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Quotation of the Day…

… is from page 250 of Matt Ridley’s great 2010 book, The Rational Optimist:

It is the planned economy, not the market, that requires perfect knowledge.

DBx: The core, ’tho not sole, reason for this truth is that agents who are part of a plan have much less scope to adjust to mistakes and new opportunities than do individuals acting within markets. Individuals acting within markets pursue the fulfillment only of their own plans (and in doing so they better enable a large number of other individuals to fulfill their own plans – see Adam Smith on butchers, brewers, and bakers).

In contrast, each agent in a plan is assigned a role by the planner – a role defined both by the particular purpose that that agent must pursue and by the range of means that that agent is permitted to use in pursuit of his or her assigned purpose.

Agents in a plan simply cannot be allowed to act in any ways that are inconsistent with the plan, of which he or she is merely a tool. And so when an agent in a plan encounters some reality that the plan’s designers did not anticipate – for example, an unexpectedly small available amount of some resource, or an unanticipated failure of one part of the plan to mesh well with another part, or a surprise opportunity to innovate by using some means outside of the narrow range permitted by the plan to the agent – the agent cannot respond effectively. Were the agent to respond in ways that individuals respond in markets, the plan would be upset; any such response, by its nature, is inconsistent with the plan and so cannot be allowed.

Here it’s worth emphasizing that when any part of the economy is truly and meaningfully planned by government, this reality must hold: individuals have no incentives to innovate. Genuine innovation is not foreseen and, hence, cannot be part of any real plan. And so unlike in markets which reward individuals for successful innovation, in plans agents must be punished for attempts to innovate, for such agents are attempting, however innocently, to upset the plan.

Therefore, the notion that a nation’s economy can be made more innovative and its growth enhanced by industrial policy is deeply mistaken. People who make assertions to the contrary simply have not thought carefully about what industrial policy is and what it entails. Oren Cass, Daniel McCarthy, Marco Rubio, as well as legions of “Progressives,” are enchanted by their own fine words and good intentions. It is, after all, very easy to say “Let’s plan this!” and “Government should work to achieve that excellent outcome!” And one can, with equal ease, imagine happy outcomes. Yet when the nature of national economic planning is explored with any seriousness, the reality summed up above by the quotation from Matt Ridley is revealed.

It is no good response to the above to point to profitable firms as examples of successful planning. Yes indeed, firms do operate according to plans. And workers within firms are subject to the same restraints mentioned above about agents in a government economic plan. But fundamental differences – too many to review here – distinguish firm-planning from government economic planning.

Two differences are these:

First, because firms operate in a competitive environment, meaningful feedback is continuously received from the larger market within which each firm operates. If a firm is not using labor and other resources efficiently, the firm’s owners experience losses and are thereby led to change the details of their plan. If the firm’s owners fail, the firm goes bankrupt and the resources once used by it are released for better use elsewhere. In contrast, the economic plans that are part of industrial policy do not operate in any similar competitive environment, and are not subject to the same bankruptcy constraint that is always present for privately owned firms.

Second and relatedly, among the many achievements of the competitive environment within which privately owned firms operate is the discovery of the optimal size of planning units (that is, of firms). Firms that are too small are outcompeted by firms that plan on a larger scale; firms that are too large discover that they cannot effectively plan at such expansive scales and are driven by market competition to shrink.

When industrial-policy enthusiasts such as Oren Cass quote successful entrepreneurs such as Andy Grove in support of industrial policy, these enthusiasts reveal that they do not grasp the above, vitally important point. The quoted business executives themselves also often do not grasp it. Yet two facts can hardly be denied:

(1) government officials are not entrepreneurs, if only because the former, unlike the latter, are not residual claimants, and

(2) it’s a logical fallacy to conclude that because planning to produce a relatively small range of outputs at scale X can succeed, planning to produce an arbitrarily larger range of outputs at scale 100X or 10X or even 1.5X can succeed.

Ronald Coase won a Nobel Prize in economics in part for his pioneering work on the nature of the private business firm, and on what determines its size. His ideas are not terribly complicated, but they are foundational and important. It’s too bad that people such as Oren Cass and Marco Rubio’s staffers are apparently unaware of Coase and his insights.