Mon, 02 Jun 2003

The Impossibility of Economic Calculation

How do you make decisions about things when resources are limited? Well, quite clearly you do a cost versus benefit comparison. You decide which thing gives you the most benefit for the least cost. It's not necessarily just dividing and taking the largest number. Sometimes something will cost a very large amount (that you can't afford) and give you a larger unit of benefit per unit of cost than something which costs less that you can afford.

How do you compare the costs of two things? It may seem obvious but the most straightforward method is to compare the prices of them. That doesn't necessarily reflect reality for you, but it comes close. Now, how do you compare the cost of two things which are priceless? It's much, much harder. We normally call something "priceless" when we really mean that there is no price for which we would trade the thing away. Another way people use "priceless" is to mean something whose price is infinite. But that's just another way of saything the same thing.

What you've just done is called "economic calculation". You're using market prices to compare two otherwise incomparable things. Let's say, though, that you're working for a government. You're supposed to purchase some land, to protect it from development. Which land do you purchase, though? Again, you make a cost vs benefit comparison, and you purchase the land which gives you the most benefit.

Now comes the problem. What if the things you're comparing have no prices? If they're literally priceless? Let's say that you're charged with protecting the environment in Massena, NY. Do you dredge the St. Lawrence river to remove PCBs? Or do remediate the soil in the Andrews St. park which is contaminated with oil (actually, I'm just making this one up)? The government already owns the river, and already owns the park. How can it possibly determine the value of the river and compare it to the value of the park, if both are priceless? Nobody is considering selling off the park, nor the river. Both are literally priceless.

Governments cannot make wise economic decisions because they have no basis for comparison. They can ask the voters to create fake prices by polling them, or by asking for a vote. However, people will say one thing, but when they have to expend their own resources, they'll do something else. People will say, not what is best for society, but what is best for them. That's not a prescription for making wise decisions.

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