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0:37Intro. (Recording date: January 20, 2025.)Russ Roberts: Today is January 20th, 2025, and my guest is economist Peter Boettke of George Mason University.Our topic for today is socialism and what is known as the socialist calculation debate. We’re going to base the conversation on Pete’s book of the same title, The Socialist Calculation Debate, that he has written with Rosolino Candela and Tegan Truitt.This is Pete’s ninth appearance on the program. He was last here in May of 2018 discussing public administration, liberty, and the proper role for government. Pete, welcome back to EconTalk.Peter Boettke: Thank you very much for having me. I’m thrilled to be here with you.1:15Russ Roberts: So, what is the socialist calculation debate? I just want to say, for listeners who might think this is some ancient, weird, archaic academic dispute: It is that; but it turns out it’s not so archaic and it’s not so academic, and it’s much broader than it comes to appear at first glance–is what I learned from your book. But, let’s start with the archaic academic debate of early third of the 20th century, I guess.Peter Boettke: Well, I guess the easiest way to put it is that Karl Marx, who was the most systematic socialist, not the only socialist–there was a variety of socialisms–right?–that came about. In fact, if you go back in the history of socialism to the First International, it’s not like Marx was the only socialist there. You have Bakunin. You have other kinds of people who all want to envision this possible future that would rid the world of the social ills that the sort of old regime had generated. It’s a little misnomer to talk about it always in capitalism versus socialism because capitalism really wasn’t fully developed then either, right? I mean, it was kind of a different idea–mercantilism, all kinds of other things. But they were going to step inside of the future and see a better world, a world that would eliminate the injustices of the 19th century as they saw it and the instability of the 19th century as they saw it.In order to do that, they were going to bring the invisible hand forward to be a visible hand–so, nothing going on in the backs, behind the backs of the people. In doing so, they hoped to achieve a movement from what Marx called the kingdom of necessity–the world of scarcity-to this kingdom of freedom, which is a post-scarcity world because of a burst of productivity. So, there’s an economics claim that by moving the invisible hand and the anarchy of production to in front of us and orchestrating it, we can increase the yields, the productive yields of society. And as we increase the productive yields of society, we’ll be able to eradicate the conflict between the classes, and we’ll be managing the cyclical variations, so we won’t have business cycles anymore. We won’t have monopoly power, privilege, these kinds of things. So, we won’t have exploitation.And so, there’s a very specific claim: I’m going to increase productivity and I’m going to do it by rationalizing production; and I’m going to rationalize production by having collective ownership over the means of production rather than private ownership of the means of production. So, that was the plan.Russ Roberts: And, by rationalizing, you don’t mean it in the everyday sense of the word, which is to justify or excuse. You mean make it more rational, make it more scientific, right? More purposeful.Peter Boettke: Right. And, to produce more with less, right? This is a key issue, right?So, from an economist’s point of view, when you translate it, it’s like I’m going to produce more with less, and I’m going to do it now with collective ownership rather than private property ownership, with planning rather than prices.So, this was the original claim. And, then in 1920–actually, I should point out that Max Weber in 1919 originally writes a critique of this sort of project as well, and he draws on some nuggets of comments that Mises has in his first book, Theory of Money and Credit, but the nuggets are how markets actually work. So, the Theory of Money and Credit is not a critique of socialism: it’s how the monetary system under markets work. And Weber understood that what that entailed was monetary calculation. This goes back to that more is preferred to less and the role that private property and prices play in enabling us to engage in monetary calculation of profit and loss and this stuff.So, Weber highlights this, but draws on Mises. Then Mises in a book about World War I, called Nation, State, and Economy, he also highlights this problem with war planning, but he fully develops the argument in an article called “Economic Calculation under the Socialist Commonwealth.” In that article, he takes directly on this claim that I’m going to rationalize production by having collective ownership and planning versus prices. What he tries to argue there is a logical criticism, which is that: when you abolish private property in the means of production, you’re going to abolish markets in the means of production. And when you abolish markets in the means of production, you’re going to abolish the relative prices. Without the relative prices indicating the relative scarcities, then economic actors are going to be unable to engage in, monitor economic calculation of whether or not to invest in project A or project B.So, we’re going to end up by basically being so many steps in the dark, which will mean that we will end up by not having rationalization of production, but we’ll end up rather than producing more with less, we’ll produce less with more. And so we get systematically not the–if you can’t engage in rationalization of production, you’re not going to be able to move from the kingdom of necessity to the kingdom of freedom.Russ Roberts: And, that article was written when? What year?7:12Russ Roberts: So this is while, I think, roughly the first five-year plans are coming out of the Soviet Union, and there’s an immense intellectual excitement about the Soviet Communist experiment as a potential replacement for market capitalism and the American system, which is the most dramatic example of it you could argue at the time.What Mises’s critique is, which is hard to remember because you have to remember what year it is–it’s not now, it’s 1920–is that that’s just not going to work. It’s not ‘I don’t like communism.’ It’s not ‘I don’t like what communists are trying to do.’ He’s simply saying–and you stress this in the book–he’s making what in economics we call a positive analysis, meaning not encouraging, but rather just saying what the facts are and where does the so-called science lead. And he’s saying: Not going to work very well. The incentives aren’t there. People don’t have these sources of information about relative scarcity, so inevitably they’re going to waste resources both in how they produce things and in what they produce–because they won’t be able to produce things according to what people necessarily want, right? The price- and profit-and-loss signals that business people are constantly reacting to won’t be there; and there’s no way that a government, centrally planning it, can do nearly as well. That’s the claim, right?Peter Boettke: Yeah. I think that the way to think about maybe the debate as a whole is to think in terms of the different stages in which economists had to bring sense to these very romantic claims about what was going to be achieved.At first, as I said, the movement from the kingdom of necessity to the kingdom of freedom is a denial of scarcity, right? So, you have to remember in the late 19th century, early 20th century, it was very common for social activists to argue that we had solved the problem of scarcity and that what we had was poverty amidst plenty. And so, the question wasn’t whether or not the system yielded output, but whether or not politics decided how to distribute the output.So, as an economist, you first have to come along and argue, ‘Hey, we live in a world of scarcity. Scarcity implies trade-offs. Trade-offs need to be negotiated. We need tools to the human mind to help us negotiate the trade-offs.’ And those negotiating of trade-offs are both a question of incentives and information, right?–the way we weigh the different marginal benefits and marginal costs of our different activities.So, the first stage of the debate is to insist on the importance of private property rights, right? This is one of the oldest arguments in intellectual history. It goes all the way back to Aristotle’s critique of Plato, okay? But, it had to be resurrected, the idea that property rights matter.And then the second thing is: property rights not only produce incentives, but they are the generator of the prices that we use to negotiate the trade-offs to help us.So, prices guide us. Property incentivizes us. Prices guide us. Profits lure us to new changes and losses discipline us.So, understanding the role that these three Ps play basically–property, prices, and profits–in the system, it ends up by being a challenge to the idea that the socialist system which was trying to abolish property, prices, and profits, right? ‘We are not going to produce for profit, we’re going to produce for direct use.’ Those were all the slogans of the socialist project at the time.And so, as you pointed out–correctly–Mises is not choosing to argue with the socialist on their ends. So, he’s not going to do that. He’s going to argue–he’s going to say, ‘Okay. You want these laudable ends: move from the kingdom of necessity to the kingdom of freedom. I’m all with you. How are you going to do it?’ That’s the question. And ‘Your means–the abolition of property, prices, and profit–is not going to be able to achieve your end of increasing the yield.’So, that’s why it’s the problem of rational economic calculation. Again, going back and forth. It’s not a justification. And it’s also not hyper-rational, like, ‘I’m going to make no mistake. I’m Homo Economicus. I’m a lightning calculator of pleasure and pain.’ It’s literally the words the socialists use. They are going to rationalize production by getting rid of the anarchy of production, which was taking place under liberal markets–what they understood to be liberalism. So, Mises is adopting their language, adopting their ends, and showing that their means cannot obtain their ends.12:13Russ Roberts: So, he writes the article in 1920, and then he writes a book called Socialism in 1922. Is that right?Peter Boettke: 1922. Yeah.Russ Roberts: 1922. That book is still in print. I would just remind listeners that you and I have–I think we’ve done an episode on Mises–and listeners can go back and find those references and get an introduction to Ludwig von Mises, the Austrian economist.So, that book comes out in 1922. The other side doesn’t go, ‘Oh, well, I guess we made a mistake. We’re barking up the wrong tree or heading down the wrong path.’ They fight back. So, the most prominent responses to Mises come from Lange and Lerner, if I’m not mistaken. What do they say? How do they answer him?Peter Boettke: I think just to put things in somewhat context first, is that this book comes out in 1922 and has a sea change, sort of a mind-quake effect on two very important thinkers–Friedrich Hayek, who was young and in Vienna at the time and part of Mises’s seminar, and then Lionel Robbins, who it turns out is fluent in German. So, when he floats in and out as a young economist–he’s a student of Edwin Cannon–but he’s a young economist who actually ends up by having to go to Germany and come back and he gets exposed to Mises’s book. This plays a major role in the 1930s because by shock of sheer accident, a very young Lionel Robbins–because Alwyn Young dies from the flu–becomes department chairman at the London School of Economics (LSE) at the ripe age of 29, and then eventually he recruits Hayek to come and be part of this program at the London School of Economics.They are trying to communicate Mises’s ideas to the English-language-speaking community. Mises’s book and article don’t get translated until 1935 and 1936. So, Mises himself–the original responses to Mises are all in German; and those are all not yet the effective, Lange–they’re more like people like Karl Polanyi, sort of these social scientists in the German-language world. Jacob Marschak actually has a criticism.But, what happens is Hayek and Robbins translate Mises’s ideas, and it creates an English-language debate. So, the shocking thing–sorry for the detour, but I think it sets this up–is that when Hayek gives his inaugural lecture at the London School of Economics called “The Trend of Economic Thinking,” he argues that if you’re a neoclassical–Russ Roberts: What year is this?Russ Roberts: Okay. Go ahead.Peter Boettke: So, he says, ‘If you’re a neoclassical economist’–by that he meant a marginalist and they didn’t see themselves as Austrians being different. There was Marshallians. There’s Walrasians. There’s Mengerians. But, they’re all basically sort of the same thing with different points of emphasis. One is more sort of what we would today call partial equilibrium. Other people are general equilibrium; and the other ones are more the market process that produces the equilibrium. But they see themselves as all linked as marginalists, as–you know that.And so, Hayek says, ‘If you are a neoclassical economist, you can’t be for interventionism and socialism, right? Because, economics teaches you property, prices, and profits; so you can’t be one of these other things.’ So, he says, ‘The problem is that the older critics of markets against classical economics is still in our head–the institutionalists and the historical school–even though we’ve now defeated them.’ So, this is what he’s laying out.Well, what happens is, is around that time in the 1930s, you have two things going on. One of them is the Great Depression. So, people’s faith in the market is really shaken. Okay?The second thing is that people start using the tools of neoclassical reasoning to defend interventionism. All right?So, Lerner, who is actually Hayek’s student, his dissertation is called “The Economics of Control,” which is: How can I use the tools of marginalist economics to optimally plan when, in the real world they end up because of monopoly and business cycles, unable to achieve the results of the model? So, we can make the model because again, remember, we’re going to move from the backs of people, right?In neoclassical economics, the optimality theorems emerge from the activity of individuals, many of whom don’t even know that they’re doing anything like marginal calculations, right? But, if I’m going to do rationalize, I’m going to move it to the front. I’m actually now going to scientifically do that.So, what Lange and Lerner argue is that, ‘What’s the problem? We just tell the central planning board to set price equal to marginal cost and produce output at the minimum point on the average cost curve. Look, we have a diagram that tells us that that will yield the optimal.’ And, ‘Precisely because they can now do that–the planning bureaucracy can do that, and we’re going to work at that optimal–we’re also going to get rid of the business cycle.’So, not only can we show that socialism can perform in theory identical to capitalism–just set the same optimality conditions–socialism will outperform capitalism in practice because we’ll get rid of all the bad stuff that’s associated–that we’re looking when we look out the window we see, right?Because remember that at the same time that you have Keynes, you also have Berle and Means. Right? So, it’s at the same time. There’s sort of a separation of ownership and control and the problem of the modern corporation creates all these dysfunctions on the micro level, at the same time that the breakage between savings and investment is going to cause all the problems on the macro level.So, the faith of economists–that is, standard, mainstream economists–in the power of markets to coordinate economic activity through time is at a real low at this time. And, that’s when you have these really bright, young, I mean, genius-level economists like Lange and Lerner coming up with this solution that they want to do. And then Hayek and Robbins are kind of taken by surprise.19:06Russ Roberts: That’s a fantastic summary. For listeners who aren’t economists, ‘marginal’ doesn’t mean unimportant the way it does in everyday language. It’s a methodological statement that–just to make it simple, it means that–well, supply and demand is a useful way to think about how prices get determined rather than some other theory. I’ll leave it at that. Statements like ‘price equals marginal cost’ or ‘produce at the minimum point of the average cost curve,’ these are ideals that economists use as descriptive under certain conditions and that lead to certain good results under certain conditions. But the counterpoint is, ‘Oh, but those certain conditions don’t hold, so we don’t get there. But we can get there instead of just hoping through emergent order and bottom-up activity, we’ll get there–we’ll get there with intention.’ And this, by the way, it’s a 90-year-old, 95-year-old debate, but it keeps coming up in our profession.And this is an aside. Because it drives me insane that people say, ‘Yeah. Well, markets are good in theory, but in practice they’ve got these flaws because–‘. Yeah, correct. These so-called assumptions, underlying conditions, don’t hold. They’re right. But that doesn’t imply, therefore, that a non-market solution is going to do better.So, that’s fundamentally what’s fascinating. What’s fascinating about this is that fundamental argument. We see as economists that markets can do things and achieve things that are surprising given that they’re not planned, that they’re not intentional.The other side–the interventionist side–says, ‘Yeah, but think how much better it could be if you tried to do it on purpose.’And in fact, this is the subtle point you’re making, Pete–I want to re-emphasize for listeners–we’re going to use the tools that you use to justify bottom-up market activity to make top-down centralized activity even more effective.And that’s the debate. What year are we in now? Mid-1930s?Peter Boettke: Well, they’re writing their article in 1936, 1937. Hayek eventually–you know, and Robbins responds in the late 1930s, early 1940s. But then Robbins, of course, goes to work in the war effort. So, he gets out of being active in the academic literature by the late 1930s, early 1940s because he’s involved in the war effort. Hayek, on the other hand, ends up by writing not only The Road to Serfdom, but then also the “Use of Knowledge in Society,” but also essays like “The Competitive Solution,” where he’s trying to counter these different positions.But, I wanted to say something. I mean, you’re a master teacher of economics and communicator of microeconomics, basically good price theory. But I wanted to mention your colleague at Hoover, Thomas Sowell, who I think actually is brilliant on this. So, first, in the meta issue, this is his book on the Conflict of Visions, basically, right? The one is the idea that you see things bottom-up. The other one is that you have to sort of stand outside and plan from the top-down. At the very end of his book Knowledge and Decisions, which I think doesn’t get talked enough about, he has one of the best paragraphs I’ve ever read: but basically what he says is that ordinary people can do extraordinary things if given the freedom from–their others, that I try to impose on them. Whereas I think the opposite side believes extraordinary people can achieve extraordinary things if you just give them the power.So, this conflict of visions is played out in this debate all the way through, whether or not–so, imagine if I had the best and the brightest to plan the economy. Or now–we’ll talk about this–the best and the brightest computers to plan the economy. Then we can give them extraordinary powers and they can rid us of all our social ills. Where, the other side is basically, like, ‘I got to worry about that power problem.’ Right?So, instead, what I want to rely on is ordinary individuals, as McCloskey puts it, giving it a go: we are going to end up by generating this information and this incentives within the process itself, which will enable us to achieve productive specialization and peaceful social cooperation. That’s the key idea going all the way back to Adam Smith, to Vernon Smith, is: how is it that we achieve productive specialization and peaceful social cooperation without a commander, right? We do that through the higgling and bargaining of the market, as you’ve talked about.24:11Russ Roberts: Yeah, that’s very well said, and thanks for the kind words. But, in my mind–and I was surprised to hear you say this because it seems opposite of what I would have thought–you suggest that in the debate between Oskar Lange and Lerner on the one hand, and Hayek, Mises, and Robbins on the other, that by the 1950s most academics would have said that the socialist calculators–the people who defended the central planning solution–had won. Is that correct, in your view?Peter Boettke: Yeah, I think you have to understand two things about that. One is the utter–and this is really quite well captured in Jennifer Burns’s book on Milton Friedman, because it captures that time. Because again, Friedman is educated in the 1930s and comes to the forefront of profession. He starts at University of Chicago, I think, 1946, right? In 1947, Friedman writes a wonderful critique of Lerner’s book that anticipates his long and variable lag and all kinds of things like that. But, here’s the dilemma that he points out in that book: there’s nothing logically wrong with Lerner’s book; it’s just that Lerner doesn’t pay attention to the administrative side of things. Right? That is, the actual way in which politics would make these decisions, or the way in which even if we assumed well-intended bureaucrats, how would they go about achieving these kind of ideas?So, the reason why they have this immense faith is because the Great Depression destroyed the faith in the invisible hand. But then the Western Allies defeated the Nazis, and they did it through war planning. So, can’t we use war planning in peacetime to plan and solve all of our problems?So, these economists, like Samuelson, who are brilliant and recruited into the field of economics due to the Great Depression–if it would have been 40 years earlier, he might’ve become an engineer because of his math skills and things like that. But he ends up by becoming an economist; and his idea is–and again, think about his major innovations: linear programming, all these kind of things like that. They’re all associated with the economics of planning and fixing the economy. As Samuelson puts in his economics book–not his Foundations, but actual textbook–he says, ‘Men of good will, will be called upon to use the power of government to solve our problems of all the social ills: poverty, ignorance, squalor. We as economists are entrusted with these tools and with this now power to be able to achieve that.’ And that was a heyday of them doing it.I know you’ve had Appelbaum (Binyamin Appelbaum) on your show about The Economists’ Hour, and I think he got it wrong. The economists’ hour was the Keynesians, not Friedman and what he calls the Neoliberals. The Economists’ Hour–Samuelson and Solow–and later on, all the way up to people like Larry Summers and others that believe they can control the levers of the economy and fine-tune the economy. That’s what’s been called into question by the failure of the regime, but that’s a different debate for a different time.But, at this time in 1950, and now it is a little hard not to do it somewhat technical, and I don’t mean to derail us, but what they believed was that they could prove a social welfare function that could tangently kiss at the outer frontier of the Pareto frontier, right?Russ Roberts: I’m going to cut you off there, Pete, but can I try to put that into English for listeners?Peter Boettke: Yes. Yes. Sorry about that.28:23Russ Roberts: No; it’s actually extremely important because I think the intellectual effort that economists have gone into in what you just described is remarkably seductive and dangerous. I’m going to cut through the Gordian knot of the technicalities and say the following.A large portion of the economics profession came to believe–and many still do–that there is a set of production decisions that are best for, quote, “the economy as a whole”–not for the economy–for the people. That a benevolent dictator–which doesn’t exist, but we’re going to imagine it–a benevolent dictator would do this and maximize the wellbeing of the people, ignoring the fact that people have different goals, different desires. Ignoring the fact that inevitably there will still be trade-offs. Ignoring the fact that we can’t say whether it’s better if so-and-so gets this apple rather than someone else.And, the idea that that’s reality is unbearable. And it really goes back–this is one of the few things I understand about history of economics. I’m sure it goes back further than this, but it goes back to at least as far as Bentham. Bentham wanted to–to use the word we’ve been using–rationalize the weighing of relative well-being of different people. And that cannot be done, in my view. But he found that frustrating; and economists don’t like that. I need a way to figure out–since almost every policy benefits some and hurts others–I need a way to figure out what the net impact is.And the social welfare function–the phrase you used–is an intellectual abstract concept to try to compare different outcomes in different worlds under different rules, under different levels of output, and who gets it.And I think that’s a fool’s game. Worse, I think it’s dangerous. But, that is part of what’s happening in this post-World War II period–this confidence that we can say things that are decisive about well-being, not just of a person, but of groups of people, and especially diverse groups of people.And let’s be honest: economists like to apply the power of incentives to everyone except themselves. The idea that we as economists–to quote George Stigler, ‘There’s only one social science and we are risk practitioners.’ But more than that: we are the kings. We are the king-makers. We are the engineers. We will engineer an outcome for society that is the best of all that it could possibly be. And I think that is intellectually bankrupt. But it was–the point I’m making about incentives is that if you think economists can do that, you should give them a lot of power and reward because they know how to make not just someone better off, but everyone; and not just everyone better off, but in some sense, the society better off even though there might be many people who are worse off. And they purported to be able to weight those trade-offs–and they still do: still a very seductive aspect of what is called welfare economics, which is not about payments to poor people, but rather about the well-being of people.Peter Boettke: Well, I think that you hit the nail on the head, and I think that between 1950 and 1980, this was actually the dominant version of economics. There’s a reason why there was challengers to that from Chicago, from UCLA (University of California, Los Angeles), from Rochester, from Virginia, these other things which we maybe can talk about; but the dominant MIT (Massachusetts Institute of Technology), Harvard, Princeton, Yale way of teaching–Russ Roberts: Oxford.Peter Boettke: Yeah, Oxford teaching–Russ Roberts: LSE (London School of Economics).Peter Boettke: Yeah. And it had a huge impact also not only on domestic policy, but international policy that was taking place after the war. Right? So the way that you export it, how to advise to underdeveloped countries, how they should–like India: how should you do your economics? Nehru was very influenced, for example, by the sort of Fabian, as well as Soviet planning. It was kind of a mix–right?–between some version of Fabian socialism and Soviet hardcore industrialization.That all had to play out, and then eventually it crashed and burned; and the economies had to go through different reforms in the 1990s.But, this heyday that we’re talking about right now, 1950, that is a heyday of market failure theory. Right? Markets fail to achieve any kind of optimal output or even desirable output. They’re going to be plagued by monopoly power, externalities, public goods problems, right? That’s the market–Russ Roberts: Business cycles, as you mentioned earlier.Peter Boettke: Yeah. And then, macro-failure, which is the business cycles.And so, again, we have a very strong argument that says: Economic system left to its own devices is going to give us not betterment, but in fact human suffering. We are going to suffer from idleness, unemployment. We’ll suffer from poverty. We’ll suffer from squalor. We’ll suffer from ignorance. Okay? And so, all of those social ills need to be eradicated by conscious government activity, and economics is giving us the tools by which to do that.34:25Russ Roberts: So, let’s move. Obviously, we can talk about a lot of different things, but I want to move to Hayek’s particular critique of the socialist planning idea and the role that knowledge plays, because I think that is a rather extraordinary intellectual achievement.But, just to foreshadow–and I want to spend a decent amount of time on some of the intellectual things that came out of this: we’ll talk about Ronald Coase’s theory of the firm and Michael Polanyi’s insights into the philosophy of science.But obviously, just like the Great Depression caused people to lose faith in markets–whether that was rhetoric doesn’t matter–when the Depression caused a lot of people to come to a decision about the reliability of markets, the collapse of the Soviet Union, which is the 40 years into the heyday that we’ve been talking about on the part of planners, that shakes people’s faith in the ability of markets to be superseded by planning.And in particular, the realization–which took quite a while–that the Soviet Union was an utter failure as a productive cornucopia. It did not produce the cornucopia of goods that planners promised–the more from less. It was the opposite. It was very unproductive. And it took a long time for people in the West to realize that Soviet data was not reliable, and that actually the Soviet Union wasn’t outperforming the United States in the 1950s, 1960s, and 1970s. It was woefully inferior.So, when that became a realization and when the Soviet Union collapsed, Hayek and Mises essentially in many ways won the calculation debate. But it’s not going to end, because there’s a 21st-century variant we’re going to get to, which is computers. But, I want to talk about Hayek’s insight.So, we have Mises who argues that you don’t have the right incentives. You don’t have the power of profits and loss that private property induce to give people the incentive to make the right choices. They don’t have the prices: therefore they can’t make choices between a relative value of one good over another, or one input over another in the production process.But Hayek has a deeper and more, to me, deeply satisfying insight about how knowledge actually works in the real world and how it works in an economic system. Talk about that.Peter Boettke: So, this is a great question, and in the evolution of the debate. I did just want to say something for the listeners so they might put this in context because they might’ve heard this when they were in school or whatever. But, when Khrushchev picks up his shoe at the UN (United Nations) and says, ‘We will bury you,’ he doesn’t mean militarily. He actually means in productive goods. They’re going to outproduce us. The space race–the fact that they put Sputnik up before us–suggested to everyone that they were technologically superior to us. The fact that Stalin was able to move a peasant economy to an industrial economy strong enough to produce a military apparatus that could take on Hitler, that proved to people that it was all working.So, everyone had tremendous faith in the technological achievements of what socialism could have, and they didn’t realize that it was all crumbling on the inside. Right? We didn’t have access to the information and all of that as a scientist. They didn’t let Westerners in. They did just Potemkin villages–that is made-up–Russ Roberts: Facades.Peter Boettke: visits from the–so that’s important to keep in mind.The second thing that I want to go back to just very quickly before I’ll dive into the knowledge issue is that, as I said before, the argument went from property to prices to profit-and-loss, and then what you have–so that property gives us incentives, prices gives us information, profits-and-losses and the lure and the disciplinary gives us innovation. But then, what you have to realize, what Hayek said is that: You know what? All of economic life takes place within law, politics, and society. So, politics gives us the institutional infrastructure, so institutions matter. So, he goes through this debate and he hits the different points.Now, why doesn’t he just stop at the old economists’ argument that collective ownership–if everyone owns everything, no one owns anything, therefore they don’t have the incentives, right? It’s because that debate was ruled out-of-court by two forces. Yeah, it’s so weird to read 1930s economics. Hayek’s colleague, H.D Dickinson, at LSE–when he teaches his course on economics of planning, his first statement is, ‘We will truck with no incentive talk here.’ Okay. Lange, in his famous paper on socialism, says that incentives are psychological problems and therefore not economic theory. All right. So, if Hayek responds back and just hammers home the incentive argument, they’re not even listening, right?Russ Roberts: Yeah. Fascinating.Peter Boettke: So, then what he asks people is: he says, ‘Okay. So, what is the functional significance of a price? What does a price do?’ And, at the time, a lot of economists thought prices were a summary of past costs, right? What Hayek’s brilliant insight was, ‘No, no, no. Prices are guides for us to engage in future activity. They’re the things that guide us.’And this knowledge that is embedded in the price system is only revealed within the act of engaging in the exchange. If you don’t engage in that exchange, that knowledge doesn’t exist.So, it wasn’t a computational problem: ‘Oh, there’s just so many equations that we have to solve. It’s complicated,’ or whatever. It’s literally a generative problem. Without the price system and without the competitive bidding and asking of prices, the knowledge that’s necessary to coordinate just simply doesn’t exist. It’s not there. And so Hayek tries to communicate this.So, use his famous example. I mean, you’ve dealt with this tremendously in various of your books that, where you’ve talked about, so I’m sure you could summarize it better than me; but think about his famous tin example, right? It’s not that the knowledge of understanding the relative scarcities of tin exist somehow out in the abstract. It only comes about because I see the prices moving. If the prices don’t move, I don’t know that that’s the case, and I have no way of accessing that that’s the case.And so, it’s this generative nature of the knowledge–the contextual, what Hayek calls knowledge of time and place–that is so vital to our coordination of our activities.41:53Russ Roberts: It’s just one of my favorite things in economics because it’s not obvious and it’s really cool. Which is, the way I think about it sometimes is: Where can I look up how scarce tin is? Where’s the book that’s the annual survey of tin supply? And of course, that book doesn’t exist.And then, the other book you would want once you found out it was scarce: you’d want to get the book of alternatives to tin. And, that seems like a reasonable thing to be able to find, through some armchair theorizing and maybe some research. So, if I use tin in a process of production and tin has gotten more expensive, I need to think about an alternative, perhaps, as a way to cope with this higher price, because now tin is more scarce.And the idea that I can’t look that up–that I can’t just make a list of what the alternative ways I could avoid using tin–what I have to do is be under pressure. I have to realize that, ‘Oh my gosh, tin has gotten a lot more expensive. My business might disappear. I better find an alternative way to produce what I produce that uses less tin.’And under that stick, that threat, I might come up with something new. And that something new might be worth it–that’s the profit lure–but it might be a mistake. It might cost me money; and that’s the discipline of a loss that you talked about so well.And then that idea that the things that we observe out in the marketplace are response and not just a compendium of knowledge is extremely, extremely deep.I think a first-rate economics course helps a person appreciate that. And of course, it’s what you and I talk about all the time when we’re teaching, because it’s a very subtle idea. If you’re listening and you haven’t heard that before, I hope it makes some sense, right? It’s the idea that the knowledge that I have only emerges when I’m encouraged to go find it. And that’s why it has an exploratory element, a discovery element.And sometimes I’m the only person who thinks of it, and for a while I get an edge. If other people discover it or see what I’ve done and copy it, my edge starts to decrease. And that’s magnificent aspect of price, profit, and competition. So, all of a sudden my insight, which saved me a lot of money and allowed me to profit, suddenly I’ve got to share those profits with consumers often because competition forces me. I don’t want to. Doesn’t matter whether I’m a nice person or not. Competition is going to make that happen. And that’s the power of the decentralized system when it works correctly.Peter Boettke: Yeah. So, this is Hayek’s idea of competition as a discovery procedure, which he–so this debate that he was involved in forced him analytically to keep peeling the pieces of the onion back as he kept on trying to understand more and more of the nuggets of the foundation.You know, you and I both think the world of Adam Smith. I think one of the things that’s underappreciated is Adam Smith’s capturing of what science is all about, because what he says is it moves from a wonder, to surprise, to appreciation. So, wonder is when I look up in the stars, I wonder. When I see a common woolen coat on the back of a day labor, I wonder how the hell it got there. Right? The surprise is that I find out that it got there because of individuals pursuing their own interest and everything like that, guided by the sort of market trade-offs that they face, and appreciation is then an understanding of the power of the price system and division of labor and all these things like that.If we could, in economics, still teach wonder, surprise, and appreciation, that would be the best thing we could do as economics. And just as an ad to you, I think you have this book on the price system called Price of Everything; and you have a wonderful book called Wild Problems, which is actually the–it’s easy to have, not easy, but it’s the world that the people that were building the model of perfect competition and thus the model of market socialism were dealing with was a world absent of wild problems. It was a world that didn’t necessarily need innovation and all these other–and didn’t have to cope with change and all of that stuff. So, that’s why Hayek, when you start–Russ Roberts: And, everything was measurable. Everything could be computed.Peter Boettke: Yes. Yes. And they saw the problem as a computational complexity problem, right? So, all you need to do is have really smart people figure out how to do the math, and then you could get it and solve the issue. Which we’ll come back to when we talk about the current computational discussions.But, what Hayek was trying to get at is this constant and ceaseless change, adaptation, and adjustment that was required–and, going back to what you just said, novelty. The reason why we progress is because of novelty, because of imagination.So, again, to your listeners, there were economists other than Hayek and whatnot, that emphasizes things like Julian Simon telling us all about the ultimate resources–the human imagination–because necessity is a mother of invention. Or, I’m sure Matt Ridley–one of my favorite books since the last time we talked is How Innovation Works. And Ridley has this fantastic phrase. He says, ‘Innovation is the child of freedom and the parent of prosperity.’ Right? He goes exactly to your issue.One of the problems that, all the way from Mises to Hayek on this issue with socialism, was not only as Mises put it, ‘How are you comrades–how are you going to have the chickens fly into the mouths of the comrades?’ Right? ‘Just deliver the goods?’ It was also: How is it that you end up by getting constant improvement and revolutionizing the process of production in the same way that we saw the move from 1750 to 1850? How are you going to see from 1850 to 1950, from 1950 to 2050? Where are you going to get all this sort of spur of innovation? It’s not just technology; and it’s not just a technological and engineering issue.48:38Russ Roberts: It’s really important to emphasize this. Well, I mean, it seems obvious. People just think of new things. That’s why we make progress. They get creative.But, the inside of this debate that we’re treating as this sort of, again, as I said earlier, some kind of arcane academic dispute, it’s really a fundamental difference in how we look at the world. If you look at the world and you say, ‘Well, people think of new things,’ but the question is a lot of the new things they think of aren’t worthwhile. So, you can’t fund everything. And you shouldn’t fund everything. So, then you’re faced with the choice: How do you decide what to fund?In a market system, no one decides that. It’s decided by people throwing things against the wall and seeing what sticks. Most of them don’t. Thank goodness, we don’t keep investing in them. So, in a private decentralized system, the market test is what determines what leads to a better world.Now, I’m not going to romanticize it. Well, I do because I think it doesn’t get enough romance. But obviously many things stick for the wrong reasons, stick because they have an edge, stick because of cronyism. I don’t want to overstate how the perfection–and you’re very similar–we don’t overstate the perfection of the market system. It’s remarkable that it works at all given that no one’s guiding it, at least in the obvious sense that you would normally think of.Peter Boettke: So, one of the things that we really try to stress in the monograph is actually: What is actually the function of economic calculation? And the function of economic calculations is: Sort from the array of technologically feasible projects those which are economically viable.So, there’s many different ways, for example, to have transportation, but not every way of transportation do the benefits outweigh the costs, and unless you have this mechanism of the price system, you’re not going to be able to do it.I’ll tell you a funny story when I first started teaching economics back when I was a graduate student. So, at that time, George Mason, when I went to graduate school there–I went there from 1984 to 1988, and then I was away for 10 years, and then I came back. But in the late 1980s, George Mason went from a school of 10,000 students to 15,000 to 20,000 in a very short period of time. So, we had a parking problem, right? There was a huge problem of parking. So, I’m teaching this giant Principles class, 500 kids, and I say, ‘Listen, I want you to solve the parking problem at George Mason with the price system and only with the price system. Okay?’Now, what sticks out in my head all these years later is the students all came up with solutions, none of which were price-related solutions, but all technical solutions that were in the technical feasibility set, but actually economically ridiculous. So, one of them was: Let’s just divide all of the slots on campus in half and ban all four-wheeled vehicles, and you could only get to campus on a two-wheeled vehicle. So, everyone had to drive motorcycles or bicycles, and then we could double the parking space.The best one–which you’ll laugh about–is that down Braddock Road, you hit into 495, so you have a major thoroughfare right there–build a giant building that has a helicopter on top of it, and the helicopter–students park there and then the helicopter can take them to the main center of the campus and drop them off there.Again, these are all possible. It’s not like Captain Kirk, ‘Beam me up, Scotty.’ They didn’t come up with that.But, what they didn’t do is they didn’t use the price system. I just wanted them to price the spots closer to the campus at a very high price; out by Braddock Road price them at a low price–because at the time, everything was priced the same. So, the students would circle and circle and circle before and they’d be late to class and all the stuff like that.But, that little story tells a kind of a funny thing just about the way in which we sort from the technologically feasible–which is an engineering problem–to an economically viable, which is an economic problem. And the only way we get that knowledge is actually through the competitive bidding-and-asking process, and the failure. It’s like, as you pointed out, in Gambling with Other People’s Money, right? Failure of the market is a major part of the way the market actually operates. It’s not just the profits, it’s: the losses have to be there.Russ Roberts: It’s Milton Friedman–he loved to say, ‘It’s not a profit system. It’s a profit and loss system.’ The losses are, of course–I like the way you said it: it’s discipline; and I like ‘lure versus discipline.’You a minute ago said something along those lines, and I just wanted to remind people, like we said: Not every innovation is worthwhile and some of them are too innovative because they cause losses. They might be brilliant, but they might be before their time and so on.Peter Boettke: That’s the other thing, is they might not be brilliant now, but they might be brilliant 20 years from now when the conditions change in–Russ Roberts: Prices.Peter Boettke: the market by having all these hands. One of my mentors was a guy named Dick Cornell, and he talked a lot about the nonprofit sector, but one of the things he always used to say to me is says, ‘Peter, remember there’s many hands that make up the invisible hand,’ right?Russ Roberts: That’s nice.Peter Boettke: If you just think about it, this is one of the things–Hayek, you were mentioning before: Hayek points out that the costs of what it takes to produce something in the factory have to be discovered anew every day, right? They’re either going to be discovered by the existing entrepreneur, or another entrepreneur that has–what? The freedom to enter and then challenge, right?Russ Roberts: Yeah.54:38Russ Roberts: Let’s talk about Coase for a minute. Coase’s theory of the firm: summarize it briefly and talk about its relationship to the calculation. I thought that was extremely interesting.Peter Boettke: Ronald Coase was a student at the London School of Economics. He was a student of Arnold Plant, who was a very close colleague of Hayek and Robbins. And, Plant would teach about the socialist calculation debate. And Coase as a young student thought to himself, ‘Well, this is kind of weird because if markets are so much superior to planning, why can’t we just have spot markets for everything? Why would we ever have firms? Why wouldn’t we just bid every day for the different resources?’ Well, he came up with the idea that transaction costs–the transaction costs of bidding every day for the resources that you utilize–is too high. The cost of engaging in those exchanges, that’s the transaction cost.Russ Roberts: Meaning that a firm doesn’t use prices internally. It makes decisions about whether to invest in a new thing or not, whether to hire people or not. There’s no markets for half of the things they do. They just make top-down decisions. It’s what a firm is. In theory, that should be a disaster if Hayek and Mises are right.Peter Boettke: Yeah. But, Coase also has the opposite side–which gets further developed by people like Alchian and Demsetz and whatnot–which is that if firms are so good, why can’t we have just one giant firm? Right? There, it’s because of metering and monitoring costs, right? So, you have transaction costs–costs associated with the next exchange that I have to engage in–and then you have these metering and monitoring costs, which is the cost of both overseeing what’s going on in decision-making and measuring whether or not it’s profitable or unprofitable for us if I get rid of the market system. So, Coase found this idea of the firm to be in between these two extremes of USA, Inc. or everyone is their own firm or whatever, their own enterprise.So, we have this notion of firms and he thought that that explained the contractual basis of modern market society, that why you have some hierarchies. So, then transaction costs become a tool for him in conceptualizing: what happens when we lower transaction costs? We get more exchange. What happens when transaction costs are higher? We have more hierarchies. So, there’s firm-ness that’s associated with all this. So, that’s how I would summarize Coase very quickly.57:26Russ Roberts: You alluded to it briefly about wonder, surprise and appreciation; but, in the book, you make a very beautiful connection between the calculation debate and Michael Polanyi’s insights into the philosophy of science. We tend to think of science as: Well, you just go out and you test this theory, and if it’s confirmed by the data, then you’ve learned that it might–you’ve gotten confirmation for it or you’ve increased your confidence that it’s true.But, the Polanyi insight is that: How do you know what to test? It was beautiful to see that that’s similar to the calculation debate. So, explain that.Peter Boettke: Well, Polanyi wrote a wonderful essay that you can find called “The Growth of Knowledge in Society,” and he explains how it is–and, science is essential metaphor for Polanyi and all of this stuff.And, just a little background: Polanyi was a leading physical chemist, and he’s Hungarian, Austro-Hungarian, but Hungarian by birth. But, he was the head of physical chemistry at the Kaiser Wilhelm Institute in Berlin when Einstein was the head of theoretical physics; so they were quite close. Okay. But, what happened, of course, is the 1930s; and so you have to leave, right? So they get out of there as fast as possible. But some of his friends didn’t get out. They might’ve got out from the Nazis, but they didn’t get out from the Soviets. And, both the Nazis and the Soviets wanted to control science for the purpose of the state. Okay?And so, Polanyi started to reflect on the nature of science in a free society. Why is science and scientific inquiry so essential for what we understand to be a free society and how does it contrast with what happens in a planned society? And so, that’s why he shifts–when he moves to Manchester from physical chemistry eventually into philosophy–and has these reflections as you’re talking about. (More to come, 59:30)
