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Planning for When the Market Cannot
The “knowledge problem” is real, but a more practical approach is needed for navigating the challenges of government planning.
The ardent anticommunist intellectual Raymond Aron, when asked to describe the excesses of “liberal [libertarian] economic orthodoxy,” pointed to its reflexive hostility toward any kind of government planning. In this worldview, observed Aron, planning is seen as “the beginning of servitude, if not misery. Planning becomes inherently evil, just like Marxists view capitalism as evil.”
Indeed, for Friedrich Hayek and his followers, government planning was the root of all tyranny. Twentieth-century fascism, for instance, was not the contingent result of economic collapse, war, historical circumstances, or specific ideological developments—it was the inevitable outcome of government planning. And those who advocate for government planning, said Hayek, “can think of nothing better than to imitate Hitler.” Not only is the quality of any particular plan irrelevant, in this vision, but the planning of Hitler or Stalin differed from the planning of the Roosevelt administration only in degree.
Since the end of the Cold War, this anti-planning orthodoxy has in some ways hardened further. Not only Soviet-style efforts to ration resources and micromanage firms by centralized diktat, but also the traditional efforts of liberal democracies to ensure investment in long-term economic and social priorities are now gathered under the “planning” heading and treated as indistinguishably awful. At least savvier neoliberals such as Milton Friedman were once able to admit that the U.S. government’s direction of the economy during World War II was beneficial (and that government planning for such an overriding strategic purpose generally could be). Hayek himself famously allowed for basic social insurance and specifically defended “planning for competition”—using the state to create or reinforce market mechanisms. Today’s market fundamentalists, however, brook no such concessions. Ambassador Nikki Haley recently argued in the Wall Street Journal that policies like “more tax credits here, more subsidies there, more mandates for this, more regulations for that” represent a “watered-down or hyphenated capitalism, which is the slow path to socialism.”
The critics do not understand their critique. The theoretical basis for their objections is Hayek’s “knowledge problem,” which has become widely accepted, even by many who do not share Hayek or Haley’s politics. But the knowledge problem is not generically applicable to all forms of planning, and its indiscriminate use reduces the complex issues surrounding planning to a misleading binary of planning versus liberty that sets every policy discussion on the slippery slope toward tyranny.
The fact that government planners are not omniscient is obvious, but it does not automatically follow that planning is always ineffective. Perfect information is simply not a precondition of successful planning in either the private or the public sectors.
The essence of Hayek’s argument is that no central planner could possibly aggregate, process, or act upon information as efficiently as decentralized participants respond to the information and incentives conveyed by the price system in competitive markets. Not only will a central planner allocate resources poorly, but the mere attempt to do so will impede the progress and utilization of social knowledge. Government planning, seen in this light, is not simply inefficient but inherently arbitrary and oppressive.
On the surface, the argument that government cannot plan effectively because it cannot possess all the knowledge dispersed across society seems at once philosophically elegant and a matter of common sense. But this argument is based upon a non sequitur, and the categorical rejection of planning that results from it is ideological overreach. The fact that government planners are not omniscient is obvious, but it does not automatically follow that planning is always ineffective. Perfect information is simply not a precondition of successful planning in either the private or the public sectors.
The information that is conveyed by market prices is also severely limited. Price signals, even when perfectly undistorted, are not sufficient for either businesses or government to allocate resources effectively, much less do they engender a “spontaneous order” that is the best of all possible worlds. The fact that government is not subject to market competition does introduce unique perils, but it also creates unique opportunities and even duties. Unfortunately, metaphysical speculation about the “knowledge problem” cannot help us to understand either. A more practical approach is needed for navigating the problems and limitations of government planning, as well as the circumstances in which it is necessary and beneficial.
The Problem with the Knowledge Problem
The most common modern objection to government planning begins from the premise that, in Hayek’s own words, “the ‘data’ from which the economic calculus start are never for the whole society ‘given’ to a single mind which could work out the implications and can never be so given.” The assertion that no central planner can possess all available knowledge is hardly controversial. What too often escapes scrutiny, however, is the assumption that such knowledge is necessary to plan effectively in the first place. The historical record makes clear that it is not.
Nonetheless, several generations of libertarian writers have continued to repeat derivative “knowledge problem” arguments. Consider, for example, a recent essay by Richard Reinsch in National Affairs:
In a 2006 paper, economists Howard Pack and Kamal Saggi laid out a list of suggested questions that federal bureaucrats would have to be able to answer in order to successfully implement the sort of industrial policy many economic nationalists now seek. For example, they would have to identify which sectors have a long-term comparative advantage, which benefit from dynamic scale economies, which firms and industries generate knowledge spillovers, and what the magnitude and direction of inter-industry spillovers would be.
This is just a tiny sampling of the types of questions federal agencies would need to confront, the answer to each of which is time-sensitive, detailed, and discoverable only in pieces by certain actors with deep and regular experience in very particular sectors. Uniting all the answers into some coherent, communicable whole is virtually impossible. This leaves us with the question of how best to approach such questions: via individuals and firms working for their own self-interest, who are heavily dependent on prices and the desire for profits to guide their decisions; or via state actors imposing blunt general directives on industry?
All this may be part of the catechism in the cloisters of libertarian nonprofits, but it is completely at odds with practical experience. Indeed, it is possible to argue that these very questions have been ignored by every successful implementation of industrial policy, which is surely planning insofar as it requires the setting of goals and the development of policy in their pursuit, but which includes no Party functionaries deciding how many pounds of screws to send where.
It certainly would not have been possible to identify any “comparative advantage” in Taiwan’s semiconductor industry before the Taiwanese government essentially created it, nor in South Korea’s semiconductor, shipbuilding, or auto industries before its government undertook ambitious industrial policies. Likewise, it is possible that the Chinese Communist Party perfectly calculated “inter-industry spillovers” before directing billions of dollars in state subsidies to Huawei, but even if it did, that calculation probably has little to do with the company’s present dominance of 5G components. And the same is true for Israel’s defense technology sector, America’s biotech sector, and countless other examples past and present. Whatever knowledge is necessary to conduct an effective industrial policy, “uniting all the answers into some coherent, communicable whole” is simply not part of it.
If anything, government intervention—and thus planning—becomes more necessary when less market and industry knowledge is available. If a project’s commercial prospects (dependent on factors such as comparative advantage and potential commercialization across different or new industries) are easily known, then risk is low and investor capital is cheaper and easier to raise. But if a project’s commercial prospects are only dimly perceivable, then it may simply be impossible to raise capital from economically motivated investors, no matter how important the effort. Thus governments typically must take a leading role in critical areas like basic research and the development of infant industries, among many others.
If anything, government intervention—and thus planning—becomes more necessary when less market and industry knowledge is available.
Perhaps, as Reinsch implies, any enterprise unable to raise profit-driven investor capital should not exist. But then it is hard to imagine how thriving U.S. industries built on everything from radar to the space program to the internet would have materialized, or how so many of the companies built via the Asian development model have come to be world leaders. The reality is that many technologies and even entire industries now recognized as foundational or world-leading—including ones that ultimately generated massive commercial profits—required government support at some stage. Had the vast profit opportunities of all these technologies and industries been known prior to their creation, then no government involvement would likely have been needed to produce them. It is precisely because indicators like the potential for commercialization across industries are often unknown and unknowable, however, that government funding and planning can sometimes prove valuable.
Planning also plays a vital role when knowledge, even if available, is of no interest to the private sector. Nations have a wide range of goals beyond the maximization of profit, which the most perfectly free and efficient market will make no effort to achieve. In such situations, it is absurd to reject the planner’s imperfect efforts for lack of knowledge and opt instead to rely upon private actors behaving like perfect imbeciles.
None of this is to say that government intervention is always necessary or desirable—only that the extent of “knowledge” possessed by the planner is not a helpful guide in deciding whether it is or not. What differentiates governments (at least those that borrow in their own currency) from the private sector is that they are not constrained by internal profits or external market forces. They can, therefore, take on much greater economic risk than any private-sector actor, which allows them to fund important but highly prospective endeavors. Of course, the danger inherent in such freedom from market discipline is that governments may fund counterproductive activities—maintaining corrupt patronage networks, attempting to realize ideological fantasies, and so on—indefinitely. That danger is real, but it has very little to do with a lack of market knowledge among the planners. One might raise precisely the same concerns of corrupt patronage networks and ideological fanaticism, and indeed find them realized right here in America, among a governing cadre that has forsworn planning entirely. The availability of “knowledge” is simply not a useful metric for evaluating the soundness or unsoundness of any particular government plan.
The Price Is Wrong
In fairness to Hayek, his own critiques of government planning were more subtle than those of his epigones today. Hayek’s principal argument was not that central planners would fail to achieve their goals because they could not properly identify comparative advantage or calculate the magnitude and direction of inter-industry spillovers. He largely rejected the pretensions and presuppositions of neoclassical and marginalist economics, and recognized that a lack of perfect knowledge did not make planning impossible in either the public or private sectors. Instead, the main problem with government planning, he argued, was that it prevented the spontaneous coordination of individual plans via market competition.
The crucial function of the price system, as imagined by Hayek, is that it enables the unconscious coordination of many decentralized individual plans, despite the imperfect knowledge and intentions of each actor. Thus, market competition allows for the maximum utilization of knowledge and best allocation of resources for society as a whole. Government planning, regardless of whether any particular project succeeds or fails, undermines this unconscious coordination.
But do market prices actually accomplish what Hayek claims they do? Tellingly, abstract theoretical discussions occupy much more of Hayek’s attention than any actual, practical commercial activity. Consider one of the few practical examples given in his canonical work, “The Use of Knowledge in Society”:
Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system. . . . The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all.
Central to Hayek’s theory of the price system is his claim that the users of any given commodity do not need to know why its price has changed. They simply need to observe the price change in order to adjust, allowing the entire system to maintain its harmony without any conscious design. All the information necessary for the system to function, in other words, is communicated by the price change itself.
Only a lifelong academic like Hayek could possibly believe this. In fact, all but the most trivial buyers of a material need to know the reasons behind price fluctuations to allocate capital effectively in response. If, for instance, the price of tin in Hayek’s example changed because of some temporary and random phenomenon, the buyer might simply seek to mitigate the effects of large price fluctuations by purchasing hedges from a financial institution. If, on the other hand, the price change was related to the buyer’s transport and warehousing costs, he might look for other distributors. If the cause was the exhaustion of the mineral resource, he might invest in switching to another input material. If it was due to the formation of a monopoly or cartel, he might lobby for antitrust action or attempt to develop another source of supply. Other tin producers, likewise, will need to know the causes of price movements and ascertain how long a new price level is likely to last before investing substantial capital in the development of new resources or curtailing existing production. Price signals alone simply do not communicate sufficient knowledge upon which to base the most important economic decisions. Even the arbitrageur—a figure who occupies a prominent place in both Hayek’s writings and today’s financialized economy—requires information about the reasons behind price differences to know whether an opportunity will persist long enough to execute the arbitrage.
Only a lifelong academic like Hayek could possibly believe this. In fact, all but the most trivial buyers of a material need to know the reasons behind price fluctuations to allocate capital effectively in response.
Hayek’s notion of knowledge discovery and market competition fundamentally confuses rationing and investing, but there is a difference between the two. Price competition often (though not always) works well for rationing, or deciding who gets what in the present, which need not require a view of the future. The same is not true of investing capital, which requires taking (more or less) risk on a (more or less contrarian) view of the future. Long-term investment capital (and thus productive capacity) simply cannot be prudently allocated on the basis of price signals alone. Hayek’s spontaneous order, in more than one sense, has no future.
Hayek also fails to consider the possibility that the price of tin may have changed because a foreign government banned exports. Or, to make the example timely, what if a foreign government begins subsidizing a strategic industry, resulting in lower returns on domestic investment in that industry? Following price signals and market incentives alone will ensure that domestic investment evaporates and leadership in the industry shifts to the foreign competitor. Perhaps this doesn’t matter—consumers should just take advantage of these subsidies, according to one argument. But what if the foreign government subsequently threatens to cut off medical supplies in the midst of a global pandemic, supplies which can no longer be produced in one’s own country as a result of the failure to counter the foreign subsidies?
In short, the price system offers no guarantee of optimal—or even adequate—social knowledge coordination or capital allocation. Market prices are just as likely to transmit the interventions of hostile foreign governments as the workings of some benevolent spontaneous order. Indeed, it is an act of blind faith to imagine that any such order exists at all.
Because slavishly following market signals does not always produce the best of all possible worlds, government planning does not always represent the first step on the road to serfdom. Indeed, a healthy market economy often depends upon sound government planning, and sound government planning often intentionally strengthens the private sector—from Hamilton’s National Bank to the Homestead Act to various New Deal programs to Defense Department research funding. Contra Hayek, government planning does not automatically lead to tyranny; if it did, the American experiment would have failed long ago. But any political community that cannot plan for its own collective future is neither free nor self-governing in any meaningful sense—and probably cannot remain wealthy for long.
Overcoming Secular Dogma
Ultimately, Hayekian critiques of government planning are compelling only insofar as one is willing to ignore practical reality. His theories may have been adequate as anti-Soviet propaganda, but they are completely useless as a guide for policy. To be sure, attempting to maintain Gosplan-like control over the economy or to eliminate all market competition would be utterly foolish and in practice impossible. One does not need Hayekian theory to recognize that. The ideological antipathy toward all government planning that such theories inspire, however, has been devastating to America’s political economy and strategic position during the last few decades.
Yet no matter how many strategic industries are lost, or how obvious the deterioration of broad swaths of the country has become, another market theodicy is always being written. In this sense, as Aron suggested, Hayekian libertarianism—and much of the economic thinking dominant on the right for decades—is best understood as an ideological project akin to Communism. As political movements, both rely more on secularized theology than any serious reading of history or intelligent analysis of policy. Both are, in the words of Karl Löwith, “essentially, though secretly, a history of fulfillment and salvation in terms of social economy. What seems to be a scientific discovery . . . is, on the contrary, from the first to the last sentence inspired by an eschatological faith, which, in its turn, ‘determines’ the whole sweep and range of all particular statements.”
Thirty years after the Cold War, it is time to stop performing Hayekian morality plays. Instead of pretending to dwell in the spontaneous order imagined in theory, we should give ourselves permission to start planning and building a healthier political-economic order in reality.See more from this series
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