Nominal GDP (NGDP) Targeting and the Supply Chain Knowledge Problem

 Background: The Supply Chain Knowledge Problem

Last year a wrote a post titled The Supply Chain Knowledge Problem addressing what I believed to be some of the core and fundamental drivers of the increase in prices over the last couple years. Describing the knowledge problem as the fundamental problem of economics (and society), 'know how' and 'know what' are spread across many minds and the knowledge required to make anything isn't possessed by any one person, company, or policy maker. And, especially can't be resolved by any central banker. 

In reference to COVID and our economy I used an analogy of an environmental disaster like a forest fire and the recovery of our economy being analogous to an ecosystem. 

"Just as restoring an ecosystem after an environmental disaster requires an understanding of ecology, we must understand the ecology of our markets and supply chains in order to restore our economy and avoid an even worse ecological disaster. We must recognize that the knowledge problem post COVID is more challenging than pre COVID made evident by recent price spikes and shortages that some people could be confusing for monetary inflation."

"COVID and our response to it unfortunately destroyed the ‘know what’ and ‘know how’ that was spread across millions of minds and across decades of building our supply chains. There is no simple blunt monetary or fiscal policy that can substitute for the ‘know how’ and ‘know what’ it’s going to take to rebuild them. It’s going to take time. Prices have to search and signal for the ‘know how’ and ‘know what’ to rediscover and rebuild what was lost."

I have been dreadfully concerned that if we get out of the way and just let 'P' do its job searching and signaling that there would be political pressure to paper over the damage with an excessive increase in interest rates by the Fed, or even worse politicians passing bills in the name of inflation reduction that might make matters worse. And even more dreaded, we'd experience complete economic amnesia manifested by calls for price controls. 

At the same time, a person would be blind not to consider the impact of the expansive monetary policy of the Federal Reserve prior to, during, and after the pandemic, not to mention the aggressive but necessary fiscal response. This made the knowledge problem above seem even more intractable. How much of the current inflation is truly 'inflation' in the monetary sense, and how much is P just doing its job? How can we tolerate temporary price fluctuations and spikes so that P can do its job, and at the same time mitigate what constitutes actual monetary inflation at the same time? 

To this point no economist or commentator has really come close to answering this call of concern. Too few were talking about the fundamental micro foundations of the knowledge problem, and too many had appeared to abandon it completely in pursuit of sky high interest rates. 

Nominal GDP (NGDP) Targeting 

Recently in the essay The Causes and Cure of the 2021-2022 Inflation Surge, David Beckworth provides the synthesis that I was looking for as both a student and consumer of economics. As I read it, NGDP targeting allows us to both address the challenges of monetary inflation while at the same time letting P do its job.

What is NGDP targeting? Beckworth explains:

"NGDP measures total current-price spending on final goods and services in the economy—it is the economy we see in the real world. Put differently, NGDP growth has both real GDP growth and inflation embedded in it. Using this measure creates a monetary policy framework that is called NGDP targeting."

Dr. Beckworth has been carrying the torch for NGDP targeting for quite a while so it's not totally new to me. But I never quite understood the power of it until he put it in the context of our current economic challenges and became the first economist to offer in my mind a satisfactory explanation and policy direction. (As I said above, and full disclosure, I am a consumer and student of economics, not an academic producer of economics, especially not macro, and heavily influenced by the mainline economic thinking of the Austrian, Public Choice, and New Institutional schools).   

In the excerpts below Dr. Beckworth takes the knowledge problem discussed above head on with NGDP targeting:

The distinction, then, between rising inflation caused by supply shocks and inflation caused by excess aggregate demand growth is essential for successful central banking. But therein lies the rub: It is impossible to know this distinction in real time.

So what are central bankers to do? How can they overcome this knowledge problem? 

Instead of trying to divine what part of inflation is due to aggregate demand shocks and should be managed, we should look directly at aggregate demand itself. This approach cuts out the middleman of inflation and goes straight to the underlying source of inflation movements that is amenable to monetary policy.

The amazing thing about this approach is that it provides a clever workaround to the central banker’s knowledge problem. That is, by forcing monetary authorities to focus on stable aggregate demand growth, it keeps trend inflation anchored but allows for temporary inflation caused by supply shocks. 

NGDP targeting allows for price fluctuations caused by supply shocks while still aiming for a stable trend inflation rate.....NGDP targeting, in other words, is a two-for-one deal that gives central banks the inflation cure they are seeking.

He goes on to explain how this approach would have allowed the Fed to get ahead of the curve and act quicker last year regarding monetary inflation and how NGDP targeting can plot a course going forward. This sounds a lot better to me than the rather blunt approaches we have seen to this point with the Inflation Reduction Act and no end in sight interest rate increases that risk papering and plastering over the supply chain problems only to find them again later when we're remodeling our economy after the recession that's projected as a result. Without NGDP targeting, how many remodels can our economy take?

The Supply Chain Knowledge Problem

While current supply chain problems are unpleasant, they really should not be a surprise to anyone that understands the fundamental problem of economics, the knowledge problem. The knowledge problem, originally characterized by Hayek:

"The economic problem of society is not merely a problem of how to allocate given resources....it is a problem of utilization of knowledge which is not given to anyone in its totality."

This can be understood by recognizing that 'know how' and 'know what' are spread across many minds to paraphrase some of the work by economist Kenneth E. Boulding and as discussed in Peter Boettke's Living Economics. The knowledge problem is also exemplified in the words of Leonard E. Read's pencil in his essay I, Pencil, "Not a single person on the face of this earth knows how to make me."

How does this apply to our supply chain issues? Well because 'know how' and 'know what' are spread across so many minds, not a single person on the face of the earth knows how to make anything. As a result, no one has the knowledge to fix our supply chains. Our supply chains are the result of human action but not human design. They are the product of a hidden emergent order. Of course this is a feature and not a bug. As a result most consumers and policy makers usually remain comfortably blind to the knowledge problem and only briefly opened their eyes to notice when the meat counter was empty during the early days of COVID. Many refuse to see on the grounds of political or philosophical reasons, and employ rhetoric and support policy that bites the invisible hand that literally feeds them.

If planners and policy makers have viewed our economy as an engine that would automatically restart after shutting down like the engine of a car at a traffic light, they have committed the folly of every social planner in history. Instead of thinking of our economy and the supply chains that sustain it as a mechanical system that can be engineered by technicians, a better analogy is an evolving ecosystem. Each product we consume and its components have evolved to fit into very specific niches. We must think of our supply chains as habitats that have been threatened by COVID and our response to it.

Just as restoring an ecosystem after an environmental disaster requires an understanding of ecology, we must understand the ecology of our markets and supply chains in order to restore our economy and avoid an even worse ecological disaster. We must recognize that the knowledge problem post COVID is more challenging than pre covid made evident by recent price spikes and shortages that some people are calling inflation. We have to understand that our supply chains evolved over a number of years, even decades, and ‘regrowth’ will take time and things may not grow back to look like they did before.This could mean higher prices now and well into the near future for a number of goods, with some items reaching new higher equilibrium levels as tastes, preferences, and production practices may have changed post COVID. 

But this is not a monetary phenomenon. The stance of monetary policy cannot necessarily be determined simply by the level of interest rates but is a function of money supply relative to demand. Increasing the cost of credit in response to price changes that have non monetary but very micro foundational causes related mostly to supply chain disruptions could be a recipe for disaster. In the same way, we won’t print our way out of the supply chain crisis we are seeing. 

We should also be very careful on the fiscal policy front. Lawmakers are debating a 4 trillionish dollar spending package. We need to go through this with a fine tooth comb to understand how any changes might exacerbate demand given the current supply constraints and ensure that we don’t add additional frictions that would prevent workers from taking a job or businesses from expanding output. It goes without saying that should be very cautious about any hint of price controls during this period of transition.

Additionally we should consider all other supply side frictions including taxes and regulations. We learned during the pandemic the potential of relaxing prohibitions such as those in healthcare which allowed supply to creatively meet demand using telemedicine. What other opportunities exist to help rebuild our supply chains?

Policy makers must think carefully about how to respond going forward. We don't want to add fuel to the fire with misguided monetary, fiscal, and energy policy responses and must be willing to allow new species to emerge as different sustainable patterns of specialization and trade evolve post COIVD. If anything, COVID has reminded us all of the words of Frederick Hayek:"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

Notes and References:

Friedrich Hayek (September 1945). "The Use of Knowledge in Society" (PDF). The American Economic Review. 35 (4): 519–530

Living EconomicsYesterday, Today, and Tomorrow. Peter J. Boettke. 2012.

Who is John Galt....and would he wear a mask?

 It has been said that those that refuse to get vaccinated or wear a mask are acting selfishly. Others are claiming it is a matter of individual liberty and personal freedom to refuse vaccines or to refuse to wear a mask when necessary. (see: https://www.nytimes.com/2021/08/01/opinion/unvaccinated-delta-variant-covid.html?fbclid=IwAR16VNQUky_Ql2s8jIlR_jhg-p9ygt6_MfgsSCnAu5eoZ58sL1tDNi-QZGk). 

"It’s enraging to listen to people complain that wearing a mask or getting a simple shot is akin to an assault on their freedom while children who have no choice bear the brunt of their nonsense."

This makes me wonder, in the ideal libertarian society described as Atlantis in Ayn Rand's Atlas Shrugged, would John Galt have worn a mask or been vaccinated? Would refusing to wear a mask or refusing to get vaccinated be regarded as 'selfish' behavior - frowned upon - or held up as a standard of value?

In her book 'The Virtue of Selfishness' Ayn Rand does not refer to selfishness in the conventional sense. She defines selfishness as the pursuit of one's rational self interest. More specifically, it is to support oneself by one's own effort in non-sacrificial relationships with others. She is very clear that it is not a license to do as one pleases. A 'selfish' brute in the more conventional sense that is motivated by any number of irrational whims, urges, or wishes is not consistent with Rand's standard of selfishness.

To quote specifically:

"the moral purpose of a man's life is the achievement of his own happiness. This does not mean that he is indifferent to all men, that human life is of no value to him, and that he has no reason to help others in an emergency."

To me, COVID19 and the delta variant seem like plausible emergencies where rational self interest and selfishness (at least the way I understand that Rand described it) would very likely mean getting vaccinated and wearing a mask in close places where COVID transmission is likely.

The moral superiority of selfishness is contrasted with the moral cannibalism of altruism and collectivism which are based on the premise of sacrificial relationships between members of society and which fail to recognize that life is an end in itself. Rand writes:

"the principle of trade is the only rational, ethical principle for all human relationships, personal and social, private and public, spiritual and material."

So Rand's ethics implies that in both business and personal relationships, we can practice ethical behavior through non-sacrificial relationships with others, trading value for value in a number of ways that transcend mere market transactions. So how do we apply the ethical principles of selfishness depicted in Atlas Shrugged to the case of COVID? By NOT wearing a mask where necessary and REFUSING the vaccine, one IS refusing to acknowledge the value of other human lives that may be at stake. By contributing to the continuing spread of COVID and its variants, one is fostering sacrificial relationships with others. This is not an exchange that we could say represents 'value for value.' To add some clarity, we are not talking about something minor here like dropping chewing gum on the sidewalk or refusing to clean up after walking one's dog. We are talking about real value for value here (or lack thereof) as it impacts real individuals and not some abstract collective (as Rand would argue - ethics can only apply to individuals). We are talking about putting the health and well being of many lives and the mental well being of children at risk. 

While no claim of authority on ethics is being made here, nor any claim of being an expert in Rand's Objectivism, it seems though that in a rational society like Atlantis, John Galt would have worn a mask and would have taken the vaccine (although others have tried to claim the opposite I am not convinced). Atlantis might have in fact been the first to produce a vaccine (given there would likely be fewer public choice related hurdles to navigate! While there would likely be no laws requiring vaccinations or mask mandates in Atlantis, I have a feeling most folks there taking the oath required to be part of that community would also make the same selfish decision to mask up and take the shot.

"I swear by my life and my love of it - that I will never live for the sake of another man, nor ask another man to live for mine." - Atlas Shrugged

The Problem of Social Cost - COVID Vaccine Edition

Externalities and COVID19

In the simplest way we might define negative externalities as an uncompensated harm to third parties. What does this mean in the context of COVID19? During the pandemic it was possible to unknowingly become infected and either pre-symptomatically or asymptomatically spread it to others. Any behavior you may exhibit going about your daily life could be posing unwanted and uncompensated risks on me and vice versa. These risks and harms could have potentially proliferated throughout the food and healthcare system (as we saw in our food supply chains and currently witnessing in India).

There are a number of remedies for negative externalities. Probably the most well known solution is related to the Coase Theorem named after economist Ronald Coase. In the typical example of environmental pollution, the assignment of property rights and bargaining internalized the externality. Either the polluter pays their neighbors for any harm done, or the neighbors pay the polluter to pollute less. As long as transactions costs are low and property rights are clearly defined both parties can reach an agreeable solution. 

Alternatives to the assignment of property rights and bargaining include taxing or regulating the behavior to get less of it. But without rapid and available COVID testing it was hard to know who to tax or regulate, at least on a person by person basis (and what would that even mean - fines/citations/house arrest?) Similarly, it's hard for two individuals to reach a solution from bargaining.

Unfortunately, this lead to controversial and blunt solutions including lockdowns/shutdowns/capacity restrictions and mask mandates. The genius of Coase was the recognition that externalities are reciprocal. While my pollution may harm you, polluting less harms me. Similarly, shutting down businesses may have reduced the spread of COVID, but it also imposed costs on owners and employees not to mention mental health and other costs. 

Based on field research and game theoretic reasoning, Elinor Ostrom concludes that in many cases social dilemmas like those recognized by Coase can be handled through cooperation:

“If one sees individuals as helpless, then the state is the essential external authority that must solve social dilemmas for everyone. If, however, one assumes individuals can draw on heuristics and norms to solve some problems and create new structural arrangements to solve others, then the image of what a national government might do is somewhat different…National governments are too small to govern the global commons and too big to handle smaller scale problems.”

In many cases we saw and continue to see businesses and other organizations adopting their own related practices to mitigate the risks of COVID. The formation of 'bubbles' and 'pods' are one example. It is an interesting question what social conventions and alternative arrangements to government interventions would have developed in absence of the response we saw from federal, state, and local governments. One silver lining was our system of federalism, that at least allowed different communities to experiment with different ways of dealing with COVID vs a one size fits all blunt federal solution. 

Technology Changes Everything - Vaccines 

Howard Demsetz holds that technology and knowledge play a crucial role in the development and adoption of property rights and the internalization of externalities and social dilemmas:

Changes in knowledge result in changes in production functions, market values, and aspirations. New techniques, new ways of doing the same things, and doing new things-all invoke harmful and beneficial effects to which society has not been accustomed. It is my thesis in this part of the paper that the emergence of new property rights takes place in response to the desires of the interacting persons for adjustment to new benefit-cost possibilities.

Vaccines absolutely change knowledge and tradeoffs about COVID risks and mandate new adjustments to the different cost-benefit possibilities they bring. Once the vaccine is readily available the externality mostly becomes internalized. 

***Once an individual is vaccinated the probability that they can become infected and risk infecting others is very small. They are practically no longer able to pose unwanted and uncompensated risks on others. Likewise, even if a large number of individuals choose to remain unvaccinated, they are no longer able to pose any significant unwanted or uncompensated risks on others if they become infected with COVID. All that is required is individuals are free to obtain the vaccine to protect themselves from those unwanted risks. And those that choose to remain unvaccinated are willingly accepting the risks that go along with that decision.***

Internalizing the externality of COVID does not require herd immunity or that we meet some aspirational goal of vaccinating 70% of the population. There is certainly an additional challenge related to those vaccinated that may be immunocompromised and may not mount the necessary immune response to be protected from the unvaccinated. This calls for a bit more thinking and maybe an additional requirement of a certain percentage of the population be vaccinated and continue mask mandates until that threshold is reached. I'm not sure that percentage is 70%.

***With that exception, given sufficient access and availability, we no longer have uncompensated harms and no longer need the blunt makeshift regulatory solutions (restrictions and lockdowns) or social conventions (masks) we had before.  Sufficient availability means each individual in society has the opportunity to take or avoid the relevant risks of COVID without any need of further restrictions or new social conventions to be built around 'vaccine passports' or the like.***

Instead of putting energy into figuring out a vaccine passport scheme or maintaining excessive restrictions until some large number of people are actually vaccinated, our goal should be to focus that energy on simply making it available for those who want to get it (including children) and combating misinformation about it.

NOTE:  To be clear I am not saying that the unvaccinated pose ZERO risks to others or that they cannot infect other people that are unvaccinated. I'm not saying it is SAFE to be unvaccinated. There will continue to be people infected with COVID if they are unvaccinated and there could still be serious health consequences for some. I am only saying that these risks are becoming willingly accepted and those choosing to go unvaccinated are accepting these risks and the consequences in a way that was NOT POSSIBLE before the vaccine became widely available. The negative effects of COVID cases DO NOT GO AWAY but most of the uncompensated negative effects do go away because those that want to avoid  or at least drastically reduce the risks/costs can easily do so by getting vaccinated. I personally believe there continue to be POSITIVE externalities associated with the vaccine and the more people that get vaccinated the better. I personally received the J&J vaccine. I am in no way whatsoever making an antivax/anti-mask argument, or have intention here to undermine vaccination efforts. 

***UPDATE***  More recent data suggests the tradeoffs have changed. It is not true that those that want to easily avoid the externalities can do so by making the private choice of getting vaccinated. With the new variant and current low levels of vaccination, many more uncompensated harms will materialize.  In broad economic terms the positive externalities (public good aspects) of vaccines extend beyond herd immunity and slowing the spread of the virus to include dampening or reducing new variants. That’s the good news. The negative externalities generated by the unvaccinated extend beyond spreading the virus to selecting for more infectious variants (and of course all the negative health consequences that go with extending the pandemic to include virtual schooling and mental health). We’ve got a long way to go internalizing these externalities.

For example see:  COVID-19 vaccines dampen genomic diversity of SARS-CoV-2: Unvaccinated patients exhibit more antigenic mutational variance. Michiel J.M. Niesen, Praveen Anand, Eli Silvert, Rohit Suratekar, Colin Pawlowski, Pritha Ghosh, Patrick Lenehan, Travis Hughes, David Zemmour, John C. O’Horo, Joseph D. Yao, Bobbi S. Pritt, Andrew Norgan, Ryan T. Hurt, Andrew D. Badley, AJ Venkatakrishnan, Venky Soundararajan https://www.medrxiv.org/content/10.1101/2021.07.01.21259833v1 

References:

The above was a very broad brushed discussion of externalities and the Coase Theorem. For more details see: https://economicsprinciplesandapplications.blogspot.com/2013/03/externalities-coase-ostrom-demsetz.html 

 The Problem of Social Cost. R. H. Coase. Journal of Law and Economics, Vol. 3 (Oct., 1960), pp. 1-44

A Behavioral Approach to the Rational Choice Theory of Collective Action: Presidential Address,

American Political Science Association, 1997. Elinor Ostrom. The American Political Science Review

Vol. 92, No. 1 (Mar., 1998), pp. 1-22

Toward a Theory of Property Rights. Harold Demsetz

The American Economic Review, Vol. 57, No. 2, Papers and Proceedings of the Seventy-ninth

Annual Meeting of the American Economic Association. (May, 1967), pp. 347-359

The Knowledge Problem and Innovation Within Firms

In his podcast Vance Crowe has a discussion with Rick Holton about venture capital and why firms can't innovate. Vance uses a great analogy about the nature of firms and innovation: 

"you think of these large capitalist companies....but once you are inside the walls of a company there's a form of communism that goes on"

This remark is very similar to what Ronald Coase (who won the Nobel prize in economics in part because of his insights about the existence of large firms) said about firms in his famous article The Nature of the Firm. He effectively described firms as little islands of socialism:

"we find “islands of conscious power in this ocean of unconscious co‐operation like lumps of butter coagulating in a pail of buttermilk...Why are there these “islands of conscious power”? 

Indeed why? And how?!  Doesn't this conflict with Hayek? If the very idea of socialism is impossible due to the knowledge problem, then how can firms get away with it? Coase explains:

Outside the firm, price movements direct production, which is coordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur‐co‐ordinator, who directs production....the distinguishing mark of the firm is the supersession of the price mechanism.…“related to an outside network of relative prices and costs."

Innovation happens largely as part of the entrepreneur's (including venture capital) response to the uncertainty that firms face and their inability to 'calculate.' The role of the entrepreneur and profit and loss system (capitalism) is to maintain alignment with the 'outside network of relative prices and costs' or else firms could not exist, and we would have no innovation. 

It's the profit system that allows firms to thrive despite their internal struggle with the knowledge problem. The market, venture capital, and the entrepreneurial response to uncertainty represents a set of institutions for managing innovations that are not possible within the planned economies of individual firms. 

References:

The Vance Crowe Podcast. Rick Holton: Venture Capitalist on failed deals why corps can't innovate & helping the imprisoned. March 15, 2021. https://share.transistor.fm/s/0b9824be  (14:50)

Coase, R.H. (1937), The Nature of the Firm. Economica, 4: 386-405. https://doi.org/10.1111/j.1468-0335.1937.tb00002.

The Use of Knowledge in Society. F.A. Hayek. The American Economic Review Vol 35 No 4 (Sept 1945) p. 519-530

See also: The Knowledge Problem in Firms

What is Socialism?

One of history's most important economists, Ludwig von Mises, writes in In Human Action: A Treatise on Economics about two patterns of socialism:

"There are two patterns for the realization of socialism. The first pattern (we may call it the Lenin or the Russian pattern) is purely bureaucratic. All plants, shops, and farms are formally nationalized (verstaatlicht); they are departments of the government operated by civil servants. Every unit of the apparatus of production stands in the same relation to the superior central organization as does a local post office to the office of the postmaster general.

The second pattern (we may call it the Hindenburg or German pattern) nominally and seemingly preserves private ownership of the means of production and keeps the appearance of ordinary markets, prices, wages, and interest rates. There are, however, no longer entrepreneurs, but only shop managers (Betriebsführer in the terminology of the Nazi legislation). These shop managers are seemingly instrumental in the conduct of the enterprises entrusted to them; they buy and sell, hire and discharge workers and remunerate their services, contract debts and pay interest and amortization. But in all their activities they are bound to obey unconditionally the orders issued by the government's supreme office of production management. This office (The Reichswirtschaftsministerium in Nazi Germany) tells the shop managers what and how to produce, at what prices and from [p. 718] whom to buy, at what prices and to whom to sell. It assigns every worker to his job and fixes his wages. It decrees to whom and on what terms the capitalists must entrust their funds. Market exchange is merely a sham. All the wages, prices, and interest rates are fixed by the government; they are wages, prices, and interest rates in appearance only; in fact they are merely quantitative terms in the government's orders determining each citizen's job, income, consumption, and standard of living. The government directs all production activities. The shop managers are subject to the government, not the consumers' demand and the market's price structure. This is socialism under the outward guise of the terminology of capitalism. Some labels of the capitalistic market economy are retained, but they signify something entirely different from what they mean in the market economy.

It is necessary to point out this fact in order to prevent a confusion of socialism and interventionism."

Mises goes on to elaborate on this confusion:

"The system of interventionism or of the hampered market economy differs from the German pattern of socialism by the very fact that it is still a market economy....these are isolated acts of intervention. It is not the aim of the government to combine them into an integrated system which determines all prices, wages and interest rates and thus places full control of production and consumption into the hands of the authorities."

Politicians among the right and the left will often obfuscate policy debates by confusing or modifying these terms.

Vaccines and the Knowledge Problem

 Below is an excerpt from the blog Marginal Revolution:

"Northam’s health department has also forbidden people from crossing county lines to get the vaccine. If the county next to you has an abundance of the vaccine, you can’t get it. Only residents of that county may get their vaccine.These new rules will result in many people either having their vaccination appointment canceled or delayed for months." 

https://marginalrevolution.com/marginalrevolution/2021/01/our-virginia-regulatory-state-is-failing-us.html 

Vaccination clearly represents a public good and arguably falls within one of the legitimate roles of government. That means socially planned vaccine distribution. Chic-fil-A knows how to distribute chicken sandwiches efficiently through their drive through during a once in a hundred year pandemic, but government bureaucrats do not (and fundamentally can not! ) know how to distribute vaccines during a once in a hundred year pandemic.

Socially planned vaccination will demonstrate all of the key characteristics of social planning and socially planned economies: delays, shortages, excess, waste, abuse, arbitrary rules etc. This is NOT a partisan anti-government rant, or even a subjective personal point of view. It is an objective quality of bureaucratic decision making that no economist can deny. It's as much the nature of social planning as it is the nature of dogs to bark.

Socialism Can't Calculate

At the root of these unfortunate consequences is what economist Frederick Hayek characterized as the knowledge problem. Governments allocate resources in a fundamentally different way than individuals do in through the price system. The result is a well coordinated spontaneous order guided by prices that reflect tradeoffs based on the knowledge and preferences of millions of individual decision makers. Governments (via democratic processes and social planning) allocate resources based on the limited knowledge and preferences of a few voters, elected officials, or appointed bureaucrats. The fundamental problem facing all forms of government including democracies is that centralized decision makers never have enough information or proper incentives to act on the information at hand. That's the knowledge problem. Its not just a problem for governments, its also one of the biggest challenges faced by firms too.

Socially planned economies could never achieve the level of knowledge coordination required to give us things we take for granted today like smart phones:

   

 Or even something as simple and basic as pencils:

   

So What is the Answer? Federalism.

The fact remains that vaccination is still a public good and falls squarely and solidly within the scope of government decision making. Operation Warp Speed is a great example of how the national government can achieve some success in this space. By incentivizing production and largely getting out of the way from a regulatory perspective the national government was actually able to facilitate ways for private firms to step in and solve the knowledge problem related to vaccine discovery and production. These kinds of public private partnerships are a model for at least reducing the information loss associated with social planning writ large.

So we are forced into a socially planned vaccination effort. The good news, in the United States at least, instead of putting everything at risk with a single national plan, we get 50 chances to get it right, one in each state. While no one state will be able to necessarily avoid the knowledge problem, some may do better than others and we can learn from successes and failures getting closer to an approximation of the feedback mechanisms provided by the price system. This is one of the strongest arguments for our constitutional republic and federalism that our founders envisioned. 

By flirting with the nirvana fallacy and we might claim that a single national plan would be better than 50 different inconsistent plans - especially if some states prove incompetent. While we might argue that one set of planners (or administration) at the national level could get better results than another (enter political partisanship) that doesn't change the fundamental nature of the knowledge problem. Maybe there are economies of scale that the national government can realize, or maybe it has access to better resources or leadership with more expertise. Would these gains make up for what is lost in the local knowledge that states and counties have that the federal government could never grasp? Devolve as much decision making as possible to the most local level possible. Cooperation between national government, private enterprise, and local initiatives is probably the better answer. In fact, the current approach of the federal government incentivizing the development and purchasing a large supply of vaccines while allowing the states to distribute according to their own plans is consistent with this federalist approach.

Diversification is our best hedge against the the many risks of socially planned decision making. And it's probably the greatest reason our system of government has been able to tolerate a mixed economy as well as it has the last 50 years or so. 

Milton Friedman said: 

"the ballot box produces conformity without unanimity, the marketplace produces unanimity without conformity."

Our experience with a socially planned vaccination effort should provide teachable moments we can point back to in the future when politicians propose planning other aspects of our economy that aren't necessarily national emergencies or public goods. We don't want to introduce unnecessary fragility into our lives by creating unnecessary dependencies on plans whose relative failure or success has to rely on who's in charge. 

Note: In no way should any point above be used as an argument to undermine the effort to vaccinate the public at large.  This is not intended to be a criticism of the current vaccine effort or government. In fact the current approach is largely consistent with the ideals of federalism discussed above. This essay is meant to be totally descriptive and comparative. Getting to 70% + herd immunity is vital to fighting the pandemic. It's a huge public good and every effort by state, federal, and local government agencies and private institutions and individuals deserve great applause. We cannot expect to hold the performance of socially planned efforts against the standards of the price system in terms of their relative ability to solve the knowledge problem. The above is not an attempt to do so, but to illustrate the fundamental differences in resource allocation under a system of social planning compared to the price system. The distribution of vaccines provides a palpable illustration. Neither should this in any way imply that government employees and bureaucrats are incompetent. Everyone responds to incentives. The issue is incentive alignment.

Reference:

The Use of Knowledge in Society. F.A. Hayek. The American Economic Review Vol 35 No 4 (Sept 1945) p. 519-530

More about markets and the knowledge problem:

Models and Assumptions: Efficient Markets, Imperfect Information, Rationality, and Prices 

Economics, Evidence, and High Causal Density

 

 Related:

The use of knowledge in disaster relief: http://www.independent.org/publications/tir/article.asp?a=628

The Government's Response to Hurricane Katrina- A Public Choice Analysis: http://www.peterleeson.com/hurricane_katrina.pdf