A Note on Socialism and the Business Cycle

To the contrary of many claims, the socialist state, or the command economy derived under socialism is most definitely not free from those boom and bust cycles that is generally thought to be avoided. While almost all economists even in the Austrian tradition have thought that the socialist economy is exempt from these business cycles, this is not the case.

Even such advocates of the Austrian business cycle theory such as Ludwig Von Mises and De Soto shared this common view, however, even when looking at the empirical data this is false.

Empirical Data

In Kornai’s 1992 study it was observed that certain command economies in a measurement period from 1960 to 1989 had wild fluctuations of annual investment growth, some counties include Yugoslavia which stood at 278%, Poland at 187% and Hungary at 171%, these were wild annual investment growths retrospective to the capitalist economies included, which had Ireland at its highest value sitting at 159% annual investment growth.

Based on the lack on informational availability in command economies it is no uncommon these jolts can occur, when a miscalculation happens and the situation needs to be adjusted, but this can’t be isolated and adjusted, the whole economic processes need to adjust from how interconnected productive processes are, and thus if there is a mistake in the central planning’s judgment, things will need to be constantly readjusted, leading to the economy having to be kickstarted over and over.

Winiecki states the following conclusion:

“The FYP (Five Year Plan) typically starts with significant built-in distortions in its investment component. These distortions exercise, over time, an increased pressure on aggregate equilibrium…shortages multiple and excess demand begins to grow.”

It was observed that the traditional peaks of the boom was about three years into the plan, where planners began to recognise the production processes put into action cannot be covered by real savings, and thus many are liquidated and a depression begins.

But this is only empirical data, so what about the theory? This still does not vindicate the claim that socialist economies are void of the business cycle, for two particular reasons, first, the planners inability to access the totality of all localised or private knowledge about consumer wants leads to a lack of information about market phenomena contained by the central planner, and thus he would not be able to sufficiently understand the opportunity costs or trade offs made in production regarding say the substitutability of capital goods or which capital goods are required to form the most valued capital combinations and which capital goods are needed in combinations elsewhere, this will lead to irrationally high and more roundabout production to target higher economic growth, which is the exact same thing that happens when central banks mess with credit expansion, issue false money unbacked by real savings, shift the supply of loanable funds creating a lower interest rate and thereby increasing the structure of production as this is interpreted as a higher future profitability.

Second, as a planner necessarily sets arbitrary signals and fixed amounts rather than allowing cohesive local knowledge to form monetary calculation, the planner will always necessarily be completely unaware to supply and demand shocks of a certain product. Only when these shocks become EXTREMELY obvious at an aggregated level will the planner be aware.

These longer, more roundabout production structures caused by an allocation through higher growth targeting by the central planner as representations of the fault signalling described in the traditional austrian business cycle theory, when the planner has faulty signals based on the lack of private information he comes to acquire then he artificially increases the length of the production structure on a fault assumption of a lower time preference, tying more capital goods into production and moving the first stage further from the last by increasing the amount of intermediary stages and thereby the complexity of the structure, this leads to growing prosperity until it is realised these capital structures cannot produce their intended end consumption good, and thereby as all value of capital goods are necessarily derived from the total value of that consumption good discounted by the waiting period of production (or interest) then capital goods lose relatively all value unless they can be substituted to other uses that fulfil the needs and wants of consumers.

As these central planners necessarily need to have variables large enough that shocks within their internal economic conditions are observable as an aggregate, they will divert recourses arbitrarily into courses of production with larger observable aggregated magnitudes, and thus make a trade off sacrificing the less observable costs of production, which misses a whole load of local information demanded by consumers, and thus the trade offs under production will be even more arbitrary than what the economic calculation problem previously thought.

To see an example of these aggregative measures we can look to the capital intensity of certain command economies such as the Soviet Union and China, for higher capital intensity it was aimed at a higher output capacity while reducing inputs, to do this in the Soviet Union they placed the machine-building industry on top priority and directed more capital to that industry for more material savings technology, about 40% of the technological processes developed were said to consist of no substantial variation in technological growth. The same can be said of China which in an evaluation of each FYP since 1981 has emphasised the importance of a more capital intensive production structure and yet excess levels in primarily industrial sectors remains increasingly high, and not to mention that since 2007 China’s overall aggregate capital-output ratio has steadily increased.

Marxism and Local Knowledge

Marxists and their contemporaries believed that the development of modern industrial society would lead to the decreasing relevance of localised knowledge based on the development of interconnected communication between each member of society, under this consideration it was believed that soon local knowledge would become.

Now given the clear flaws in attempting to formulate economic growth through this method the board will turn to extensive long term growth as previously noted, and as this necessarily follows with a lack of local information replaced by that of general knowledge through intertemporal communication communication.

Obviously however, technological development has not come even relatively close to this complete transparency in intertemporal communicative transfer of local knowledge. While any technological development absolutely may render some form of local knowledge previously utilised to a high capacity in the division of labour obsolete and useless, much like automation it simply then creates more local knowledge about the interworking of conditions on that subsequent development, thus technological development will always lead to an expansion of local knowledge much to the contrary of the Marxian hypothesis.

Thus, central planning boards accumulated information must rest on five formulations in which differs from true, real world conditions which are:

• It covers only informational knowledge that is of relevant social interest The knowledge known by the planner necessarily leaves out nondeclarative knowledge and only refers to aggregative measures rather than the subjective knowledge of each actor
• These aggregative measures typically remain static until a large observable shift in its properties are reflected through macro-aggregates
• These measures must always be aggregated based on 2
• These aggregate measures are generally standardised

Under real world conditions where knowledge must constantly adapt on the local level, with the central planners blindness to anything beyond these large variations reflected through the aggregates in place he will be unable to adapt to these local conditions, and thus the necessary knowledge to establish a prosperous economic order will never occur under a central planning board.

Now, given the clear flaws in attempting to formulate economic growth through this method the board will turn to extensive long term growth as previously noted, and as this necessarily follows with lack of local informational. accumulation then they will point towards larger aggregates and plan a PPF outside of full employment, thereby setting unsustainably high growth rates.

For any productive processes to occur it always requires inter-temporal coordination of the production structure, when factors of production are purchased they only have value in so far as they can contribute as a means to an end in the production to the final output, the consumption good, all higher order goods derive their value equal to the final output of the productive process. These outputs represent future goods while the purchase of capital goods are present goods, consumption must be abstained in order to allow for a longer productive process. These arbitrary growth targets are thereby distorting signals reflected through the capital structure and guided by interest on the rate of time preference.

To reflect this necessary decrease in consumption and increased investment I like to use an example proposed by Roger Garrison. Robinson Crusoe, alone on an island has no other food supply than simply fish, and in order to keep himself alive he needs to consume this available food supply, but sticking constant to this production process allows for no real growth, so what Crusoe must then is save fish, let’s say he consumes a daily average of 2 fish, but he wanted to expand the production process, he may gather 20 fish over a weeks period and instead of consuming his normal 2 fish everyday he reduces his consumption to one fish a day and saves the rest, he then invests his time and energy into constructing a fishing rod, but to do this he has sacrificed his ability to catch fish, only because of his previous reduction in consumption of fish is he able to have the available resources to keep himself alive and simultaneously construct this fishing rod. After this process is completed, he can now catch let’s say 50 fish in two weeks instead of the traditional 20. Meaning real growth has occurred, he can now consume and invest more into different lines of production, and thus real economic growth begins.

Thus, we can show that even while credit expansions and monetary systems won’t exist under a socialist system this growth targeting is analogous to the interest manipulation described in the Austrian Business Cycle theory. Both signals are indications of the social rate of time preference, thereby making artificially high growth rates synonymous to that of artificially low interest rates by credit expansion increasing the supply of loanable funds. More capital will be shifted into more roundabout production structures which causes a subsequent disequilibrium between the supply and demand for goods and the aggregate capital appraised to be necessary to complete these processes.

As these failures into productive processes become evermore manifest in the aggregated statistical data capital will have to be shifted into the areas previously less manifest in opportunity costs and thus the more roundabout production will be put on hold or rendered incomplete as they will have to curtail the capital invested in these structures, and from this follows a depression.

Socialist Error Cycle Theory

This was proposed as a better reformulation of the business cycle theory to the previously described ‘consequentialist’ austrian business cycle theory, it was said this theory was unsatisfactory as so long as beings are necessarily compromised by free will, the correctness within the substance of any action is antecedent to its consequences. It was said that the traditional claim that increases in the money supply would cause entrepreneurial malinvestments is not sufficiently justified under the consideration that these variations can be forecasted, this is what’s called ‘the rational expectations’ critique.

In a boom period there is a significant amount of actors who in an intertemporally make the same mistakes, referred to as a cluster of errors, the socialist error cycle theory then takes the question of what causes these errors as a sort of ‘ultimate given’, so rather than explaining how these errors come to be, it becomes a question of how do we analyse and explain the continuous repetitive errors of individual actors, which is said to be an error inherent in the subject independent of spatial-temporal system which is referred to as ‘the illusion.

In the case of the socialist error cycle theory this institution is the state, the illusion referring to the idea that society is unable to function without the use of force institutionalised by the state.

So long as we take the government to be this illusory institution then it directly follows that so long as it exists, and the further its outreach the more actors will make erroneous behaviours regarding saving, investment and the loanable funds market. Under a socialist consideration where the illusion controls all of economic considerations of higher order goods, this is where the illusion will be most manifest, and thereby the erroneous behaviours of the subsequent actors is also most manifest. Under central planning this is a centralised manifestation of the illusion, and thus the business cycle is not necessarily an issue of interest manipulation exclusively, but rather a more general problem of centralised state intervention.

Attempted Refutations

Some refutations to this theory were presented, generally on a few grounds.

• The view the state is an arbitrator of aggression can be easily refuted by one not consistent with this line of thought
• Aside from the aforementioned ABCT, only two examples of this centralised illusion are provided, first in the ‘military-imperialistic cycle’ and second the ‘social security cycle’
• The central characteristic of the business cycle doesn’t necessarily need be the aggression of the state, but rather the blindness of the central planner to local information

Some Essential Characteristics of a Business Cycle;

• An expansionary impulse through credit expansion/growth targeting
• This leads to a distortion in the socially aggregated social time preference which is followed by
• Malinvestment
• Excess demand for products
• Curtailment to fulfill this excess demand resulting in liquidation of those more roundabout capital structures

Conclusion

While Mises has presented an extremely important argument with his Economic Calculation Problem that should under no circumstances ever be taken out of discourse, this follows in the knowledge problem, and from the knowledge problem then follows the dynamic implications of both the ECP and the knowledge problem manifested in the business cycle. While the central planner may be blinded in a sea of local knowledge, unable to coordinate this structure, it will be able to see a very limited degree of this information, but as this is not static and constantly changing it will always necessarily result in a misallocation of capital to certain production structures. Leading to continuous overestimation of growth targets and thereby bubbles that will burst when it becomes known through aggregates that capital must be curtailed and expended into different sectors.