Sunday, September 21, 2008

Economic Calculation

In his seminal article on economic calculation under central planning, Mises showed that a central planner cannot allocate productive factors in a manner consistent with consumer demand because the planner does not have the ability to calculate in terms of market prices. Market prices come about as the result of a competitive bidding process among decentralized private property owners who are seeking to earn profits.

In some cases, firms are not just being bailed out, they are being nationalized. Nationalization means that the ownership of the firm changes from the private sector to the government. This puts the Fed, or the Treasury, or whoever becomes the de-facto owner of these firms, in charge of them.

While the nationalization of the health care sector, the coal industry, the airlines, or any other industry would be bad enough, the nationalization of a single industry mainly destroys the ability of that industry to allocate capital rationally. But even within that industry, they have access to external market prices for their inputs and their outputs. And nationalized firms can still adopt technological advances that are generated by the competitive part of the economy.

The role of financial institutions within a market economy is to allocate capital. Banks, for example, borrow from small depositors and lend to home buyers or small businesses. Investment banks invest the equity of the share holders in asset markets, facilitate the issuance of new securities, and manage the capital of private investors.

This is why the recent round of bailouts of financial institutions is so damaging. The impact of these nationalizations is multiplied compared to the takeover of an industrial sector because the capital allocation function is so critical to a market economy. Financial institutions do not produce a physical good, they act entrepreneurially within the total capital structure of the economy to allocate productive factors. In no sense can this entrepreneurial function be replicated by a central planner operating outside of the profit and loss system.

Some related news stories:
  1. Borrowing $700 billion of taxpayer funds to make taxpayers owners of bad mortgages. If we are to be forced to own the mortgage industry, couldn't we at least own the good mortgages? Russian Roulette with other people's money.
  2. Little idea what we are really doing. I mean really doing: Law of Unintended Consequences kinda stuff. Watch gas prices soar, etc.
  3. Patronage Plan under cover of Martial Law: struggle over details. Struggle over calculations. Note what the article discloses as two crucial details of the administration's plan to rescue the financial system: First, distressed securities would be purchased by the Treasury Department through a "reverse auction" system, in which sellers would set the minimum price they'd be willing to accept from the government. This would seem to create the most lucrative patronage imaginable, for there's no telling how the government's purchasing agents might decide what to buy and at what price. Indeed, since there is no market for these securities and the government itself will be making the market, purchases will be entirely a matter of government favor; government fiat. Second, the purchasing system would be, like the U.S. Exchange Stabilization Fund, beyond review by any court or other regulatory agency. That is, the system would have no accountability at all, unless, perhaps, Congress wanted to look at it eventually or change the law. In effect it would declare martial law throughout the U.S. financial system and the economy at large.
  4. Martial law? Isn't that a bit extreme? Well, you tell me. Section 8 of "The Plan" essentially states that whatever the Treasury does is above the law. America: a nation of laws?
  5. Which Presidential candidate would help get us out of this mess better? This article gives some perspective: it's just not a happy perspective.
  6. US Taxpayer a Giant Dumpster for "Illiquid Assets" (aka "Crap").
  7. "The Plan" is not good.

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