Thoughts, essays, and writings on Liberty. Written by the heirs of Patrick Henry.

“A man is none the less a slave because he is allowed to choose a new master once in a term of years.”     Lysander Spooner

December 7, 2008

Why Nationalization Damages Liberty and Prosperity

by tarran

Many progressives are looking forward to increased government oversight over the auto industry. They see this as a chance to influence the types of vehicles that are produced and to dictate that production be turned to socially beneficial uses, including the manufacture of green cars that auto manufacturers are not manufacturing. These vehicles are not manufactured presently because car manufacturers see bigger profits in continuing to produce SUV’s and more cheaply built sedans. Viewing this judgment as short-sighted, progressives are overjoyed at the prospect of including non-monetary considerations such as ecology or social needs in deciding what to produce. We who oppose the nationalization are viewed either as being too stupid to recognize the benefits of introducing considerations other than profits to production decisions, or as being wed to outdated economic theories or to be apologists for fat-cat capitalists.

This is incorrect. Rather, the progressives who support nationalization are being very short-sighted and are threatening to return society back to feudalism and are threatening to destroy the development of new technologies, technologies that will be vital to improving our standard of living while reducing the amount of pollution and natural resources needed to maintain such comfort. This not hyperbole but rather simple fact.

The problem, which has plagued all fascist and socialist economies throughout history, is that nationalization destroys the ability of the economy to rationally allocate capital goods and invest in the future. It is this incapability that is behind the phenomenon where communist countries seem to become mired in the past with stagnant technology, bare shelves in shops and factories that routinely fail to meet production quotas.

If asked, a manager of a factory in a communist country will explain that his inability to meet quotas arises from some combination of three factors:

1) Lack of tools or equipment that is in poor shape.

2) Insufficient labor.

3) Lack of inputs such as raw materials or semi-finished goods.

4) Sabotage.

We can set aside aside sabotage, which should equally affect capitalist economies (since according to socialists, they should have a larger share of disgruntled or exploited workers).

It is safe to concluded that any failure of centrally planned economies to meet consumer demand should be primarily due to the impact of the first three reasons. As we shall see, like electricity and magnetism, these three factors are really the manifestation of a fundamental failing of centrally planned economies, one which progressives ignore at their peril.

Under central planning, rational economic calculation becomes nearly impossible. It is impossible for a manager to calculate whether one process or another is ‘better’. Complex processes become unwieldy, and slowly, as capital equipment deteriorates, the economy grinds to a halt.

Economic Calculation: Chapter 2

The explanation as to why this occurs may be found in a paper written by the economist Ludwig von Mises in 1920 titled, Economic Calculation in the Socialist Commonwealth.  In this post, I will summarize some of his arguments.  I highly recommend that everyone who is curious read the original paper.  For a more in-depth analysis of how prices are used in economic production, I strongly recommend Chapters 4 – 7 of Murray Rothbard’s Man Economy and State.

In a free market, most economic activity consists of a cycle of a person or firm acquiring the inputs for some form of production, using them to make something or provide some service, and consuming or exchaning the result of the production to others.  In acquiring the inputs, and disposing of the produced goods or services, the producers typically engage in indirect exchange, trading money for the inputs, and selling their product for money.  The use of money trades for inputs and outputs gives rise to prices.  These prices play a critical role in allocating resources and promoting investment.

Everything economic activity that people perform is intended by the actor to satisfy some need.  The higher the value that individuals assign a particular need, the higher the price they are willing to pay for the goods they must consume to satisfy the need.  This attracts producers who wish to manufacture these consumption goods  and sell them.  These producers must acquire the inputs from which these consumption goods will be manufactured.  The prices that these 1st order producers are willing to pay for the inputs they desire will be impacted by the prices that they expect for their product. The producers who intend to produce consumption goods that are in high demand will be willing to bid higher prices for the inputs they desire.  There may be producers who wish to produce goods that are not as highly demanded.  This latter good cannot profitably employ the inputs whose prices were bid up by the former group of producers.  They will look for substitute inputs. If continued indefinitely in the absence of technological change, this process will lead to a sort of equilibrium where the inputs available to producers are being used to support the satisfaction of the highest priority needs as expressed by individuals.  And this process is repeated for higher order goods: the inputs needed to produce the goods that are inputs to lower order processes.  When one considers that the same good can be simultaneously useful in processes that are lower order or even intended for consumption and higher order processes.  For example, stainless steel can be desired by a man who wants to make cutlery, a person who intends to use it to make reactors for a pharmaceutical plant, who wants to produce artworks etc.

The production matrix required to produce three consumer goods

The production matrix required to produce three consumer goods. Note that the same high order good (green) is required to produce the three goods. In the absence of a price system, the planner has to guess when and how much of various goods he must produce - an impossible task for an economy consisting of millions of goods and people.

The existence of prices mediates between the wide range of uses the goods can be put to.  The prices also inform investors, advising them of weaknesses or shortages in the matrix of production.  It informs them of whether a proposed new business or factory will be socially useful or a waste of resources.  In a free market, shortages are signaled by high prices, and activities that will satisfy the most urgent of needs are rewarded by high profits.  Moreover, while no individual or group of people can simultaneously hold in their heads all the information needed to rationally allocate a complex basket of goods to their optimal uses, the price system allows a single individual to rationally allocate the goods that he or she controls trading them.

When an industry is nationalized, these price signals are at a minimum distorted, and – in extreme cases – can even be lost entirely.

A nationalized industry no longer needs to worry about prices.  The state commandeers resources and awards them to the nationalized industry.  It decrees the prices at which suppliers must sell goods to the industry and issues quotas as to how much they will have to supply.  It decrees the quantities and price of the produced goods.  It makes production decisions politically, ignoring the unmet needs in greater demand to satisfy lower priority needs.  If only one industry is nationalized, but the rest of the economy remains free, the managers of the nationalized firm may still have access to prices as set by the economic activity of the free sectors with which they deal.  However, the more thorough the nationalization, the less dependable the prices are, and the less information managers of the nationalized industry have available to them when deciding how to allocate production.

This is the reason why shortages appear.  A shortage in a free market leads temporarily to higher prices, which encourages other producers to enter into the market and spurs existing producers to increase production in an attempt to capitalize on those prices. When a shortage does not result in a higher price, it takes the instructions of a central planning board to order the producers to increase production.  In the absence of such orders, there will be no meaningful attempt to increase production to mitigate the shortage.

Even if the planners do give the orders, it is much less likely that the orders will be obeyed.  All actions come at a price to the actor.  A factory manager who decides to extend the factory’s hours of operation by four hours a day must spend time making arrangements for this change.  He must monitor the extra hours of work.  In order to do this, he sacrifices leisure time.  The laborer who works harder to increase production must sacrifice something to achieve that extra burst of effort (a person will not limit their work voluntarily if they would value harder work more).  This phenomenon is called the disutility of labor. The disutility of labor acts as a brake on economic activity.  In the absence of a reward for extra effort, people will not forego other uses for their time.

Immediately after nationalization, the workers and managers can continue executing the activities they did prior to the nationalization.  However, the world is not static.  Peoples’ needs change. New sources of raw materials are discovered and old sources dry up.  In a free market, these changes would result in price changes that would signal to producers and consumers which goods were more available and which were more scarce, pointing the way to more efficient allocation of the available resources to their current needs.

In the absence of prices, these changes would be manifest themselves with shortages and gluts.  One would see factories producing unwanted goods that filled up warehouses, while goods that were desired would go unproduced.  We would see workers assigned not to the factories that would make the most profitable use of them, but to factories that used them less profitably.   The result would be shortages in labor in some industries, while other industries were so well staffed that they were assigning people make work.

This misallocation of labor and production does not explain the fact that heavily nationalized economies seem to have very few gluts and a great deal of shortages.  Under the above model we should be seeing the shelves of markets with too much milk and too little meat, instead of bare store shelves.  Why should nationalization, in practice, be associated with shortages and not surpluses?

In the absence of a price system, there is no way to rigorously determine if a new venture will be usefully productive or not.  There is no way to rational way to calculate whether or not a new idea for producing existing goods is a good idea.  Nor is there any way to identify whether a new class of goods is worth producing.  There is no way to rationally decide when to pause production to replace or upgrade equipment.  There is little incentive to invent or make improvements.  People who do come up with good ideas have little incentive to put them into practice.  In many cases they lack the means to do it – they lack access the the planners who decide what it to be done.

This is why a nationalized industry typically will stagnate, with necessary improvements not being made and innovations being largely absent.  Without the information conveyed by present prices, it becomes impossible for managers to invest wisely in preparation for the future.  A nationalized industry will typically struggle to maintain production – using factories that are aging and using methods that are not evolving with time – to produce goods that are often of no better quality than those produced when the industry was nationalized.

What innovation that does take place is the innovation recommended by the central planners.  The central planners typically have only a rudimentary sense of the impact of the innovation they want to see made.  they have trouble judging how much effort to allocate to R&D, and how much to maintain their capital stock.  The central planners can foster innovation or make improvements – as has happened with the U.S. and Russian space programs.  But they will neglect vast areas under their purview.   The lack of incentives to preserve the value of capital goods such as land is also the reason why in nationalized economies there is a high degree of environmental degradation.

And, being human, the central planners will make their decisions based on what profits them personally.  A manager who identifies a method to manufacture the same number of cars with one quarter the employees would in a free market profit hansdomely by so cutting his manfuacturing costs.  A manager who would lose status and take a pay cut for supervising fewer people would not make adopt such a plan.  In fact, he might torpedo attempts to adopt such a plan in order to preserve his empire.

Thus we see why central planning is associated with stagnation, inefficiency and privation.  The lack of innovation and declines in production inevitably lead to poverty.

If we apply this to the auto industry, it would not be surprising to see car companies producing first generation hybrid vehicles that require massive subsidies while not making any effort to produce second or third generation cars that would be more environmentally sound and easier to maintain.  Rather than trying to attract customers with improvements in the product, they will attempt to placate the oversight boards appointed by the U.S. congress.  Consumers will choose to purchase vehicles from competing companies who are making decisions independently of the planning board.  Naturally the planners will call for and be granted legislation that handicaps these competitors or forces people to purchase vehicles from the car companies that are under oversight.

The result is inevitable,  a smaller selection of more shoddily built and undesirable vehicles that only meet the most basic of needs.

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  1. This is all well and good, but think of how fun it is to say Car Czar. It’s even fun to spell.

    Comment by Joshua Holmes — December 7, 2008 @ 4:52 pm
  2. Great post, you nailed this topic.
    Extra points for referring to Mises’ “Economic Calculation in the Socialist Commonwealth”.

    It really is a simple concept, but so many historians, politicians and economists totally miss the point.

    They think communism collapsed because Mao and Stalin were dictators who didn’t hold democratic elections and allow political opposition.

    The real reason is that they were economic dictators. Without prices and voluntary exchange, you just cannot allocate resources.

    Comment by Jono — December 7, 2008 @ 5:49 pm
  3. Great post, as usual…

    What I don’t think most people understand is just how hard it is to price a product. The average person talks about how these producers “set” prices. Most people think that prices are set by “cost of inputs + cost of labor + reasonable profit”. Businesspeople who have such a mistaken assumption don’t remain in business very long.

    I’ve been planning a post on this fact recently, taking the anecdotal evidence of my wife’s new business and applying it to a more general discussion of pricing. Most people’s belief of pricing is completely backwards, and I think a greater understanding would really help people not call for some of the stupid policies they advocate.

    Comment by Brad Warbiany — December 8, 2008 @ 5:09 pm
  4. Did it ever occur to anyone that the consumer might be *wrong*

    Right now, what the average American consumer is demanding is for a vehicle which makes them feel safe and protected, with comfortable seats to cushion their ever expanding asses as they go about their daily tasks living in their disgusting urine coloured, vinyl-sided sub-division.

    Since nearly every errand requires driving, a reliable vehicle is important.

    Driving to the end of their driveway to check their mail, dropping their precious snowflakes off at school (Joe sixpack is too good to let his kids ride the bus), or perhaps hopping on the interstate to get sloshed at the nearest franchise operated “sports bar”, like Fuddruckers.
    Because this is Ummerica, where even if something is withing walking distance, people would laugh at you for not driving.

    Fuck Joe Sixpack, he doesn’t know what the hell is good for him, and the market signals he generates are hurting the rest of us by distorting demand.
    He will continue to use incandescent bulbs until he can’t buy them anymore at Wal*mart, because he clings to sameness and generally just doesn’t give a shit.

    Market signals go in both directions — merchants influence the consumer.
    Why the hell do you think Joe Sixpack is such a miserable slug in the first place?
    Why does he buy an SUV? Because that is what is sold at every dealership everywhere.
    If you could buy a hybrid car everywhere, and they were cheaper, then they would be much more popular.

    Besides, much of the innovation of the 20th century happened because of massive government investment.

    Comment by progressive technologist — December 9, 2008 @ 9:57 am
  5. Progressive Technologist, mein fuehrer, why didn’t I see it before? Of course the people whose tastes and decisions you disagree with are wrong and must be ruthlessly overridden with force.

    Incidentally, you might want to try fitting two government mandated child-safety seats into the back of a fuel-efficient sedan – you’ll then see why so many people opt for minivans and SUV’s.

    Comment by tarran — December 9, 2008 @ 4:39 pm
  6. Fuck Joe Sixpack, he doesn’t know what the hell is good for him, and the market signals he generates are hurting the rest of us by distorting demand.
    He will continue to use incandescent bulbs until he can’t buy them anymore at Wal*mart, because he clings to sameness and generally just doesn’t give a shit.

    That’s where you’re wrong. Joe’s wife, Jane Box-o-wine, saw on Oprah how important compact fluorescent bulbs are, so they’re going to buy them.

    And then, as tarran points out, they’re going to take their three kids out in the SUV because nobody wants to fit three kids in the back of a damn Prius (or even a Civic or Accord).

    I, as Brad Craftbeer, choose not to buy compact fluorescent bulbs because I am still renting where I live, and right now I won’t spend enough in the cost of the bulb or electricity to make it worthwhile. I choose, for economic reasons (that will change as soon as I buy my own home) to buy incandescent instead of “saving the environment”.

    Comment by Brad Warbiany — December 9, 2008 @ 5:10 pm
  7. brad, note that the guys who choose to buy stuff that fuhrer progessive technocrat likes are ‘distorting the market’.

    No doubt an ‘undistorted market’ would produce the things that our dear leader wannabe thinks people should have at the quantities he thinks they should have.

    Comment by tarran — December 9, 2008 @ 6:23 pm
  8. [...] but the problem here is that the Constitution doesn’t give the executive branch the power to centrally plan the economy.  But the Constitution hasn’t exactly stopped Bush from doing stupid and bad things before, [...]

    Pingback by Tyranny from the Treasury « Against Tyranny — December 12, 2008 @ 2:59 pm

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