Back to the Socialist Calculation Debates

This week, Paul Krugman has been arguing that in some circumstances, the mysterious path of at least some capital investment can lead to lower wages, unemployment, and general misery. Furthermore, if the economy is not in "perfect competition," then a lot of the advantages of capital development are lost.

Likewise, he is arguing, at least some capital development can lead to monopoly in which capital is receiving large rents at the expense of workers and everyone else. There are a few things to remember as one goes through these two Krugman posts that he is not pointing out, yet do have significance.

These are interesting arguments, and they bring us back to the Socialist Calculation Debates that took place in the 1930s and 40s between socialists like Oskar Lange and Ludwig von Mises and Friedrich A. Hayek.

The first is that there is no such thing as an "aggregate production function." I remember several years ago attending a Paul Craig Roberts lecture in which he was arguing that if capital could move beyond national borders, then factors would revert to "absolute advantage," and one country would produce everything and make everyone else poorer. The disappearance of comparative advantage, of course, would mean that the Law of Opportunity Cost would also disappear, since comparative advantage is built upon the idea that there always is opportunity cost in producing anything.

He "proved" his point by using aggregate production functions, i.e. "Britain has this production function" and "China has THIS production function," and so on. That is nonsense. An attempt to aggregate something like numerous productions functions within an economy into One Big Function truly has no meaning; it is a fictitious concept like "aggregate demand" or "aggregate supply." In reality, one cannot reproduce any of these things. (Yeah, I know. This last statement will send the Keynesians into a frenzy.)

The second thing is Krugman's idea of "perfect competition" being some sort of Holy Condition. Remember that the assumptions necessary for "perfect competition" include perfect homogeneity of goods produced within an industry and small-scale capital, not to mention all firms being tiny and having no effect upon the overall supply of goods within a particular market.

Even the idea of homogeneity being the necessary ingredient for "competition" is laughable on its face. This kind of perfect homogeneity is not a basis for competition at all, but rather a basis for no competition, for if every good is exactly the same, an important mechanism for choice disappears and an economy then simply becomes little more than an exercise in randomness.

More important, socialists have argued that heterogeneity of goods then leads to inefficiency and "spatial monopolies" (to quote Joan Robinson). However, the concept of "efficiency" that Robinson and others were promoting (and I suppose Krugman believes it, too) is mathematical, not economic. The entire platform upon which these ideas are built is that everything discussed follows functions that are smooth, continuous, and twice-differentiable. While I have no problem with creating mathematical functions to use in parallel models to explain some aspects of an economy, the idea that an economy MUST follow exactly the constructs of mathematical models or it is creating great harm and must be smashed by the state is ludicrous.

It is obvious, then, that the entrepreneur in this whole Brave New Economy is a parasite, someone who disturbs the Holy Production Function, and creates heterogeneity, which then takes the economy down the Path of Perdition. There is a problem here that Krugman and others cannot answer: Why were the socialist economies of the U.S.S.R. and its satellites much more primitive than the economies of the "monopolistic" capitalists when the Soviet Union collapsed in 1991?

After all, the aggregate planning mechanism of the socialist world followed what Robinson, Lange, and others claimed would create "efficiency." Lange argued that if planners had access to (1) production functions and (2) prices of goods (which could be found on financial pages in western newspapers), then planning an economy was as easy as solving a whole slew of simultaneous equations.

In fact, the Soviets were very good at solving these equations. As my math econ professor in grad school put it, the Soviets created a number of advancements in using matrices to solve these equations. However, he added, "It didn't do the economies any good."

Krugman, in trying to explain why corporate profits might be high at a time of high unemployment, simply reverts to the arguments used by Lange and Robinson and others: the U.S. economy is not in "perfect competition," monopolies abound everywhere, and the capitalists have managed to create aggregate production functions that don't benefit the workers, only the capitalists.

Salvation, in this view, lies in the omniscience of the monopolistic state. Yes, that huge monopoly known as government also contains the Very Secrets of how to create the perfectly-competitive economy that always operates at the point of efficiency. Bureaucrats and elite academic economists can collaborate to impose efficiency because they know exactly where the points of efficiency exist and they have the wisdom and foresight to move us to that point of Nirvana.

Krugman always is lambasting "faith-based" economics. I would contend that the economics of Paul Krugman requires the kind of religious faith that is not found in even the most fundamentalistic aspects of any religion. In the end, we get Faith-Based Keynesianism.

(To further demonstrate the whole idiocy of the Soviet economy, here is the link to a video on some of the automotive masterpieces produced by the Soviets back in the days when Paradise ruled.)

Krugman and Medical Care: We Need More Socialism

I've not posted since the U.S. Supreme Court upheld the insurance mandate of Obamacare, and am leaving much of the back-and-forth to other writers. Peter Schiff writes that if the government really does have the authority to levy a "tax" upon any citizen who does not purchase what the government demands they buy, then there really are no more checks on the power of government.

I tend to agree. In the last decade, we have seen exponential growth of the surveillance state, the prison state, the militarization of the police, and we now have a president who believes he has the authority to order missile strikes anywhere in the world and to kill whomever he likes -- and it all is done "under color of law." In other words, lawless behavior by state agents now is an oxymoron, since by definition, state agents cannot break the law.

This SCOTUS decision will unleash the IRS in a way that will astound people, and one can bet that the powers that government seized with the passage of the Patriot Act and other such legislation will be put to use in new and oppressive ways. Furthermore, this decision will further unleash to power of federal prosecutors to criminalize just about anything they choose.

(I deal with their brutality of the innocent in my other blog, not that Keynesians really care about the brutality of the state. They just want to see more because, in their minds, a leftist state cannot be brutal since by definition, socialism cannot oppress.)

However, according to Krugman, the decision by the Supreme Court is something I should cheer because I now am a "winner." Funny, I don't feel like a winner, probably because I actually understand what socialism does to medical care over time, something that I doubt any Keynesian ever could understand because, frankly, Keynesians don't understand (or want to understand) the simple act of production. And forget the role of entrepreneurship in medical, as Keynesians would consider even the possibility of such to be anathema.

The Keynesian-Socialist View of Production vs. Ludwig von Mises and Economic Calculation

During the Socialist Calculation Debate between Ludwig von Mises and Oskar Lange in the 1930s and 40s, Lange demonstrated what I would call a mainstream view of how production and the firm might work. Indeed, what he said was hardly different from what I was taught in my production classes.

In mainstream neo-classical analysis, one analyzes production via the production function and input prices. (Yes, I constructed many a cost function using both things.) If one has both, then one can deduce the optimal use of inputs in production. (When graphing these items, the "optimal" position -- where costs are minimized -- is found where the production function, or isoquant, is tangent to the isocost.)

Lange held that a production function was pretty easy to find, and that government central planners could find prices simply by checking the commodities exchanges in the capitalist world, and with both in hand could then "plan" an entire economy by solving a huge batch of simultaneous equations. In fact, economists in the former Soviet Union became quite good at solving these equations by using matrices, and while their economic calculations generally turned out to be disastrously applied, nonetheless the world of matrix algebra advanced.

Socialism, Lange argued, actually would be more effective than capitalism because capitalists, after all, had to waste time and money making profits. Socialist production, having solved the issue of economic calculation, would produce more goods that were superior to what might be produced in the capitalist economies, or so he declared.

That is the essential argument that people like Krugman and Paul Craig Roberts have made about medical care. Everyone knows the "medical production function," right? So, what's the problem? For example, Roberts declares:

The American health care system is the most expensive of all on earth. The reason for the extraordinary expense is the multiple of entities that must make profits. The private doctors must make profits. The private testing centers must make profits.The private specialists who receive the referrals from general practitioners must make profits. The private hospitals must make profits. The private insurance companies must make profits. The profits are a huge cost of health care.

However, he adds, "single-payer" (which essentially is socialist or fascist, since fascism left much production in private hands with the state declaring what should be produced) eliminates the problems caused by profits:

The beauty of a single-payer system is that it takes the profits out of the system. No one has to make profits. Wall Street cannot threaten insurance companies and private health care companies with being taken over because their profits are too low. No health-provider in a single-payer system has to worry about being displaced in a takeover organized by Wall Street because the profits are too low.

What Roberts does not say, but what is obvious from his words is that we should not stop at medical care. If we know the proper production function for all aspects of medical care (which seems to be an assumption here) and if government simply by fiat can declare whatever prices it sees fit with no problems of resource misallocation, then directing a "rational" system simply is a matter of doing the math.

Roberts would argue, not doubt, that many of the profits in the medical system are not due to "free markets," but rather government favoritism given to politically-connected firms. Yet, even though government involvement via a regulatory system politically creates rents, his "solution" is for government to have even more regulatory power. Yet, if government already is a toady of private enterprise, as he says, then why should one expect that by the simple act of giving government even more power in the pricing and paying of medical care, that corruption would disappear and regulators suddenly would become pure in heart and be possessing the ability to perfectly allocate medical resources?

Likewise, Krugman argues that markets are the problem, and certainly not a solution in medical care, writing:

There are two strongly distinctive aspects of health care. One is that you don’t know when or whether you’ll need care — but if you do, the care can be extremely expensive. The big bucks are in triple coronary bypass surgery, not routine visits to the doctor’s office; and very, very few people can afford to pay major medical costs out of pocket.

This tells you right away that health care can’t be sold like bread. It must be largely paid for by some kind of insurance. And this in turn means that someone other than the patient ends up making decisions about what to buy. Consumer choice is nonsense when it comes to health care. And you can’t just trust insurance companies either — they’re not in business for their health, or yours.

This problem is made worse by the fact that actually paying for your health care is a loss from an insurers’ point of view — they actually refer to it as “medical costs.” This means both that insurers try to deny as many claims as possible, and that they try to avoid covering people who are actually likely to need care. Both of these strategies use a lot of resources, which is why private insurance has much higher administrative costs than single-payer systems. And since there’s a widespread sense that our fellow citizens should get the care we need — not everyone agrees, but most do — this means that private insurance basically spends a lot of money on socially destructive activities.

 This is interesting and very telling from two different viewpoints. First, Krugman has limited the entire conversation to "markets" for systems of payments for medical care, the third-party system, yet there is an entire web of complex relations within medical care that he ignores. (He does claim that improvements (like the MRI device) are responsible for the high cost of health care, which would make medical care quite unique because capital in a market economy tends to allow more goods to be created with fewer resources, but since he others already have declared that medical care is "different," then capital in the medical field apparently is a liability, not an asset.)

Unfortunately, Krugman does not even address the efficacy of third-party payments themselves, yet the proliferation of third-party payments for anything is going to mean that an important connection in economic exchange is distorted. The role of third-party payments in the rise of medical costs hardly is controversial, but Krugman seems to accept that the system can function only if all payments come from third parties.

The second point is that Krugman implies that a government system would not deny care, as though the Law of Opportunity Cost applies only to private insurers. Yet, even Krugman himself has endorsed denial of care and, yes, "death panels" (his words) as a way to hold down costs. So, one supposes that government is not subject to opportunity cost, but if it is, government agents will act wisely and compassionately.

Thus, we are supposed to conclude that (1) medical care is different than any other good one might purchase, (2) opportunity cost applies only to private care or at least manifests itself less if government agents decide who is to receive care, and (3) since everyone already knows the production function and since government has the power to set prices, there is no economic calculation problem, which means that the system does not need profits and losses to guide its decision makers.

Is There a Role for Entrepreneurs in Medical Care?

In the MBA classes I teach, I emphasize the role of the entrepreneur, not simply as an individual, but also the role of entrepreneurship within the firm itself. I use a lot of material from the Austrians, including Peter Klein's new book, The Capitalist and the Entrepreneur: Essays on Organization and the Markets.

Klein reminds us that most of the mainstream economic literature long ago discarded the entrepreneur as either socially useless (or even harmful) or irrelevant in a world of "economic" analysis based upon production functions, "given" input prices, and probabilities. These things, many mainstream economists believe, have demystified economic analysis to the point where any semi-competent economist, along with bureaucrats from the Federal Trade Commission or the Department of Justice, can both see and create the "optimal" system of production.

The Soviets certainly believed the entrepreneur was nothing more than a parasite, and all private entrepreneurship (legally called "speculation") was outlawed, with execution as a penalty always on the table. Production functions were obvious and planners could find prices by reading the Wall Street Journal, so the system did not need entrepreneurs, and especially did not need profits, as socialism already had done away with profits, which were nothing more than what Marx said they were: an unjust expropriation of the compensation that belonged to the workers.

As the Soviet economic planners found out, however, this was not a formula for "rational production," but rather a prescription for utter chaos. The economy of the former U.S.S.R. was legendary for its shortages, its poor-quality products, bad food, and, yes, poor medical care. When the Soviet Union still existed, American defenders would agree that maybe the government was too repressive and, yes, its economy was not good.

However, they would add: "It has free healthcare." (Likewise, I remember when a Marxist who teaches economics at the University of Tennessee-Chattanooga claimed that Romania's economy under communist rule was superior to that of the western nations because "there is no unemployment there.")

One of those former Soviet planners, Yuri Maltsev, has written about what that "free" care was like for ordinary people:

Being a People’s Deputy in the Moscow region from 1987 to 1989, I received many complaints about criminal negligence, bribes taken by medical apparatchiks, drunken ambulance crews, and food poisoning in hospitals and child-care facilities. I recall the case of a fourteen-year-old girl from my district who died of acute nephritis in a Moscow hospital. She died because a doctor decided that it was better to save “precious” X-ray film (imported by the Soviets for hard currency) instead of double-checking his diagnosis. These X-rays would have disproven his diagnosis of neuropathic pain.

Instead, the doctor treated the teenager with a heat compress, which killed her almost instantly. There was no legal remedy for the girl’s parents and grandparents. By definition, a single-payer system cannot allow any such remedy. The girl’s grandparents could not cope with this loss and they both died within six months. The doctor received no official reprimand.

As one reads the tales of Soviet medical care, it is clear once again that socialism is a system in which the consumer plays no role. Whether it was doctors and medical personnel killing patients or forcing them to pay bribes for basic care, patient care was the lowest priority. Ironically, at least one prominent Democrat politician, following the SCOTUS decision on Obamacare, declared that a future step should be the unionization of doctors. One can be assured that if this is part of our medical future, actual care for individuals will be secondary to preserving the political players in the system, as doctors through their unions will receive even more political cover.

One of the characteristics of a socialist economy was the various "time warps" that it created. When the Berlin Wall fell in 1989 and East Germans soon began to drive their Wartburgs and Trabants over the formerly-forbidden border to West Germany, people found that there was little difference between the 1989 Wartburg and the 1948 make of the same car. During my visit to East Germany in 1982, I found that much of the country, from its infrastructure to its street lighting looked unchanged from the 1940s.

Why the time warp? In a word: entrepreneurship, or the lack, thereof. While a lot of economists tried to explain the difference between the East and West as being to to "superior technology" in the West, that really is no explanation at all. New technologies do not magically appear; entrepreneurs must find a way to apply technologies in a way that will appeal to both the needs and budgets of average people.

Economic entrepreneurship in the old communist bloc was a crime; furthermore, a bureaucratically-run economy was going to be resistant to change because governments are loathe to take any kinds of risks. Car manufacturers stayed with the "safe" production function. Bureaucrats rarely receive any rewards for being right when they take risks, but often are punished for making errors, unlike entrepreneurs, who receive profits when they make correct decisions about the future and losses when they are wrong.

In the West and Japan, however, auto manufacturers had at least a measure of private entrepreneurship, and the result was a better automobile, even in the face of massive government political and regulatory interference with the production process. (Yes, some companies were bailed out, and it is my belief the government should have simply let Chrysler and General Motors go out of business. Entrepreneurship, after all, works best with a profit and loss system.)

What both Krugman and Roberts claim is that the real problem with medical care is entrepreneurship, and once the entrepreneur is removed from the picture and government directs the resources within the system, all will be well. Yet, why should that be the case we see opposite results elsewhere?

In the end, the single-payer advocates claim that medical care is different, and is not subject to the laws of economics. That would be a first in all of human history: a scarce good that is not subject to the Law of Scarcity.

For all of the talk of "American Exceptionalism," the real exception in the United States historically has been that entrepreneurs have had great freedom here, and we as citizens and consumers have benefited mightily from their actions. For that matter, every medical device that has saved lives and every development of medical procedures that make once-impossible surgeries now easy and commonplace has come ultimately through entrepreneurship.

And what will happen if the government tries to outlaw medical entrepreneurship? The system ultimately will slowly deteriorate, medical innovation will come to a halt, and patients will find themselves at the bottom of the totem pole.

Another thing will be commonplace, too. We will see politically-connected people like Paul Krugman and Michael Moore either using their great wealth to receive medical treatment in other countries that are not as restrictive as the USA, or they will use their political connections to be bumped ahead of everyone else. Oh, and Krugman and Moore and others will continually be propagandists in telling us how good we have it now that we have state-run medical care.