Explaining the Economic Calculation Problem in a Principles Class

Explaining the Economic Calculation Problem in a Principles Class

03/14/2018Jim Cox

A microeconomics principles class presents professors with the opportunity to at least briefly explain the economic calculation problem. Almost every text spends a page or two on the production function — the relationship between inputs and outputs by a firm.

Here is the relevant data and graphs from one such text.

The professor can ask the students, “at what output should the firm produce?”— which is a central issue in microeconomics. Looking at the figures and the graphs the students will likely answer, “at the peak of Total Product”, or “at the highest Marginal Product”, or “at the highest Average Product”.

None of these responses is correct, as there is no rational way to answer based on the limited information given. There is no rational way to answer because the data only include quantities of inputs and quantities of outputs. There is no value in the form of prices attached to either the inputs or the outputs. Until the prices of these are included there is no answer.

Here’s an example to illustrate this point:

If the outputs are valued by consumers in the market at a price of \$1.00 while each input costs the firm \$100.00 it is obvious that to produce any of these outputs would be a financial disaster for the firm in the way of major losses (and thus the firm will be destroying value in the world). Conversely, if the consumers in the market value the outputs at a price of \$50 each and the input costs are \$2 for each, the firm can make major profits (and thus the firm can be adding value in the world).

Socialists had proposed abolishing both money and prices leaving them in the same position as our students in trying to determine which output quantity would be best. Pointing this out allows the professor to recount Ludwig von Mises’s highlighting this problem in his 1920 article, "Economic Calculation in the Socialist Commonwealth" and the resulting debate over the issue in the 1920s through the 1930s.

While Mises — and Hayek who also participated in this debate — maintained their views, the socialist critics retired from the debate self-satisfied that they had answered the challenge by claiming that the socialist authorities could direct the managers to adjust production by simulating markets, that is non-existent markets! They would just be “playing market”.

As Mises pointed out, even the best intentioned socialist manager would be lost in trying to discover just what the best output would be.

I also like to make the point in my classes that playing market with assets one does not own is far removed from risking personal assets one does own! When one owns the assets, such decisions will have a major impact on the owner’s personal financial well-being.

(By the way, I have never in my many years of teaching principles classes seen a text that raises the economic calculation issue at all.)

Central Banks Get Scared: Forget About Promises to Reduce Balance Sheets

54 min agoRyan McMaken

After two years of a lot of aggressive-sounding talk about reducing the Fed's balance sheet and raising the target interest rate, the Fed in recent weeks has reversed  itself, and declared that now's a time to take things more slowly.

At the January FOMC meeting, officials:

widely favored ending the runoff of the central bank’s balance sheet this year while expressing uncertainty over whether they would raise interest rates again in 2019, minutes of their January meeting showed.

“Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year,” according to the record of the Federal Open Market Committee’s Jan. 29-30 gathering released Wednesday.

This just represents more of the "we'll return to normal someday!" routine we've been getting from the Fed for about a decade. Over that time, we've repeatedly heard that once the economy is strong again, the Fed will reduce its balance sheet back to normal levels, and will raise the Fed Funds rate back to what had historically been more normal rates. Yet, after years of near-zero rates, and a Fed balance sheet of more than \$4 trillion, it looks like the Fed lacks the resolve to do anything about it. Yet, if the economy isn't strong enough right now, with record-low  unemployment, and surging job growth, when will it be strong enough?

The lack of Fed action has long been an indication of how weak the US economy has long been, in spite of headline numbers that suggested strength. In reality, incomes and wealth growth only reached former peak levels in the past three years, with most of the period of 2009-2016 being in negative territory when compared to 2000 or 2007.

But after what looks like three years of real growth, the Fed is still worried that even the mildest hawkishness on monetary policy will undue the moderate gains of the past decade.

For a sense of how far the Fed has come from more "normal" times, we can see how total assets remain near all-time highs, as the Fed attempts to manufacture demand in the economy:

And then there is the Fed Funds rate, which, in spite of 18 months of increases, remains well below where it was prior to the most recent two recessions:

Worldwide, we're seeing some similar hesitation from other central banks.

Yesterday, "Bank of Japan Governor Haruhiko Kuroda said the central bank would “of course” consider easing monetary policy further if the economy lost momentum toward achieving its 2 percent inflation target, the Asahi newspaper reported on Friday."

Meanwhile, the European Central Bank shows no signs of budging from its extremely accommodative monetary policy. Overall, it looks like European growth is flatlining.

Overall, if we look at major central banks worldwide, we see that only in the US and Canada have central banks done anything that might be considered "tightening." And even in the US and Canada, rates remains quite low. And in no cases do we see any significant moves toward reducing central bank assets.

This is apparently the best the central banks can do in a time of "expansion."

A summary of the most recently set rates:

• USA: 2.5%
• UK: 0.75%
• Australia: 1.5%
• China: 4.35%
• ECB: -0.4%
• Japan: -0.1%

Note: All graphs by Ryan McMaken. Here are the specific key rates discussed here, with links:

"Concentration Camp" Is Not a Pejorative Term

02/21/2019Ryan McMaken

On February 19, 1942, President Franklin Roosevelt issued Executive Order 9066 authorizing military personnel to lock Americans of Japanese descent in concentration camps that are often euphemistically called “internment camps.”

To this day, some apologists for the internment camps — and the harsh measures carried out by the Roosevelt administration — contend that the term "concentration camp" is needlessly provocative and makes the Japanese confinement took worse than it was.

Yet, the term "concentration camp" is not a pejorative term. Using the term to describe the camps for Japanese-Americans is both appropriate and properly descriptive.

Nowadays, many people rightly are repulsed by the idea of concentration camps because they have become closely associated with the Nazi concentration camps which were often also extermination camps. Historically speaking, however, the term has not implied that the purpose of the camps in question are necessarily to carry out purposes of mass murder.

This is no doubt partly why Chief Justice John Roberts officially referred to the Japanese camps as concentration camps last year when Roberts wrote: "The forcible relocation of U. S. citizens to concentration camps, solely and explicitly on the basis of race, is objectively unlawful and outside the scope of Presidential authority."

Roberts is surely aware that the camps for Japanese-Americans were dissimilar to Nazi camps in a variety of ways. Yet, he still employed the term "concentration camp."

After all, the term — and the concept — both predate World War II by decades. The term was first used to describe camps used by the Spanish government against dissidents in the late nineteenth century. The term was then later used to describe camps used by the British Empire during the Boer War.

In both cases, these camps were unsanitary places where food was scarce. Disease spread easily. But, in both cases, it does not appear those who created camps intended to murder large numbers of women and children — as was the case with the Nazi camps. In the case of the German camps, for example, many witnesses reported seeing large numbers of potential camp residents executed on arrival. This alone would distinguish them from other types of deadly camps where death was usually the result of disease and malnourishment.

Moreover, in the Spanish and British cases, it appears the deadly conditions were often due primarily to a lack of funding and a lack of effort on the part of officials to keep the camp residents well supplied. Extermination need not have been a true motivation.

In the case of the Japanese camps in the United States, the residents benefited from a general and relative abundance of food which the United States in general enjoyed during the Second World War. Moreover, after 1941, at no time was the US losing the war in any meaningful sense. The US always enjoyed an advantage in terms of industrial capacity, and the physical security of the continental United States. This reduced the incentive to carry out reprisals against the camp's residents.

It's not a coincidence, for example, than many of the worst excesses against dissidents and "enemies of the state" in Nazi Germany took place after the devastating losses for the German regime at Stalingrad. As the war turned against the Germans, paranoia and internal revanchism increased, leading to an escalation of reprisals against all perceived domestic enemies.

The US did not experience a comparable situation.

So, while the American camps were relatively safe and healthy, it would be unwise to attribute to assumed American generosity. The fact is the US regime could afford to feed the residents while the general population more less forgot about them. Had the US experienced something like Stalingrad, the Roosevelt Administration — which was not above prosecuting peaceful Americans under the Espionage Act — may have turned to harsher measures against interned populations.

As it turned out, the American camps were decided non-deadly by historical standards up to that time. This, of course, did not protect the residents from the effects of confinement. Most residents lost their businesses and property since they were unable to pay rent or make mortgage payments during internment.

Social Justice Warriors: It's Not Just About Economics

If you think that the “tax the rich” rhetoric from the left-wing of the Democratic Party is primarily about economics you would be sadly mistaken. After all, there isn’t enough tax revenue in the highest income bracket, even with a 90% marginal rate, to fund anyone’s pet social program for more than 48 hours. Do progressives know this? Of course they do.

The same observation holds true for the so-called ”Green New Deal” legislation recently proposed by Alexandria Ocasio-Cortez, the outrageous media darling from Queens. It’s true that this grab bag of environmental regulation, if enacted, would likely cost trillions and produce a systemic change in the American life-style. But you miss the deeper message if you think that the actual purpose of this legislative monstrosity is to save the planet before it expires in 12 years.

No, the current wave of extreme progressivism has a far more nefarious goal than simply higher taxes on the super-rich or carbon taxes to scrub down the environment. Indeed, the long-run objective of the new socialists and the gang of social justice warriors (SJW) is to gradually delegitimize the very foundations of modern capitalism by obliterating conventional notions of property rights, fairness and justice. If this sounds far-fetched you have not really been paying attention.

It is often assumed that capitalism is founded rock solid on economics. Not necessarily. Strictly speaking, economic considerations, though important, are secondary. Instead, it’s the relatively unique system of individual property rights that primarily legitimizes all capitalist institutions.

Take, for example, the most obvious and essential capitalist institution: the private stock corporation. It is solidly rooted in the notion that individuals have rights; that these rights include the right to incorporate; the right to instruct managers of corporations to maximize profits; and the right of owners to sell their shares. These individual rights (entitlements) are the “moral” foundation for the existence and operation of all modern business organizations.

This particular theory of property rights was made explicit in the 18th and 19th centuries by philosophers such as Adam Smith, John Locke and John Stuart Mill. It holds generally that it is morally appropriate for individuals to own property including, of course, their own labor; to exclusively determine its use; and to enjoy the benefits (income or otherwise) earned from production or exchange. Adam Smith, who taught “moral philosophy” (not economics) at Glasgow University in Scotland termed these rights “natural” and once famously observed that free markets and voluntary exchange were morally appropriate because they were “consistent with liberty and justice. ”

Modern progressives and socialists reject this classical approach to rights theory. They hold, instead, that rights to property (and capitalist institutions such as the corporation) are arbitrary constructs of an elite and conservative legal system; that there is nothing “natural” or legitimate about them; and that, therefore, they have no special moral status. But if they have no special moral status, then neither does the income and privileges that these “rights” currently generate for owners. Indeed, government may now alter these arbitrary property arrangements and redistribute income and privileges to, say, anyone in the name of fairness and social justice.

It is now apparent that this radically different approach to property rights can be employed by critics to rationalize higher taxes on the rich, a drastic reduction in CO2 emissions, an increase in the legal minimum wage to \$15/hour, and even the federally chartering of corporations (an Elizabeth Warren pet proposal) in order to make them “socially responsible.” Indeed, there is almost no tax or regulation that cannot be justified from this perspective. And that’s precisely the point.

In conclusion, the social justice warriors and the new socialists are not primarily concerned with economics as such. The tragic lessons of, say, Venezuela are not their concern. Instead, their objective is to continue to delegitimize the classical foundations of property rights and then implement, through legislation and the courts, a radically different theory of justice in social affairs. Whether such a program will be successful has yet to be determined.

Originally published at LewRockwell.com.

The Transportation Boom Ends

02/16/2019Doug French

Sales of Class 8 trucks (18-wheelers) hit the ditch in January, with orders down 58 percent from a year ago hitting a level not seen since October 2016, near the end of the transportation recession, “when Class-8 truck orders had plunged to the lowest levels since 2009, and truck and engine manufacturers responded with layoffs,” writes Wolf Richter.

The other day I posted about the plunge in the Baltic Dry Index and now news is the Cass Freight Index dropped in December. The Cass “index covers shipments of merchandise for the consumer and industrial economy but does not include bulk commodities, such as grains or chemicals. It was the first year-over-year decline since the transportation recession of 2015 and 2016 — and trucking companies have seen this coming for months:”

Baltic Dry Index

Shipping indexes provide a barometer for how the economy is doing. Less shipping means less buying, selling, and producing. Government interference in the form of low interest rates and the threat of tariffs pulled economic activity forward. However, now the economy is digesting that bubble (malinvestment) of activity. Richter explains,

The trucking business is a barometer of, and dependent on, the goods-based economy. In late 2017 through the summer of 2018, demand for transportation services, such as shipping by truck, surged under the simultaneous impact of a strong goods-based economy led by red-hot e-commerce; a buildup of inventories; pandemic front-running of potential tariffs, a resurgence of drilling activity in the oil patch that required equipment and supplies to be trucked in, etc. Freight rates spiked. Squeezed shippers wheezed in their earnings reports about these spiking transportation costs, while truckers were on Cloud-9 and ordered new trucks to meet the demand, and truck manufacturers were swamped with orders.

Now shipping activity has cooled off and trucking capacity has improved.

The Flatbed Monthly Load-to-Truck Ratio by DAT tracks demand-capacity imbalances. After skyrocketing, the industry figured out how to deal with ELDs just as a slowdown in the industrial sector set in, particularly oil & gas. Now, the average load-to-truck ratio has plunged, down 41% from December a year ago.

Donald Trump's Democratic Wall

02/15/2019Tho Bishop

After a month of “will he, won’t he” drama fitting for reality television, Donald Trump has announced his plans to declare a national emergency in order to get the funding he desires for his border wall. While the wall itself invites debate on subjects such as practical immigration policy, eminent domain, and government contractors – the use of a national emergency has brought a renewed look at executive power.

For weeks Trump has been warned by Republican leadership about the dangers of the precedent being set by such a decision. Nancy Pelosi has already suggested that a Democratic politician could use a “national emergency” to enact gun policy.

While such concerns are justified, it’s amusing to see such objections being raised by conventional beltway-types as the long-standing trend within Washington has been the gradual expansion of the executive branch. What is the practical difference, for example, between a president going around Congress for a border wall and a president going around Congress for military action? Or President Obama’s own immigration-related executive order that granted protection to “Dreamers” after Congress refused to bend to his will?

One does not have to support Trump’s wall to identify hypocrisy. Once again, we see that Trump is at his worst when he simply continues long-standing political trends.

While the gradual expansion of the executive leviathan is concerning, it is also predictable given the 20th century deification of American political democracy.

After all, if we are to buy in to the idea that political action is validated through participation, then it makes sense for the single political office voted on by the entire country to gradually expand its power – particularly given the obstructions to majority rules the Constitution purposefully placed on the legislative branch. The preference for general majority rule at the expense of state-based representation is also what motivates the modern lefts interest in effectively abolishing the senate and Electoral College – both of which act as checks on the imperialism of democratic excess.

While the 20th century set the stage for the modern state, it was Andrew Jackson who was the first American president to understand how the promotion of democracy could directly feed an imperial presidency. While Jackson could be praised for his views on central banking and federal debt, his presidency offered some of the most flagrant examples of hostility towards both states rights and limits to executive power.

In his first address to Congress, he outlined his vision of a truly democratic executive. He called for the abolishment of the Electoral College, and criticized the role of a large legislature in frustrating popular rule. In his view, “the first principle of our system…[is] that the majority is to govern.” As the best representative of what he saw as the will of the people, he placed his own interpretation of the Constitution as equal to all other branches of government – best illustrated by his rejection of John Marshall’s decision regarding the property rights of Native Americans leading to the Trail of Tears.

While Trump has gone the furthest in openly inviting comparisons to “Old Hickory,” Jackson’s view of the democratic presidency has long prevailed. In the words of John Yoo, “Jackson remains one of the greatest Presidents because he reconstructed the office into the direct representative of the American people.”

Unsurprisingly, it was Yoo who provided the legal defense for many of the excesses of the George W. Bush presidency.

A Family Connection

02/14/2019David Gordon

Mr. Mark Lautman has given me permission to share the following letter:

When I started reading Rothbard’s book, I gave the three-line summary to my wife. “It’s a book written by Murray Rothbard in the 1950s about libertarian economics. It’s published by the Mises Institute. Rothbard was a disciple of an Austrian economist Mises.”

“Mises?” she asked. “Ludwig von Mises?”

“Yes. Do you know about him?”

“Do you know who Ludwig von Mises was? He was my grandfather’s cousin!”

Sure enough, Paul Lourie, my wife’s grandfather, mentions Ludwig von Mises in his memoirs!

Central Banks Buy Gold, Baltic Dry Index Sinks

02/13/2019Doug French

David Rosenberg tweeted a graph of the plunging Baltic Dry Index with the comment, “Is there a more deflationary chart than the Baltic Dry Index of global freight rates?”

Perhaps, or there is the New York Times business headline, “ Some Central Banks Have Gold Fever, and It Might Be Sensible .”

However, central banks are notoriously bad in timing gold purchases.

Swaha Pattanaik slams gold enthusiasts while praising central bankers.

Gold bugs aren’t always rational. That’s not the case for central banks, whose purchases of the yellow metal last year were the highest since the United States broke the link between gold and the dollar in 1971.

Pattanaik gives us the numbers.

Central banks bought 651.5 tonnes of gold in 2018, the second highest annual total on record and up 74 percent from the year earlier, according to the World Gold Council. As in the past three years, Kazakhstan, Russia and Turkey were significant buyers, but were last year joined by the likes of Hungary, India and Poland.

Gordon Brown’s infamous sale of UK gold cost the Bank of England nearly £5 billion.

Christopher Hope wrote for The Telegraph in January 2009,

The sale of more than half of the country's gold reserves between 1999 and 2002 has proved to be deeply controversial. Critics say that signalling such a large sale of bullion to gold traders helped to drive the precious metal to a 20-year low. In 17 auctions, Mr Brown as Chancellor of the Exchequer sanctioned the sale of 395 tonnes of gold.

Markets are About Freedom, not Competition

02/12/2019Ryan McMaken

I really enjoyed Antony Sammeroff's article last month about how the distinguishing characteristic of markets is free and voluntary exchange. Although many people like to speak of "competition" as the defining characteristic of markets, they're wrong. There is competition for resources in every political and economic system. In markets, however, that competition for resources is more free and less violent than in other systems.

Sammeroff explains more in a recent interview with Tom Woods:

Mark Thornton on Why Socialism Is Deadly and Dangerous

02/12/2019Mises Institute

Mark Thornton explains why socialism can never work, the history of the death and misery its caused and we discuss a better way to help everyone live a more free, peaceful and prosperous life. We need look no further than Venezuela.

Powell Claims No "Elevated" Risk for US Recession, NY Fed Models Disagree

02/12/2019Tho Bishop

Today Jerome Powell got out of the beltway and enjoyed some southern hospitality at Mississippi Valley State University, speaking at the Hope Enterprise Corporation Rural Policy Forum.

Most of the Fed Chairman’s talk was dedicated to talking about how the Fed could the financial needs of rural areas, a questionable claim considering the direct role central banks have played in increasing wealth inequality. He did, however, provide some additional thoughts on the strength of the US economy as a whole.

In particular, when asked about future risk, he said he did not “feel that the probability of recession is at all elevated.”

What’s interesting is that this claim does not follow the models published by the NY Federal Reserve which shows the current risk of recession at the highest they’ve been since 2008.

Of course, given the poor track record of Federal Reserve models, perhaps more useful is that this rosy view of the US economy seems to contradict the recent policy trends from the Powell Fed.

This includes changes to recent FOMC statements and projections about the rate of future rate increases, as well as indicating a willingness to stall the slow normalization of the Fed’s balance sheet that is currently in process. As he said in late January:

We’re listening carefully with – sensitivity to the message that the markets are sending and we’ll be taking those downside risks into account as we make policy going forward...If we came to view that the balance sheet normalization or any other aspect of the normalization was part of the problem, we wouldn’t hesitate to make a change.

Though the statement was made in carefully managed “Fed Speak”, the message it communicated couldn’t have been more clear – particularly since Powell has long been an inner Fed voice concerned about the size of the Fed’s balance sheet.  The market understood that Trump finally got the Dovish Federal Reserve that he has spent the last year campaigning for. The day of the announcement was the first in Powell's tenure that the market reacted positively to one of his rate-setting announcements.

Unfortunately for Powell, none of the arguments for “normalizing” monetary policy has changed since Powell first outlined his desires for a slow and gradual wind down. The economic data that the Fed claims to make its decisions off of continue to look strong and the dangers of facing a crisis with the monetary interventionists tools they desire have not gone away. So what has changed? Maybe, just maybe, it’s the perceived risk of a future recession that the Fed’s models, other signals, and a growing legion of economists are projecting.

Of course, in the Chairman’s defense, it would be a mistake to see the Fed’s top role as one of truth teller. The Fed’s job is necessarily a political one, to project an air of confidence and try to maintain confidence in the system. Unfortunately, hot air only goes so far, as Bernanke learned in 2007.

Luckily for Powell, it pays to play the role of Baghdad Bob for the US economy, as Bernanke’s \$1 million book deal and speaking fees illustrate.