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Socialism Actually Works:
a New Defense of Free Markets

Stephanie Herman | 4.15.12



Back in the 1700s, there was a loosely-connected group of men trying to figure out how economies worked. They theorized and wrote and came up with some good ideas. We've named this group of men the classical economists, but alongside their good ideas, they put out one pretty horrendous clunker: they believed that the value of an item was based on its cost of production.



This meant that whatever went into making it -- especially the labor -- determined its value. So, if it took a long time to make, it was worth more. If it was expensive to make, it was worth more. You get the idea.

Of course, there were obvious flaws with this "Labor Theory of Value" -- what if you decided to build a chair, but didn't really have any chair-making skills? It takes you four days to make a rickety chair, while the chair expert down the street can pump out two sturdy chairs in one day. Would your unfortunate, structurally-challenged chair really be worth MORE than your competitor's sturdy chairs, just because it took you forever to build it?

Well, no, and the classical economists recognized this, too. Common sense tells us that the value of a chair is REALLY based on what the consumer thinks of it. But the classical economists stuck to their guns -- rejecting consumer value in favor of the costs of production -- because they faced a puzzle that they couldn't solve.

The puzzle was this: if value really WAS based on what the consumer thinks of the item, then why is a diamond worth more than water? Everyone knows that water is necessary for life. And everyone knows that diamonds aren't necessary for anything life-saving. They're for decoration! Surely if value really DID come from what the consumer thinks, then the value of life-sustaining water would be much higher than superficial diamonds.

And yet, it isn't.

So, the classical economists gave up on the idea of a consumer-based value theory. The Labor Theory of Value, instead, lived on for about a century.

But another group of men came along, at the end of that 100 years, trying to figure out how economies worked. We've named this group the neo-classical economists. They were suspicious of the Labor Theory of Value, and intrigued by the whole water/diamond puzzle. So they theorized and wrote and came up with some good ideas. And three of these men, living in different countries and unaware of each other's work, solved the puzzle, each on his own, within three years of one another.



Their solution is known today as the concept of marginal utility, and it means that people don't value water as a life-giving class, or diamonds as a non-life-giving class. They don't value any commodity as a class. They value every commodity based on the satisfaction they get from it at the margin -- from the last unit they consumed.

Imagine the satisfaction some woman received the last time she got a diamond ring. And compare that with the satisfaction she got from her last encounter with water -- perhaps, when she brushed her teeth this morning.

Of course, underlying your satisfaction at the margin is the fact that your marginal utility will be higher or lower based on how many units of a resource you have, or how many units exist in the world, at large. And so, scarcity becomes an important factor in the value of any item. Water becomes much more valuable to you -- maybe even more valuable than diamonds -- when your well runs dry.

Because of this discovery, neo-classical economics, for the most part, displaced classical economics. The neo-classical school took what it liked from the Classical school, and took off in a new direction.

But -- just as the classical school had its one horrendous clunker, so did the neo-classical school: it's the idea that most everyone participating in an economy is fully rational, fully informed, and fully optimizing.

We know this isn't true. The beanie-baby craze showed us that. But because of this horrendous clunker -- this belief that economic actors have perfect knowledge and perfect optimization -- there is a whole swath of the voting public that dismisses neo-classical economic models as realistically impossible. This swath of the voting public is better known as the Left.

The Left is partial to socialism, and socialists have never embraced neo-classical economics because their idol, Karl Marx, WAS a classical economist. Marx not only supported the Labor Theory of Value... he turned it into a revolutionary movement.

So you can imagine that the socialists would never buy into any school of thought displacing classical economics. Marxism is grounded, built upon, and stuck firmly WITHIN classical economics.

But -- the socialists aren't the only ones critical of the neo-classical idea that people are fully maximizing, perfectly informed economic machines. There is another, less-well-known group of economists. They particpated in the discovery of marginal utility that overturned classical economics, but they avoided the pitfalls of standard neo-classical theory. We've named this group the Austrian economists.



The Austrian school put forth the idea that economics is based on normal, and yes, even FLAWED everyday human behavior. Mises called it Human Action. Human action is whatever we do to achieve our ends -- our goals. But human action -- because it is HUMAN -- is never fully informed, and is never fully optimizing. And while human action may be fully rational, what's 'rational' will vary from person to person.

Austrian economists believe that an economy gels and interacts and grows and self-organizes and coordinates and prospers and progresses not because its participants are super good at human action. Austrians believe it's something else, something FA Hayek called "spontaneous order."

But spontaneous order isn't just an Austrian school discovery. It was first noticed by the father of the classical school -- Adam Smith. He noticed that as economic partcipants went about their daily routines, pursuing their own self interest, the economy gelled and interacted and grew and self-organized and coordinated and prospered and progressed, and all this benefitted the society as a whole. Smith called this unknown force of emerging economic order the "invisible hand."

Spontaneous order, Adam Smith's 'invisible hand,' is the OPPOSITE of socialism. Socialism requires somebody (usually in government) to organize it... a "community organizer," for example. Socialism requires planners to decide what resources to allocate where, how to price commodities, and how much income to distribute to each type of worker, manager, not to mention the planners, themselves. Socialism requires a form of elitist planning that Hayek called a Fatal Conceit, and Tim Harford calls the "God Complex" (check out his TED Talk; it's awesome). Socialism kills spontaneous order because it is, by defintiion, an attempt to make order planned and imposed and enforced -- anything BUT spontaneous.

And this is primarily because socialists deny that spontaneous order even exists.

But does it exist? And wouldn't the whole debate over free vs. planned markets move in a completely new direction -- perhaps even go away -- if we could somehow SHOW that spontaneous order not only exists, but works?

In answering this question, we can point to the fact that spontaneous order isn't just an economic idea. Complexity theorists -- scientists -- have been studying spontaneous order since the 1980s. Stuart Kauffman is a theoretical biologist and complex systems researcher, who writes:

"Laws of complexity spontaneously generate much of the order of the natural world... We have all known that simple physical systems exhibit spontaneous order: an oil droplet in water forms a sphere; snowflakes exhibit their evanescent sixfold symmetry. What is new is that the range of spontaneous order is enormously greater than we have supposed. Profound order is being discovered in large, complex, and apparently random systems." (At Home in the Universe)

In fact, in his optimization experiments, Kauffman has seen the 'invisible hand' of spontaneous order in action.

Kauffman created a simple computer framework -- a lattice-like grid -- composed of lots of tiny squares. Each square represents an individual actor that switches back and forth between two states: 1 and 0.

Kauffman was interested not in how the individuals would behave in isolation, but when combined into quilt-like patches of varying sizes. This is what individuals in complex systems, like economies, generally DO: they separate themselves into patches or small groups. A family. A small business. A partnership.

Kauffman then instructed the squares (the individuals) to make decisions (1 or 0) but there was a caveat: The rule is that you -- the individual -- can only make a switch if it benefits the patch to which you belong.

First Kauffman made the entire lattice-grid into a single, giant patch, something he called the 'Stalinist limit.' In this scenario, no individual square can switch unless it benefits the whole, entire patch. Kauffman described this scenario as:

"We all must act for the benefit of the entire 'state.'"

So what happened? Well, when the grid was small and not very complex, one big patch worked. But when the grid was expanded and became more complex, all of the individual squares FROZE into an unchanging state.

This is socialism. This is Marxism -- a centrally planned COMPLEX system that freezes up and cannot work.

Next, Kauffman let each square be its own patch. Before switching, each individual square would decide to swtich based on the states of its four immediate neighbors. In this scenario, chaos ensued, and the frenetic switching back and forth went on without the emergence of any order, at all.

This is the chaos that the Left assumes will occur in a free market. Mother competing against child. Neighbor vs. neighbor in a cut-throat game of profit seeking and one-ups-man-ship.

But -- this is not the end of the story.

Kauffman then tried a middle ground: patches of varying numbers and sizes... the way the real world tends to organize itself. The result was that coordination and order did emerge in this scenario. This is what he found, in his own words:

"When the system is broken into well-chosen patches, each adapts for its own selfish benefit... No central administrator coordinates behavior. Properly chosen patches, each acting selfishly, achieve the coordination..."

His overall conclusion, again in his own words:

"[C]ontrary to intuition, breaking an organization into ‘patches’ where each patch attempts to optimize for its own selfish benefit, even if that is harmful to the whole, can lead, as if by an INVISIBLE HAND, to the welfare of the whole organization."

Understanding that spontaneous order does exist, we know that we essentially have two different ways of achieving a well-ordered, prosperous economy -- you can have order emerging from the self-organizing behavior of self-interested individuals in small groups, or you can have order imposed by central planning. The next question is, which way works better? The answer is, it depends.

Remember, Kauffman showed that at a low level of complexity, you CAN impose order with central planning. Socialism can work. But, the situation depends on something fundamental: it depends on SCALE.

Like Kauffman said, socialism works great in environments that aren't very big or very complex -- like a family. And families do tend to enjoy a communal lifestyle. They share in the overall prosperity of the family and genuinely seek out the common good for family members. They also share in the family's work, although some of the work shares may have to be forced upon the younger members. Planning for the family is generally top-down and authoritarian. The family is a perfect size for socialism to thrive. Think about it: almost every family you know is a purely socialist entity.

But just because it works on the small scale -- in a family -- doesn't mean it will work on the large scale -- for an entire nation. Socialism, like many other things in nature, is scale-dependent.

Let's step back and think about the concepts of small and large. We naturally look for connections between them, the microcosm and macrocosm. Atomic particles circling a nucleus resemble planets orbiting the sun. Vehicles flow through motorways like blood cells through arteries.

But when comparing the micro and the macro side by side, size does matter. James Gleick illustrates why in his book, Chaos, "Imagine a human being scaled up to twice its size, keeping all proportions the same, and you can imagine a structure whose bones will collapse under its weight."

In an environment that remains constant, transposing an object from one scale to another creates problems of context. A 12-foot human might thrive on a planet with a 50,000-mile circumference, but a 12-foot human on Earth collapses under its own weight. Household management scaled up to the national level can pose similar contextual problems. That's one reason socialism is problematic. If you see socialism as the application of family-sized economics at the national level (where the parents own the family's means of production and income is shared), problems of context emerge.

One explanation for the failure of large-scale socialism is that the family structure is scale-dependent; enlarged, it collapses under its own weight. Families, communes, and tribes are the optimal size for fostering loyalty and love (the incentives to work for one another); it's much more difficult to engender brotherhood among millions. In his book, Small is Beautiful: Economics as if People Mattered, a non-Austrian economist named Schumacher, said the same thing:

"...it is true that all men are brothers, but it is also true that in our active personal relationships we can, in fact, be brothers to only a few of them, and we are called upon to show more brotherliness to them than we could possibly show to the whole of mankind."

Austrian economics and complexity theory show us that, as a system grows bigger and becomes more complex, order can only be achieved by allowing self-organization to take place. On a large scale, you can't central plan. Instead, you need an economy full of patches: families, family businesses, small businesses, partnerships... who will create the economic order you're looking for.

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