Now, let's consider Hayek's very famous work on socialist calculation.
The three essays here are called 'Socialist Calculation: I, II and III'
and these date very much from an earlier part of the 20th century
when some nations, such as the Soviet Union
were trying to replace markets
with different forms of central planning.
Ludwig von Mises in 1920 had argued
that these attempts would be impossible
that rational economic calculation under socialism could not happen.
In these three essays, we see Hayek building upon and deepening
the original arguments of Mises.
For the basics of the socialist calculation argument
see our video 'Calculation of Profit and Loss'
from the development economics class
but we've also included it in this class on Hayek.
That video considers whether it's possible
to do rational economic calculation without any reference to prices at all.
The answer, basically, is no.
Hayek covered those arguments in the first of these three essays
on socialist calculation.
Essays II and III by Hayek focus on a more subtle proposal
for managed competition
whereby socialist economies might attempt to mimic
rational economic calculation by other means.
Today, these proposals for managed competition under socialism
are most commonly associated with the name of Oskar Lange
who was a Polish economist of the time.
But Hayek also was responding to some other writers with similar ideas
including Fred Taylor and H. D. Dickinson.
The core point of these proposals is to admit that socialism
would need some kind of business firm
but that the government could instruct these firms to act like competitors.
So, rather than acting like capitalists monopolists
these business firms under Oskar Lange's ideal
would institute a kind of perfect competition
under socialism.
So, in economic terms
you can imagine the managers of those firms
being asked to set price equal to marginal cost.
And Lange claimed that if all the socialist firms did this
they could actually calculate just like capitalist firms do
but without the disadvantages of capitalism.
One of the first questions Hayek raises, of course
is whether this is really planning or central planning at all.
It's starting to look an awful lot like capitalism.
We have firms, we have business prices
we have calculation of profit and loss
we have accounting.
The philosophy of central planning
is really making quite a few concessions here.
Hayek nonetheless thought that these schemes
did ultimately boil down to some form of planning in any case.
And he asked some very particular piercing questions
about how this form of managed competition will work.
Some of those questions were:
What would be the business unit under this managed competition?
Who would be the manager and who would select those managers?
Very important: How do resources get allocated to these firms?
And, also, if these firms start losing money
can they go bankrupt?
And, over time also, how will innovation be managed?
When you think these questions through
you realize you actually do need
some form of capitalism behind this managed competition
or, ultimately, in the final analysis
you can have governments making all of these decisions.
But then, over time, this will look a lot more like central planning.
It's not managed competition.
It's managed competition
where all of the ultimate allocation of resources
all of the changes all of the decisions
finally will rely on the decisions
of some centralized authority
and then we're back to the basic problems
of the socialist calculation debate.
Under capitalism, all of those decisions
such as which managers to hire
how to start innovations, how to close up firms
those are basically handled by private capital markets.
Those capital markets are ruled by calculations of profit and loss
and of course they are decentralized.
That's something very different from planning.
Hayek's most fundamental criticism of this managed competition
gets back to his central point
that knowledge really is the key to understanding economics.
So, what Lange's proposal is doing
is it's assuming that the knowledge of competition
has already been generated
and all you need is some kind of instructions
coming from the central planner
telling firms to act as if they are competitive.
But, in reality, that knowledge is exactly what we need to generate
and to generate that knowledge, you need competition in the first place.
That competition has to be real.
It can't be a game of competition, or play competition
or staged or managed competition.
It has to be competition where people can actually succeed or actually fail
and where capital markets allocate resources
based on these decentralized expectations of profit and loss.
So, here we see Hayek taking an earlier methodological point
that knowledge is the key to understanding economics
and then applying it to some very important
practical issues of his day
namely, the practicability of different schemes
for central planning.