Commentary on Hayek's ECP and The Dispersed Nature of Knowledge.

The economic calculation problem is concerned with the possibility of rational economic allocation in a centrally planned economy. This is to say, socialism or worse. What Hayek mentions here is a response that many make to the assertion of Austrian economists, saying that with the advancement of technology and the existence of supercomputers, the economic calculation problem is resolved, and thus, socialism and a centrally planned economy can have a rational economic order. This response must rely on the premise that it is possible for all information and knowledge to be available in a single mind, or even a single computer mind. This assumption then, allows the deluded socialist to think that the entire problem of the economic calculation problem is one of a given model, given information, given figures, and that all that we need to do, is input these into a supercomputer, the given model, the given information, and the given figures.

The Hayekian response, and in fact, Austrian response, is that this is a gross misunderstanding of the economic calculation problem. The problem was never about assuming that we magically attain such figures, such subjective preferences of millions if not billions of people. Rather, the entire problem is the discovery process in the first place! The socialist response, given this fact, does not resolve a single issue but all it does is ignore the core problem and assume the impossible. Rather, the response does not even factor in time, which is an element that is crucial to subjective preferences; People do not have static preferences. The entire matter, is that the subjective preferences of people, can never be attained by a single mind or a single computer, this is because of the simple but profound insight Hayek made, and it is that the nature of economic order is one of dispersed knowledge. Knowledge is dispersed, and it is by the mechanism of prices that a spontoneous order can be achieved.

In other words…

Finally, it is important to highlight the importance of prices. Namely, that there are two main functions that prices demonstrate.

1. Prices are information encoded. They are a reflection of relative scarcity in relation to demand.

2. They are the mechanism of coordination in an economy. They allow for a form of communication.

By these simple functions, prices allow for economic calculation. Without prices, there is no information.

A scenario that can demonstrate the importance of prices, while isolating factors and disregarding the deeper complexity of the market for the sake of convienience, is the following:

Company A wishes to build a railroad. This company is given the option to build the railroad with steel, or the alternative, iron. As it is the intention of the businessman to maximize profits by this endevour, one important factor that will determine his choice will be the price of steel and the price of iron. Given this, let us assume that the businessman goes for the cheaper option to maximize profits, the cheaper option being steel. This decision, while rooted in self interest and greed, is paradoxically the option that is better for the economy given that the businessman has unintentionally freed more iron for the rest of the market, allowing other players to use iron for their projects that are valuable for humans. The projects that are in more need for iron can then utilize the iron. This entire scenario is only made possible really through prices, as prices mirror the relative scarcity of resources.

The Hayekian insight is timeless, and it is not possible for a magical supercomputer to destroy the importance of prices nor create an economic order that is rational, one that is not connected to human action.