Big data and artificial intelligence may not make pure command or socialist economies any more feasible

Economic systems can be considered to fall along a continuum. At one end is the pure market economy, where the government only provides the basic rule of law, enforcement of contracts and property rights, and some public goods. All property and the means of production are private owned. At the other end is the pure command economy, where the government is responsible for all key production and consumption decisions, and owns most property and the means of production, on behalf of citizens.

All modern economies fall somewhere in between these two extremes, and most developed countries are closer to the market economy end of the continuum than the command economy end of the continuum. That shouldn't be a surprise. Market economies have been incredibly successful over the past century and more, while socialist and command economies have mostly fallen away. [*] However, long before it was apparent that the command economy was a slow-motion train wreck, it was heavily critiqued by the Austrian school economist Ludwig von Mises, in his famous paper Economic Calculation in the Socialist Commonwealth (originally published in 1919, then translated to English in 1920). Von Mises essentially argued that money and money prices provided the information that was necessary for the market system to function efficiently. Because a socialist economy lacked money prices, a socialist planner could not properly coordinate the economy in as efficient a manner as would be achieved in the market economy. Von Mises concluded that "rational economic activity is impossible in a socialist commonwealth".

The difficulty of rational economic planning by a central planner was brought home later by economics Nobel Prize winner Leonid Kantorovich. In a story I first read in Tim Harford's book Adapt (which I reviewed here), Kantorovich applied linear programming methods to the production and allocation of Soviet steel for a single year (it is mentioned briefly in this biography of Kantorovich as well). Solving this problem using complex mathematics took several years. And that was for a single (albeit large) industry. For a single year.

However, computing power and computer science methods have progressed significantly since von Mises' and Kantorovich's time. The availability of big data, machine learning algorithms, and artificial intelligence might suggest that command economy planning will become more feasible. Not so, according to this new article by Karras Lambert (George Mason University) and Tate Fegley (Montreat College), published in the Journal of Economic Behavior and Organization (sorry, I don't see an ungated version online).

Lambert and Fegley go back to the original arguments of von Mises and outline how the basic problem of economic calculation is not resolved by big data, increased computation, or artificial intelligence. Specifically, they note that:

Can “big data”, absent the market pricing process, generate a commensurate cardinal unit with which to meaningfully compare costs and proceeds of productive actions? Does it provide a mechanism for translating ordinal preferences into commensurate cardinal numbers? Does it give a central planner the capability to engage in entrepreneurial price appraisal without genuine market prices for goods of all orders? The answers are evidently no on all counts. As a result, “big data” itself, while undoubtedly a useful tool for entrepreneurs operating within a market system, cannot replace the pricing process or render unnecessary private ownership and ex- change of the means of production.

The key point for me is that big data and algorithms, by construction, are based on past data. The most useful data for planning are data that come from the decisions of consumers and producers. If we moved from a market economy to a command economy, the extant data would become progressively outdated over time. Eventually, relevant data necessary to estimate big data models and algorithms would not exist at all.

It seems to me the argument about whether the pure socialist or command economy is feasible needs to be set aside for a while yet. Perhaps we come back to it when we get artificial general intelligence, or where we get so much computing power that we can simulate entire people, with all of their preferences, quirks, and sub-optimal decision-making capacities.

*****

[*] Some might argue that China is a counter-example. However, when you look at the characteristics of the Chinese economic system, it looks much more like a market economy than a command economy. Indeed, it is not so much a socialist or command economy, but socialism with Chinese characteristics.

Why the destruction of two Death Stars might not have bankrupted the galactic economy

I deliberately avoided any news about Star Wars until I saw the new movie, with the consequence that there was a lot of Star Wars related stuff in my to-be-read pile when I got back from holiday. One of those was this paper by Zachary Feinstein (Washington University in St Louis). Bloomberg covered the paper, as did Mark Johnston in his blog.

In the paper, Feinstein estimates the cost of constructing two Death Stars (the one destroyed in the Battle of Yavin in Episode IV: A New Hope, and the incomplete (but operational) one destroyed in the Battle of Endor in Episode VI: Return of the Jedi). Feinstein estimates a cost of $193 quintillion ($193,000,000,000,000,000) for the first Death Star, and $419 quintillion for the second Death Star. He then estimates the size of the galactic economy (Gross Galactic Product, or GGP) at $4.6 sextillion per year, and then estimates the cost to the galactic financial system of the destruction of the two Death Stars. He concludes:

In this case study we found that the Rebel Alliance would need to prepare a bailout of at least 15%, and likely at least 20%, of GGP in order to mitigate the systemic risks and the sudden and catastrophic economic collapse. Without such funds at the ready, it likely the Galactic economy would enter an economic depression of astronomical proportions.

In other words, the Rebel Alliance may have won, but they also lost because the galactic economy would implode. Nice.

However, there is one (unstated) assumption on which the analysis is based, and that is that the galactic economy is based on a capitalist model, with infrastructure spending funded through bonds sold on relatively open financial markets. Now, perhaps somewhere the economic system of the Galactic Empire is explained in detail, but it certainly isn't in the movies (and Wookiepedia doesn't have a lot of relevant detail). And when I think about the Empire, I don't expect capitalism to be the economic system of the day (this in spite of the Trade Federation and the InterGalactic Banking Clan being represented on the Separatist Council in Episode II: The Clone Wars (see here)).

The Empire is clearly autocratic, and while that doesn't necessarily imply a low degree of market orientation, it seems to me that Imperial control of the means of production is rather more likely than not, particularly in the case of building large planet-destroying infrastructure and conducting a campaign to eliminate the Rebel Alliance. Moreover the rise of the Empire involved an immense increase in governmental control, and we know that planned or command economies are a powerful tool for enacting and enforcing economic change, so it should not be a surprise if the galactic economy (at least on those planets closely controlled by the Empire) was a command economy.

Now, because command economies have greater control over the means of production, they can apply resources to 'grand projects', and are often more successful than market economies at doing so. So the Death Stars could have been constructed by decree, with resources (labour, capital and materials) re-deployed from other uses (but at significant opportunity cost in terms of the reduced availability and quality of consumer goods). Raising significant funding through financial markets might not have even been necessary, in which case the Death Stars could have been constructed without a large systemic risk to the galactic financial system.

As a side note on the galactic financial system, according to Wookiepedia, at the end of the Clone Wars, "control of the Banking Clan was ceded to the office of the Supreme Chancellor"). So the Empire had direct control over the largest bank in the galaxy - it was effectively a state-owned bank.

Finally, a couple of other quick Star Wars related notes. The Free Exchange blog has a great post on the economics of the Star Wars universe, especially trade. Well worth a read. As for The Force Awakens, I had low expectations for it, and I guess my expectations were met. Like many, I was disappointed that the plot was essentially wholesale recycled from the original trilogy. However, there was something else that bugged me that I couldn't put my finger on. Until I read this critique, which pretty much nailed it.

Joseph Stiglitz on high frequency trading

I’ve had the occasional disagreement with my more left-leaning students about my views on markets. Usually, they’ve gotten the wrong impression of where I stand, which is that although markets are usually a good thing, there are limits. One of the things that has always quietly concerned me has been the way that financial markets work (or sometimes, fail to work). So, when I read this piece by Joseph Stiglitz (2001 Nobel Prize winner), I was quite happy to see that we share some disquiet in this area. Overall, Stiglitz appears to be quite negative on the effects of high frequency trading.

The paper is very readable (not uncommon based on other writing by Stiglitz I have read), even for those who are not technically inclined. Some highlights:

High frequency trading… is mostly a zero sum game—or more accurately, a negative sum game because it costs real resources to win in this game...

A market economy could not operate without prices. But that does not mean that having faster price discovery, or even more price discovery necessarily leads to a Pareto improvement… it is not obvious that more trading (e.g. flash trading) will result in the markets performing price discovery better...

…there may be little or no social value in obtaining information before someone else, though the private return can be quite high… And because the private return can exceed the social return, there will be excessive investments in the speed of acquisition of information.

…if sophisticated market players can devise algorithms that extract information from the patterns of trades, it can be profitable. But their profits come at the expense of someone else. And among those at whose expense it may come can be those who have spent resources to obtain information about the real economy… But if the returns to investing in information are reduced, the market will become less informative.

…managing volatility and its consequences diverts managerial attention from other activities, that would have led to faster and more sustainable growth.

Stiglitz concludes:

While there are no easy answers, a plausible case can be made for tapping the brakes: Less active markets can not only be safer markets, they can better serve the societal functions that they are intended to serve.

In other words, when it comes to financial markets, sometimes less is more.

[HT: Bill Cochrane]

The Economics of the LEGO Movie

For the last couple of weeks in ECON110 we've been talking about the benefits of markets, and this week and next we are looking at the economics of government. Part of the latter includes looking at different economic systems, the economic functions of government, and what might be the optimal level of government involvement or intervention. Which made this video on the economics of the LEGO movie amazingly timely:

I don't necessarily agree with all aspects of what Andrew Heaton is arguing, which is pretty libertarian. After all, the market left to its own lightly-regulated devices led us into the Global Financial Crisis, for instance (see here or here, but the point about inadequate regulation and the GFC remains somewhat contested). So you could argue there is still a role for government even in markets that should in theory be able to operate independently.

I have to say though, that the video does a fantastic job of characterising the differences between the market economic system (or rather the mixed economic system) that is endemic across most of the western world, and the centrally-planned (command) economy as seen in the former Communist countries and pre-reform China (not so much nowadays, with economic reform even occurring in Cuba).

Actually the whole series of EconPop videos by EconStories is to be recommended. They are all pretty great. One warning though: if you watch the LEGO Movie, be prepared to have the theme tune (Everything is awesome) stuck in your head for days afterwards!

[HT: Eric Crampton at Offsetting Behaviour]