… Everyone knows about economies of scale; after all, that’s why we have firms in the first place. What Rothbard’s analysis shows is that there are also diseconomies of scale, and that these grow more severe as vertical integration increases.

What happens when a firm grows so large, its internal operations so insulated from the price system, that the diseconomies of scale begin to outweigh the economies? Well, that depends on the institutional context. In a free market, if the firm doesn’t catch wise and start scaling back, it will grow increasingly inefficient and so will lose customers to competitors; markets thus serve as an automatic check on the size of the firm.

But what if friendly politicians rig the game so that favoured companies can reap the benefits associated with economies of scale while socialising the costs associated with diseconomies of scale? Then we might just possibly end up with an economy dominated by those bloated, bureaucratic, hierarchical corporate behemoths we all know and love. …

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Try as he might, Mises could not exempt the capitalist corporation from the problem of bureaucracy. One cannot define bureaucracy out of existence, or overcome the problem of distributed knowledge, simply by using the word “entrepreneur.” Mises tried to make the bureaucratic or non-bureaucratic character of an organization a simple matter of its organizational goals rather than its functioning. The motivation of the corporate employee, from the CEO down to the production worker, by definition, will be profit-seeking; his will is in harmony with that of the stockholder because he belongs to the stockholder’s organization.

By defining organizational goals as “profit-seeking,” Mises—like the neoclassicals—treated the internal workings of the organization as a black box. In treating the internal policies of the capitalist corporation as inherently profit-driven, Mises simultaneously treated the entrepreneur as an indivisible actor whose will and perception permeate the entire organization. Mises’s entrepreneur was a brooding omnipresence, guiding the actions of every employee from CEO to janitor.

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“Today it is almost heresy to suggest that scientific knowledge is not the sum of all knowledge. But a little reflection will show that there is beyond question a body of very important but unorganized knowledge which cannot possibly be called scientific in the sense of knowledge of general rules: the knowledge of the particular circumstances of time and place. It is with respect to this that practically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active cooperation.”

Hayek then discusses examples of this knowledge as it applies in an economic context. Producers, consumers, and other individuals cooperating in a market all possess unique knowledge that only they can use, knowledge that is utterly inaccessible to any bureaucratic central planner.

But Hayek’s point about distributed knowledge applies to more than just economic issues. It also applies to social issues. Take issues of gender. Women experience misogyny in their day to day lives. Many individual women know things about sexual harassment, casual sexism, and a wide range of other gender issues that I will never know, because I am not a woman, and I do not experience them. Recognizing that this distributed knowledge exists has consequences. It means that I should not dismiss women’s experiences of sexism or presume I know more about sexism than they. It means that within the realm of feminist activism, I should not always have as important  a decision making role as the women who actually experience the oppression caused by patriarchy. In other words, acknowledging distributed knowledge leads me to “check my privilege.”

Or, we could look at another example: disability. The disability rights movement has for years organized under the slogan “Nothing About Us Without Us” and opposed many groups that try to make decisions related to disability without ever consulting anyone who has a disability. For example, Autism Speaks, one of the largest autism related non-profits, has never had an autistic person on its board. In spite of their name, they do not speak for autistic people, but rather over us. They have put out fear-mongering propaganda about autism that many autistic people, me included, find highly offensive.  They promote programs and “cures” that autistic people find utterly unhelpful and counterproductive. They should examine how autistic people may possess knowledge of autism that they lack. In other words, they should acknowledge distributed knowledge and check their privilege.

That said, because Autism Speaks is not a governmental organization and does not have a monopoly, autistic people can, and do, start our own organizations. So the Autistic Self Advocacy Network can provide services that autistic people actually need, and  allow those with autism to speak for ourselves. If the Autistic Self Advocacy Network ever fails to serve the needs of some autistic people, these people are free to start their own groups. This is one example of how voluntary association allows distributed knowledge to be used effectively even if bigots refuse to practice epistemic humility. Autism Speaks should still check their ignorance and privilege, but their ignorance poses less of a threat as long as they are not a government or a monopoly.

Just as with economics, these social problems of epistemological hubris become bigger when government gets involved. By definition, politicians do not have the knowledge of everyone their policies will impact. But often, when marginalized groups are impacted, politicians become extra prone to ignore those from an affected population. For example, Congress has held hearings on whether to undermine the privacy rights of “mentally ill” Americans but not allowed anyone with psychiatric disabilities to testify, not deeming them sufficiently “competent.” Another example is that those incarcerated in our prison system are barred from voting in elections.  The government exacerbates its natural tendency towards lacking sufficient knowledge by disenfranchising members of marginalized groups it seeks to control. Politicians need to consider, as Hayek said, “how little they really know about what they imagine they can design.” They need to consider the experiences and knowledge of those their policies might hurt. They need to check their privilege.

Ultimately, the call for people to check their privilege is not an attempt to silence. Rather, it is an attempt to get people to recognize the limits of their knowledge. Libertarians should have the humility to check our privilege, to listen to oppressed people who discuss their experiences, and to respect oppressed peoples’ rights to direct their own struggles for liberation.

You can help support C4SS by purchasing a zine copy of Nathan Goodman’s “The Knowledge Problem of Privilege“.

Ken MacLeod‘s introduction to the North American edition of his 1995 novel The Star Fraction appears in the omnibus volume Fractions: The First Half of The Fall Revolution by Ken MacLeod (New York: Orb, 2008), and is reprinted by permission of the author and of the publisher, Tom Doherty Associates.

*     *     *

“History is the trade secret of science fiction, and theories of history are its invisible engine. One such theory is that society evolves because people’s relationship with nature tends to change more radically and rapidly than their relationships with each other. Technology outpaces law and custom. From this mismatch, upheavals ensue. Society either moves up to a new stage with more scope for the new technology, or the technology is crushed to fit the confines of the old society. As the technology falls back, so does the society, perhaps to an earlier configuration. In the main stream of history, however, it has moved forward through a succession of stages, each of which is a stable configuration between the technology people have to work with, and their characteristic ways of working together. But this stability contains the seeds of new instabilities. Proponents of this theory argue that the succession of booms and slumps, wars, revolutions and counter-revolutions, which began in August 1914 and which shows no prospect of an end, indicates that we live in just such an age of upheaval.”

This calculation argument can be applied not only to a state-planned economy, but also to the internal planning of the large corporation under interventionism, or state capitalism. (By state capitalism, I refer to the means by which, as Murray Rothbard said, “our corporate state uses the coercive taxing power either to accumulate corporate capital or to lower corporate costs,” in addition to cartelizing markets through regulations, enforcing artificial property rights like “intellectual property,” and otherwise protecting privilege against competition.)

Rothbard developed the economic calculation argument in just this way. He argued that the further removed the internal transfer pricing of a corporation became from real market prices, the more internal allocation of resources was characterized by calculational chaos.

Mises’s calculation argument can be applied to the large corporation—both under state capitalism and to some extent in the free market—in another way not considered by Rothbard. The basic cause of calculational chaos, as Mises understood it, was the separation of entrepreneurial from technical knowledge and the attempt to make production decisions based on technical considerations alone, without regard to such entrepreneurial considerations as factor pricing. But the principle also works the other way: production decisions based solely on input and product prices, without regard to the details of production (the typical MBA practice of considering only finance and marketing, while treating the production process as a black box), also result in calculational chaos.

The chief focus of this article, however, is Mises’s calculation argument in the light of distributed information. F. A. Hayek, in “The Uses of Knowledge in Society,” raised a new problem: not the generation or source of data, but the sheer volume of data to be processed. In so doing, he is commonly understood to have opened a second front in Mises’s war against state planning. But in fact his argument was almost as damaging to Mises as to the collectivists.

Mises minimized the importance of distributed information in his own criticisms of state planning. He denied any correlation between bureaucratization and large size in themselves. Bureaucracy as such was a particular rules-based approach to policy-making, in contrast to the profit-driven behavior of the entrepreneur. The private firm, therefore, was by definition exempt from the problem of bureaucracy.

In so arguing, he ignored the information and coordination problems inherent in large size. The large corporation necessarily distributes the knowledge relevant to informed entrepreneurial decisions among many departments and sub-departments until the cost of aggregating that knowledge outweighs the benefits of doing so.

Try as he might, Mises could not exempt the capitalist corporation from the problem of bureaucracy. One cannot define bureaucracy out of existence, or overcome the problem of distributed knowledge, simply by using the word “entrepreneur.” Mises tried to make the bureaucratic or non-bureaucratic character of an organization a simple matter of its organizational goals rather than its functioning. The motivation of the corporate employee, from the CEO down to the production worker, by definition, will be profit-seeking; his will is in harmony with that of the stockholder because he belongs to the stockholder’s organization.

By defining organizational goals as “profit-seeking,” Mises—like the neoclassicals—treated the internal workings of the organization as a black box. In treating the internal policies of the capitalist corporation as inherently profit-driven, Mises simultaneously treated the entrepreneur as an indivisible actor whose will and perception permeate the entire organization. Mises’s entrepreneur was a brooding omnipresence, guiding the actions of every employee from CEO to janitor.

He viewed the separation of ownership from control, and the knowledge and agency problems resulting from it, as largely nonexistent. The invention of double-entry bookkeeping, which made possible the separate calculation of profit and loss in each division of an enterprise, has “reliev[ed] the entrepreneur of involvement in too much detail,” Mises writes in Human Action. The only thing necessary to transform every single employee of a corporation, from CEO on down, into a perfect instrument of his will was the ability to monitor the balance sheet of any division or office and fire the functionary responsible for red ink. Mises continues:

It is the system of double-entry bookkeeping that makes the functioning of the managerial system possible. Thanks to it, the entrepreneur is in a position to separate the calculation of each part of his total enterprise in such a way that he can determine the role it plays within his whole enterprise. . . . Within this system of business calculation each section of a firm represents an integral entity, a hypothetical independent business, as it were. It is assumed that this section “owns” a definite part of the whole capital employed in the enterprise, that it buys from other sections and sells to them, that it has its own expenses and its own revenues, that its dealings result either in a profit or in a loss which is imputed to its own conduct of affairs as distinguished from the result of the other sections. Thus the entrepreneur can assign to each section’s management a great deal of independence. The only directive he gives to a man whom he entrusts with the management of a circumscribed job is to make as much profit as possible. An examination of the accounts shows how successful or unsuccessful the managers were in executing this directive. Every manager and submanager is responsible for the working of his section or subsection. . . . His own interests impel him toward the utmost care and exertion in the conduct of his section’s affairs. If he incurs losses, he will be replaced by a man whom the entrepreneur expects to be more successful, or the whole section will be discontinued.

Capital Markets as Control Mechanism

Mises also identified outside capital markets as a control mechanism limiting managerial discretion. Of the popular conception of stockholders as passive rentiers in the face of managerial control, he wrote:

This doctrine disregards entirely the role that the capital and money market, the stock and bond exchange, which a pertinent idiom simply calls the “market,” plays in the direction of corporate business. . . . In fact, the changes in the prices of . . . stock and of corporate bonds are the means applied by the capitalists for the supreme control of the flow of capital. The price structure as determined by the speculations on the capital and money markets and on the big commodity exchanges not only decides how much capital is available for the conduct of each corporation’s business; it creates a state of affairs to which the managers must adjust their operations in detail.

One can hardly imagine the most hubristic of state socialist central planners taking a more optimistic view of the utopian potential of numbers-crunching.

Peter Klein argued that this foreshadowed Henry Manne’s treatment of the mechanism by which entrepreneurs maintain control of corporate management. So long as there is a market for control of corporations, the discretion of management will be limited by the threat of hostile takeover. Although management possesses a fair degree of administrative autonomy, any significant deviation from profit-maximization will lower stock prices and bring the corporation into danger of outside takeover.

The question, though, is whether those making investment decisions—whether senior management allocating capital among divisions of a corporation or outside finance capitalists—even possess the information needed to assess the internal workings of firms and make appropriate decisions.

How far the real-world, state capitalist allocation of finance differs from Mises’s picture is suggested by Robert Jackall’s account in Moral Mazes of the internal workings of a corporation (especially the notorious practices of “starving,” or “milking,” an organization in order to inflate its apparent short-term profit). Whether an apparent profit is sustainable, or an illusory side effect of eating the seed corn, is often a judgment best made by those directly involved in production. The purely money calculations of those at the top do not suffice for a valid assessment of such questions.

One big problem with Mises’s model of entrepreneurial central planning by double-entry bookkeeping is this: it is often the irrational constraints imposed from above that result in red ink at lower levels. But those at the top of the hierarchy refuse to acknowledge the double bind they put their subordinates in. “Plausible deniability,” the downward flow of responsibility and upward flow of credit, and the practice of shooting the messenger for bad news, are what lubricate the wheels of any large organization.

As for outside investors, participants in the capital markets are even further removed than management from the data needed to evaluate the efficiency of factor use within the “black box.” In practice, hostile takeovers tend to gravitate toward firms with low debt loads and apparently low short-term profit margins. The corporate raiders are more likely to smell blood when there is the possibility of loading up an acquisition with new debt and stripping it of assets for short-term returns. The best way to avoid a hostile takeover, on the other hand, is to load an organization with debt and inflate the short-term returns by milking.

Another problem, from the perspective of those at the top, is determining the significance of red or black ink. How does the large-scale investor distinguish losses caused by senior management’s gaming of the system in its own interest at the expense of the productivity of the organization from losses occurring as normal effects of the business cycle? Mises of all people, who rejected the neoclassicals’ econometric approach precisely because the variables were too complex to control for, should have anticipated such difficulties.

Management’s “gaming” might well be a purely defensive response to structural incentives, a way of deflecting pressure from those above whose only concern is to maximize apparent profits without regard to how short-term savings might result in long-term loss. The practices of “starving” and “milking” organizations that Jackall made so much of—deferring needed maintenance costs, letting plant and equipment run down, and the like, in order to inflate the quarterly balance sheet—resulted from just such pressure, as irrational as the pressures Soviet enterprise managers faced from Gosplan.

Shared Culture

The problem is complicated when the same organizational culture—determined by the needs of the managerial system itself—is shared by all the corporations in a state-induced oligopoly industry, so that the same pattern of red ink appears industry-wide. It’s complicated still further when the general atmosphere of state capitalism enables the corporations in a cartelized industry to operate in the black despite excessive size and dysfunctional internal culture. It becomes impossible to make a valid assessment of why the corporation is profitable at all: does the black ink result from efficiency or from some degree of protection against the competitive penalty for inefficiency? If the decisions of MBA types to engage in asset-stripping and milking, in the interest of short-term profitability, result in long-term harm to the health of the enterprise, they are more apt to be reinforced than censured by investors and higher-ups. After all, they acted according to the conventional wisdom in the Big MBA Handbook, so it couldn’t have been that that caused them to go in the tank. Must’ve been sunspots or something.

In fact, the financial community sometimes censures transgressions against the norms of corporate culture even when they are quite successful by conventional measures. Costco’s stock fell in value, despite the company’s having outperformed Wal-Mart in profit, in response to adverse publicity in the business community about its above-average wages. Deutsche Bank analyst Bill Dreher snidely remarked, “At Costco, it’s better to be an employee or a customer than a shareholder.” Nevertheless, in the world of faith-based investment, Wal-Mart “remains the darling of the Street, which, like Wal-Mart and many other companies, believes that shareholders are best served if employers do all they can to hold down costs, including the cost of labor” (Business Week Online, April 12, 2004).

On the other hand, management may be handsomely rewarded for running a corporation into the ground, so long as it is perceived to be doing everything right according to the norms of corporate culture. In a New York Times story that Digg aptly titled “Home Depot CEO Gets $210M Severance for Sucking at Job,” it was reported that departing Home Depot CEO Robert Nardelli received an enormous severance package despite abysmal performance. It’s a good thing he didn’t raise employee wages too high, though, or he’d be eating in a soup kitchen.

As you might expect, the usual suspects stepped in to defend Nardelli’s honor. An Allan Murray article at the Wall Street Journal noted that he had “more than doubled . . . earnings.”

But Tom Blumer of BizzyBlog, whose sources for obvious reasons prefer to remain anonymous, pointed out some inconvenient facts about how Nardelli achieved those increased earnings:

• His consolidation of purchasing and many other functions to Atlanta from several regions caused buyers to lose touch with their vendors . . . .
• Firing knowledgeable and experienced people in favor of uninformed newbies and part-timers greatly reduced payroll and benefits costs, but has eventually driven customers away, and given the company a richly-deserved reputation for mediocre service . . . .
• Nardelli and his minions played every accounting, acquisition, and quick-fix angle they could to keep the numbers looking good, while letting the business deteriorate.

In a follow-up comment directed to me personally, Blumer provided this additional bit of information:

I have since learned that Nardelli, in the last months before he walked, took the entire purchasing function out of Atlanta and moved it to . . . India —Of all the things to pick for foreign outsourcing.

I am told that “out of touch” doesn’t even begin to describe how bad it is now between HD stores and Purchasing, and between HD Purchasing and suppliers.

Not only is there a language dialect barrier, but the purchasing people in India don’t know the “language” of American hardware—or even what half the stuff the stores and suppliers are describing even is.

I am told that an incredible amount of time, money, and energy is being wasted—all in the name of what was in all likelihood a bonus-driven goal for cutting headcount and making G&A [general and administrative] expenses look low (“look” low because the expenses have been pushed down to the stores and suppliers).

More than one observer has remarked on the similarity, in their distorting effects, of the incentives within the Soviet state-planning system and the Western corporate economy. We already noted the systemic pressure to create the illusion of short-term profit by undermining long-term productivity.

Consider Hayek’s prediction of the uneven development, irrationality, and misallocation of resources within a planned economy (“Socialist Calculation II: The State of the Debate”):

There is no reason to expect that production would stop, or that the authorities would find difficulty in using all the available resources somehow, or even that output would be permanently lower than it had been before planning started . . . . [We should expect] the excessive development of some lines of production at the expense of others and the use of methods which are inappropriate under the circumstances. We should expect to find overdevelopment of some industries at a cost which was not justified by the importance of their increased output and see unchecked the ambition of the engineer to apply the latest development elsewhere, without considering whether they were economically suited in the situation. In many cases the use of the latest methods of production, which could not have been applied without central planning, would then be a symptom of a misuse of resources rather than a proof of success.

As an example he cited “the excellence, from a technological point of view, of some parts of the Russian industrial equipment, which often strikes the casual observer and which is commonly regarded as evidence of success.”

To anyone observing the uneven development of the corporate economy under state capitalism, this should inspire a sense of déjà vu. Entire categories of goods and production methods have been developed at enormous expense, either within military industry or by state-subsidized R&D in the civilian economy, without regard to cost. Subsidies to capital accumulation, R&D, and technical education radically distort the forms taken by production. (On these points see David Noble’s works, Forces of Production and America by Design.) Blockbuster factories and economic centralization become artificially profitable, thanks to the Interstate Highway system and other means of externalizing distribution costs.

Pervasive Irrationality

It also describes quite well the environment of pervasive irrationality within the large corporation: management featherbedding and self-dealing; “cost-cutting” measures that decimate productive resources while leaving management’s petty empires intact; and the tendency to extend bureaucratic domain while cutting maintenance and support for existing obligations. Management’s allocation of resources no doubt creates use value of a sort—but with no reliable way to assess opportunity cost or determine whether the benefit was worth it.

A good example is a hospital, part of a corporate chain, that I’ve had occasion to observe first-hand. Management justifies repeated downsizings of nurses and technicians as “cost-cutting” measures despite increased costs from errors, falls, and MRSA (Methicillin-resistant Staphylococcus aureus) infections that exceed the alleged savings. Of course the “cost-cutting” justification for downsizing direct caregivers doesn’t extend to the patronage network of staff RNs attached to the Nursing Office. Meanwhile, management pours money into ill-considered capital projects (like remodeling jobs that actually make wards less functional, or the extremely expensive new ACE unit that never opened because it was so badly designed); an expensive surgical robot, purchased mainly for prestige value, does nothing that couldn’t be accomplished by scrubbing in an extra nurse. But the management team is hardly likely to face any negative consequences, when the region’s three other large hospitals are run exactly the same way.

Such pathologies, obviously, are not the result of the free market. That is not to say, of course, that bigness as such would not produce inefficiency costs in some firms that might exist under laissez faire. The calculation problem (in the broad sense that includes Hayekian information problems) may or may not exist to some extent in the private corporation in a free market. But the boundary between market and hierarchy would be set by the point at which the benefits of size cease to outweigh the costs of such calculation problems. The inefficiencies of large size and hierarchy may be a matter of degree, but, as Ronald Coase said, the market would determine whether the inefficiencies are worth it.

The problem is that the state, by artificially reducing the costs of large size and restraining the competitive ill effects of calculation problems, promotes larger size than would be the case in a free market—and with it calculation problems to a pathological extent. The state promotes inefficiencies of large size and hierarchy past the point at which they cease to be worth it, from a standpoint of net social efficiency, because those receiving the benefits of large size are not the same parties who pay the costs of inefficiency.

The solution is to eliminate the state policies that have created the situation, and allow the market to punish inefficiency. To get there, though, some libertarians need to reexamine their unquestioned sympathies for big business as an “oppressed minority” and remember that they’re supposed to be defending free markets —not the winners under the current statist economy.

You can help support C4SS by purchasing a zine copy of Kevin Carson’s “The Inefficiency of Capitalism”.

In this scenario, a brief Third World War – or War of European Integration, as its instigators call it – in the 2020s is followed by a US/UN hegemony over a balkanized world. The Fall Revolution in the late 2040s is an attempt to throw off this new world order and to re-unify fragmented nations. But, as one of the characters says, ‘What we thought was the revolution was only a moment in the fall.’ His remark has a theory of history behind it.

History is the trade secret of science fiction, and theories of history are its invisible engine. One such theory is that society evolves because people’s relationship with nature tends to change more radically and rapidly than their relationships with each other. Technology outpaces law and custom. From this mismatch, upheavals ensue. Society either moves up to a new stage with more scope for the new technology, or the technology is crushed to fit the confines of the old society. As the technology falls back, so does the society, perhaps to an earlier configuration. In the main stream of history, however, it has moved forward through a succession of stages, each of which is a stable configuration between the technology people have to work with, and their characteristic ways of working together. But this stability contains the seeds of new instabilities. Proponents of this theory argue that the succession of booms and slumps, wars, revolutions and counter-revolutions, which began in August 1914 and which shows no prospect of an end, indicates that we live in just such an age of upheaval.

This theory is, of course, the Materialist Conception of History, formulated by the pioneering American anthropologist Lewis Henry Morgan and (a little earlier) by the German philosopher Karl Heinrich Marx. These men looked with optimism to a future society, and with stern criticism on the present. Property, wrote one of them, ‘has become, on the part of the people, an unmanageable power. The human mind stands bewildered in the presence of its own creation. The time will come, nevertheless, when human intelligence will rise to the mastery over property … Democracy in government, brotherhood in society, equality in rights and privileges, and universal education, foreshadow the next higher plane of society …’

Beam me up. But before stepping on the transporter to Morgan’s ‘higher plane’, it might be wise to check the specifications. One constraint on the possible arrangements of a future society was indicated by the Austrian economist Ludwig von Mises. He argued that private property was essential to industrial civilization: without property, no exchange; no exchange, no prices; no prices, no way of telling whether any given project is worthwhile or a dead loss. Given that every attempt to abolish the market on a large scale has led to the collapse of industry, his Economic Calculation Argument seems vindicated. Unfortunately, there’s no reason why the Economic Calculation Argument and the Materialist Conception of History couldn’t both be true. What if capitalism is unstable, and socialism is impossible?

The Star Fraction is haunted by this uncomfortable question. For me, it was acutely felt when I was writing the book, in the late 1980s and early 1990s. As a socialist I had become interested in the libertarian critique of socialism. The fall of the bureaucratic regimes of the East found me neither surprised nor sorry.

No, what was – and remains – dreadful to contemplate was not the collapse of ‘actually existing socialism’ but the catastrophic consequences of the attempt to introduce actually existing capitalism, and the apparent inability of the millions who had brought down the bureaucratic dictatorships to assert and defend their own interests in the aftermath.

In this novel, these issues are seen through the eyes of characters who are flawed and often mistaken, but sometimes heroic. The ideologies through which they try to make sense of it all range from British-style ‘industrial-grade Trotskyism’ to American-style ‘black helicopter’ libertarianism. The big questions about history and economics fuel the adventures of angry white guys (and angry black women) with guns, whose actions tip scales bigger than they know. Their world is one where the New World Order is coming to get you, with black helicopters and Men in Black and orbital gun-control lasers.

And then there’s all the stuff I made up, which begins on the next page.

“The Star Fraction – Introduction to the American Edition” on C4SS Media.

Or, How An Argument Against the Workability of Authoritarian Socialism
Became An Argument Against the Workability of Authoritarian Capitalism

By Roderick T. Long (Originally posted 2 October 2008 for the Art of the Possible blog)

In 1920, Ludwig von Mises published an argument against the workability of “socialism” (by which he meant state ownership of the means of production), an argument subsequently elaborated by himself and his student Friedrich Hayek.

The idea in a nutshell: the value of a producers’ good depends on the value of the consumers’ goods to which it contributes. Hence in deciding among alternative production methods, the most efficient choice is the one that economises on those producers’ goods that are needed for the most highly valued consumer’s goods.

But there’s a difference between technical efficiency and economic efficiency. (The following way of explaining the difference is indebted to David Ramsay Steele’s From Marx to Mises.)

Suppose we’re comparing two ways of making widgets; method A uses three grams of rubber per widget produced while method B uses four grams of rubber per widget produced (with everything else being the same). In that case method A is clearly more efficient than method B; that’s a case of technical efficiency, because we can figure out which is more efficient just by looking at quantities expended without concerning ourselves with any economic concepts like demand.

But now compare method C, which uses three grams of rubber and four grams of steel per widget, with method D, which uses four grams of rubber and three of steel (with all else remaining the same). In this case neither C nor D is more technically efficient than the other. To figure out which is more economically efficient, we have to figure out the comparative value of rubber vs. steel – i.e., which forgoes a more highly demanded alternative use, a gram of steel or a gram of rubber? As per Mises and Hayek, that’s something there’s no clear way to figure out except through market competition and a price system, whereby consumer valuations of first-order goods get translated, by means of prices, into varying demand for their factors of production (as reflected in, say, a higher price for steel than for rubber, thus prompting producers to economise on steel). State ownership of the means of production means no market in, and thus no prices for, producers’ goods, and so no way to transmit this information.

But why couldn’t a state-socialist central planner have access to this information? Well, first, most of the relevant information about preferences is local, inarticulate, and constantly changing; it can be expressed through the actual consumer choices that embody it, but there’s no easy way to collect it otherwise. (This is the aspect of the problem stressed by Hayek – who also included other kinds of local, inarticulate, and constantly changing information – besides that concerning preferences – in his focus.) Second, even if you could get this information, it would all be in the form of ordinal rankings, and without translation into cardinal prices there’s no way to combine the ordinal rankings of different people. (This is the aspect of the problem stressed by Mises.) Finally, even if you could get the information into cardinal form, in order to use it to plan the economy you’d have to solve millions of simultaneous equations at rapid speed. (Critics of Mises and Hayek often write as though this third problem is supposed to be the main problem – and thus have supposed, for example, that fast enough computers could substitute for the price system – but from the Mises-Hayek perspective it’s a relatively minor afterthought.)

If central planning is as hopeless an endeavour as the calculation argument claims, then why haven’t state-socialist regimes like the Soviet Union been even less successful than their actual record (which, while lousy, was not as completely chaotic as one might expect the Mises-Hayek argument to imply)? The reply is that the Soviet state, like similar regimes, was never completely insulated from the price system, since it had access to international prices (to say nothing of its own internal black market). Hence the information transmission mechanism, while seriously hampered, was able to function to some extent. (Most forms of governmental intervention merely distort the price system rather than suppressing it entirely. Of course the effects of these distortions can be serious enough – as when, per the Austrian theory of the business cycle, state manipulation of the money supply artificially lowers interest rates, sending investors the signal that consumers are more willing to defer consumption than they actually are, thereby directing resources into longer-term projects (boom!) that prove unsustainable (bust!), as in 1929 – or 2008. But the application of Austrian price theory to the current financial crisis is a story for my next post.)

The Mises-Hayek account of the limits of state centralisation was subsequently extended, by Mises’s student Murray Rothbard, to cover the limits of private cartelisation as well. In his 1962 work Man, Economy, and State (see especially here and here):

In order to calculate the profits and losses of each branch, a firm must be able to refer its internal operations to external markets for each of the various factors and intermediate products. When any of these external markets disappears, because all are absorbed within the province of a single firm, calculability disappears, and there is no way for the firm rationally to allocate factors to that specific area. The more these limits are encroached upon, the greater and greater will be the sphere of irrationality, and the more difficult it will be to avoid losses. …

[I]f there were no market for a product, and all of its exchanges were internal, there would be no way for a firm or for anyone else to determine a price for the good. A firm can estimate an implicit price when an external market exists; but when a market is absent, the good can have no price, whether implicit or explicit. Any figure could be only an arbitrary symbol. Not being able to calculate a price, the firm could not rationally allocate factors and resources from one stage to another. … For every capital good, there must be a definite market in which firms buy and sell that good. It is obvious that this economic law sets a definite maximum to the relative size of any particular firm on the free market. Because of this law, firms cannot merge or cartelize for complete vertical integration of stages or products. Because of this law, there can never be One Big Cartel over the whole economy or mergers until One Big Firm owns all the productive assets in the economy. The force of this law multiplies as the area of the economy increases and as islands of noncalculable chaos swell to the proportions of masses and continents. As the area of incalculability increases, the degrees of irrationality, misallocation, loss, impoverishment, etc., become greater. Under one owner or one cartel for the whole productive system, there would be no possible areas of calculation at all, and therefore complete economic chaos would prevail.

Everyone knows about economies of scale; after all, that’s why we have firms in the first place. What Rothbard’s analysis shows is that there are also diseconomies of scale, and that these grow more severe as vertical integration increases.

What happens when a firm grows so large, its internal operations so insulated from the price system, that the diseconomies of scale begin to outweigh the economies? Well, that depends on the institutional context. In a free market, if the firm doesn’t catch wise and start scaling back, it will grow increasingly inefficient and so will lose customers to competitors; markets thus serve as an automatic check on the size of the firm.

But what if friendly politicians rig the game so that favoured companies can reap the benefits associated with economies of scale while socialising the costs associated with diseconomies of scale? Then we might just possibly end up with an economy dominated by those bloated, bureaucratic, hierarchical corporate behemoths we all know and love. (For some of the ways that state intervention contributes to the Dilbertesque nature of today’s business world, see Kevin Carson’s article “Economic Calculation in the Corporate Commonwealth” – and for more detail, his online books Studies in Mutualist Political Economy and Organization Theory: A Libertarian Perspective.)

The good news, then, is that the unlovely features of the economy that often get blamed on the free market (or on something called “capitalism,” which means either the free market, or plutocracy, or somehow magically both) are in fact the product of government intervention. We can embrace the free market without embracing big business.

But it’s not just opponents of the free market that get markets and business interests mixed up. All too many libertarians still rush to defend giant corporations like Microsoft and Wal-Mart (two firms whose whole business model in fact depends heavily on government intervention – via, e.g., IP protectionism for Microsoft, eminent domain plus socialised transportation costs for Wal-Mart, and general suppression of competition from the less affluent for both) as though such a defense were part and parcel of a commitment to markets. As libertarians we can hardly complain when we’re accused of being apologists for corporate plutocracy, so long as we’re actually contributing to that perception ourselves by allowing ourselves to lose track of the basic facts about the price system that we of all people should remember.

So long as the confusion between free markets and plutocracy persists – so long as libertarians allow their laudable attraction to free markets to fool them into defending plutocracy, and so long as those on the left allow their laudable opposition to plutocracy to fool them into opposing free markets – neither libertarians nor the left will achieve their goals, and the state-corporate partnership will continue to dominate the political scene.

That’s why we need a left-libertarian alliance.