, indeed beyond what they can physically see.”

To make material factors of production part of a centralized plan, wrote Lavoie referring to price signals, deprives the economy “of its main source of economic knowledge.” Without a market of privately-owned and traded means of production, prices would not emerge for these scarce inputs. There would be no way to evaluate where these resources are most urgently needed.

Even without outright state ownership of the means of production, government interference in the market can still override crucial market information.

“The government, if it is powerful enough, can make itself a very influential consumer bidding against the other consumers and skewing profits toward the tastes of those who control government institutions,” Lavoie wrote.

In this way, the government may allow private ownership of the means of production but still heavily influence which inputs and factors of production receive greater imputed value.

The state—due to its taxing power—can bid away scarce resources from private businesses and otherwise distort the pricing structure of productive resources relative to what they would have been absent the government’s influence. As a result, the state exerts tremendous influence over patterns of production and how scarce productive resources are organized and arranged and for what purpose.

Moreover, the government has no profit/loss calculation. Its bidding power comes from its coercive advantage to collect taxes by force. Because government does not rely on selling products to willing consumers, there is no check on how high it will be willing to bid.

Consequently, government’s arrangement of resources cannot reflect the most urgent needs of society. In a system run by the government, inputs do not derive their value from consumer demand on the finished product in which the input will be utilized, but rather, value is derived by political calculations.

In such cases, the economy proceeds down a path chosen by the political class instead of one chosen by the voluntary choices of the individuals in society. The process of entrepreneurs taking risks to fulfill a future need that perhaps only they can envision becomes overwhelmed by the narrow, backward-looking resource allocation of a central planning board.

And even beyond the destruction of meaningful price signals, government central planners also have no possible way to efficiently allocate scarce productive resources to their most urgently desired ends in the same way as individuals carrying out their own plans in cooperation with others. This is because of the unarticulated tacit knowledge contained only in the minds of the individual actors.

Here is what Lavoie wrote:

“The entrepreneur who decides to engage in a transaction, say, to buy a particular tool, has far more going on in his mind than he ever has to, or could, articulate to anyone. He views this particular tool as an integral part of a plan that in turn fits into a general expectational scenario he has about how he intends to implement that plan through time.”

He continued, “Thus even if the national planning agency could monitor each transaction in detail, it would still lack information about how each decisionmaker perceives this transaction in the context of his own plans.”

Thus, central planning is tantamount to groping in the dark. There is no rational way to economically allocate scarce means of production via central planning. Planners can do no better than hope their arbitrary diktats result in anything short of brutal impoverishment. History tells us that central planning is the true harbinger of chaos.

Narendra Modi and Mohamed bin Tughlaq : failed central planners

For these reasons, Lavoie concluded the only viable option for a thriving economy is to enable individual economic planning rather than centralized planning:

“The choices concerning which methods of production should be used – out of virtually unlimited numbers of possible methods – could not be made intelligently enough by a comprehensive planning apparatus, and so must be left to emerge as an unplanned outcome of competition among separate owners.”

With so much power focused in the hands of the small ruling elite that results from central planning, more will look to curry favor with government officials for economic advantage rather than create value for consumers. As Lavoie wrote:

“Members of society in turn struggle both against one another and against the government either to gain control over this instrument of power for their own benefit (which modern economists call rent seeking) or to protect themselves from being victimized by that power (rent avoidance).”

Pay-to-play politics—and outright bribery—will become the norm. And even if the halls of Congress become filled with angels exempt from the temptation of corruption, the fact still remains central planners would be powerless to orchestrate a well-functioning economy.

As Lavoie pronounced:

“The problem is not that people will be insufficiently motivated to do the right things but, more fundamentally, that they will not know what the right things to do are, even if they passionately wanted to do them.”

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