Lange model

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The Lange model (or Lange–Lerner theorem) is a neoclassical economic model for a hypothetical socialist economy based on a combination of public ownership of the means of production with a trial-and-error approach to determining output targets and achieving economic equilibrium and Pareto efficiency. Within this model, the state owns non-labor factors of production, with final goods and consumer goods allocated through markets. In economic theory, the Lange model states that an economy in which all production is performed by the state or some other analogous public body, but in which there is a functioning price mechanism, has similar properties to a hypothetical market economy under perfect competition, in that it achieves Pareto efficiency. In contrast to models of capitalism, the Lange model is based on a direct allocation, by directing enterprise managers to set price equal to marginal cost in order to achieve Pareto efficiency; while in a capitalist economy managers are instructed to maximize profits for private owners while competitive pressures are relied upon to indirectly lower the price to equal marginal cost.

This model was first proposed by Oskar R. Lange in 1936 during the socialist calculation debate, and was later expanded upon by several other economists, including H. D. Dickinson, Abba P. Lerner and Fred M. Taylor. Although the model was called "market socialism" by Lange and Lerner, the Lange model is actually a form of planned economy where a central planning board allocates investment and capital goods with markets reserved for labor and consumer goods. Instead of an actual market for capital goods, the central planning board simulated a market in capital goods through a trial-and-error process first elaborated by Vilfredo Pareto and Léon Walras.[1]

The Lange model has not been adopted or implemented in any form in any part of the world, even in Oskar Lange's home country of Poland, which in the post-war era had the Soviet model of central planning thrust upon it, which precluded even minimal experimentation with Lange-style market socialism.[2]

Overview[edit]

The model is sometimes referred to as the "Lange–Lerner" model.[3] Abba Lerner wrote a series of articles that had great influence over Lange's thinking. For example, Lerner (1938) caused Lange to re-write his 1936 and 1937 articles on market socialism, before they were re-published as chapters in a 1938 book. Lerner (1938) influenced Lange's thinking on social dividend payments. Lerner (1944) also argued that investment in the Lange model would inevitably be politicized.

This model was developed in response to Ludwig von Mises and Friedrich Hayek's criticisms of socialism during the Socialist calculation debate. Mises' and Hayek's criticism stated that any body that owns and consolidates a society's means of production will not be able to acquire the knowledge needed to calculate general equilibrium prices, stating that market-determined prices were essential for the rational allocation of producer goods. The model contains underlying principles from the writing of the neoclassical economists Vilfredo Pareto and Léon Walras. Lange's theory emphasizes the idea of Pareto efficiency, which states that a situation is Pareto efficient if there is no way to rearrange things to make at least one individual better off without making anyone worse off. In order to achieve this Pareto efficiency, however, a set of conditions must be formulated through a number of sequential stages. This idea of deriving a set of conditions which ensures the preferences of consumers are in balance with the maximum amount of goods and services being produced is emphasized by Walras. The theorem indicates that a socialist economy based on public ownership could achieve one of the principal economic benefits of capitalism - a rational price system - and was an important theoretical force behind the development of the concept of market socialism.

Basic principles[edit]

The Lange model suggests three levels of decision-making. Firms and households represent the lowest level, with industrial ministries as the intermediate level, and the highest level of decision-making is made up of the central planning board. The central planning board sets the initial price of consumer goods arbitrarily and informs the producing firms of these prices. The state-owned firms would then produce at the level of output where marginal cost is equal to price, P = MC, so as to minimize the cost of production. At the intermediate level, industrial authorities represented by the industrial ministries are responsible for determining the sectoral expansion of industry. At the lowest level of decision making, households decide how to allocate income and how much labor to supply by choosing between work and leisure.

Institutions[edit]

The key institutions of the Lange model include the central planning board (CPB), industrial ministries that are responsible for their specific economic sector, and state enterprises based on democratic management by their employees.

Trial-and-error price adjustments[edit]

Because prices are set by the central planning board "artificially" in order to achieve planned growth objectives, equilibrium between supply and demand is originally unlikely. To produce the correct amount of goods and services and create a balance, the Lange model posits a trial-and-error method. If a surplus in the supply of a particular good arises, the central planning board lowers the price of that good. Likewise, if there is a shortage of a particular good, the price is raised by the central planning board. This process of price adjustments takes place until equilibrium between supply and demand is met.

Central planning board[edit]

The central planning board (CPB) has three major functions in the Lange model: First it instructs firms to set price to equal marginal cost, secondly it uses the trial-and-error process to attain market-clearing prices for goods and services, and finally, it reinvests the economic profit derived from state enterprises into the economy based on a target rate of growth. The central planning board would also be responsible for distributing social dividends among the population.

Social dividend[edit]

The central planning board is responsible for the allocation of social dividends in addition to its price-setting role. Because all non-labor factors of production are publicly owned by a state entity, the distribution of the rents and profits of these resources accrues to the public. The profits and rents would be used to finance a social dividend scheme based on the individuals' share in the income derived from the socially owned capital and natural resources, providing a complimentary source of income for workers alongside their salaries and wages.[4]

Advantages[edit]

An advantage is public control over investment. The rate of economic growth would be largely state-determined due to the investment ratio being one of its major determinants. In addition, Lange argued that externalities could be better accounted for as a result of the state's ability to manipulate resource prices. Because the state controls all firms, they could easily factor the cost of an externality into the price of a certain resource. Because the decisions are made by higher rather than lower levels, it is argued that these decisions are less likely to have undesirable environmental consequences.

Furthermore, because the state uses marginal cost pricing and determines entry, monopolies, and the accompanying lack of allocative efficiency and x-efficiency can be avoided under Langean socialism.

The model claims to solve another main criticism of capitalism. Lange believed that his model would reduce cyclical instability because the state would control savings and investment, consequently eliminating a major source of inefficiency, inequality and social instability that arises from violent cyclical shifts under capitalism.

Criticisms[edit]

The Lange model has been criticized by various economists, both socialist and non-socialist.

Abram Bergson has criticized the Lange model on the ground that the costs of monitoring compliance of the price equals marginal cost criterion would be higher than the costs of enforcing profit maximization within firms.

Economist Paul Craig Roberts has criticized Lange's theory of socialist planning, saying that it is only an effort at market simulation and not the socialist alternative it claims to be, thus it is merely an imitation of capitalism. Roberts argues that the Lange model abandons the intentions of socialist planning because it disregards the horizontal organizational structure and co-operative prerequisites of socialist organization. He claims that the model only includes commodity production as an organizational structure and defines socialism merely in terms of property rights. According to Roberts, the commodity production embodied in the system of exchange of Lange's model is exactly what was intended to be eliminated by socialist planning - specifically, the fundamental focus of socialist planning was to establish a system of production for use.[5]

Recently the economist Joseph Stiglitz has criticized the theorem for replicating many of the alleged errors of neoclassical economics. He suggests that because of economic problems resulting from costs of information and missing markets, market economies solve problems in a manner different from that described by the neoclassical analysis. Therefore, according to Stiglitz, the Lange model is a poor description of how the price mechanism will work in a market socialist economy to the same extent that neoclassical economics is a poor description of how market capitalism actually functions.

Economists Don Lavoie and Israel Kirzner claim that Lange proposed an illegitimate simulation of markets. Markets cannot function without genuine rivalry in real markets. According to their perspective, simulated markets cannot match the performance of real markets.

Economist DW MacKenzie claims that the model has been misunderstood. The trial-and-error model aims at simulating spot markets. Mises (1920) suggested that socialist officials could simulate pricing in spot market. The trial and error proposal is irrelevant to the real problem of planning investment because inventories of future goods never exist. Lavoie and Kirzner both argue that Lange's trial and error proposal is illegitimate. Mackenzie argues that the trial and error proposal is irrelevant: the Lange model fails because it aims at simulating the wrong markets.

The primary criticism against socialism is that it could not direct investment efficiently without speculation in financial markets.[citation needed] Ludwig von Mises denied that socialist officials could simulate the pricing of future capital goods in financial markets. The Lange model focuses on central planning of investment and social dividend payment. Citizens in Lange's proposed state are paid a "social dividend" as equal owners of capital. The absence of private dividends means that there is no stock market to regulate industry. Lange admitted in several places that socialist officials would direct investment arbitrarily. Lange also admitted that arbitrary investment would come at the expense of consumer welfare. Lange compensated for his concessions by arguing that capitalism also leads to arbitrary investment. According to Lange, capitalism is arbitrary in the way it concentrates wealth in the hands of a few. Since investment is directed by the savings of the rich, capitalism allocates investment according to the arbitrary dictates of a few economic elites.

See also[edit]

Contributors[edit]

References[edit]

  1. ^ Hodgson, G. M. (1998). "Socialism against markets? A critique of two recent proposals". Economy and Society 27 (4): 407–433. doi:10.1080/03085149800000027.  edit
  2. ^ Yunker, James A. (1995). "Post-Lange Market Socialism: An Evaluation of Profit-Oriented Proposals". Journal of Economic Issues 29 (3): 683–717. JSTOR 4226984.  edit
  3. ^ Bator, Francis M. (August 1958). "The Anatomy of Market Failure". The Quarterly Journal of Economics 72 (3): 351–379. doi:10.2307/1882231. JSTOR 1882231. 
  4. ^ On the Economic Theory of Socialism, by Lange, Oskar. 1936. The Review of Economic Studies, Vol. 4, No. 1: "It seems, therefore, convenient to regard the income of consumers as being composed of two parts: one part being the receipts for the labour services performed and the other part being a social dividend constituting the individual's share in the income derived from the capital and the natural resources owned by society."
  5. ^ Paul Craig Roberts (29 October 2002). "My Time with Soviet Economics". VDARE.com. Retrieved 13 March 2013. Lange's 'theory' is market simulation disguised in socialist vocabulary that creates the illusion of planning...the purpose of socialist planning was to eliminate market exchange and organize production for society's direct use. 
  • Gregory, Paul R.; Robert C. Stuart (2004). Comparing Economic Systems in the Twenty-First Century. Boston, MA: Houghton Mifflin Company. ISBN 0-618-26181-8. 
  • Kowalik, Tadeusz (1987). "Lange-Lerner mechanism," The New Palgrave: A Dictionary of Economics, v. 3, pp. 129–30.
  • Roemer, John (1994). A Future for Socialism, Verso Press.
  • Stiglitz, Joseph E. (1994). Whither Socialism?. Cambridge, MA: MIT Press. 0-262-19340-X. 
  • Lo, Dic; Russell Smyth (2004). "Towards a Re-interpretation of the Economics of Feasible Socialism". Cambridge Political Economy Society 28 (6). 
  • Lange, O 1935 Marxian Economics and Modern Theory Review of Economic Studies V2 N3 pp 189–201
  • Lange, O 1936 On the Economic Theory of Socialism I The Review of Economic Studies V4 N1 53-71
  • Lange, O 1937 On the Economic Theory of Socialism II The Review of Economic Studies V4 N 123-142
  • Lange, O 1938 On the Economic Theory of Socialism B Lippincott ed. University of Minnesota Press
  • Lange, O 1940 Letter to FA Hayek, translated by Thadeusz Kowalik
  • Lange, O 1942 Economics of Socialism Journal of Political Economy V50 N2 299-303
  • Lange, O 1957a Political Economy of Socialism, reprinted in Kowalik 1994
  • Lange, O 1957b. Role of Planning in a socialist economy, reprinted in Kowalik 1994
  • Lange, O 1967 The Computer and the Market in Socialism, Capitalism, and Economic Growth Feinstein Ed. Reprinted in Economic Theory and Market Socialism T Kowalik ed. Edward Elgar pub.
  • Lerner, A 1934 Economic Theory and Socialist Economy The Review of Economic Studies V2 N1 51-61
  • Lerner, A 1936 A note on Socialist Economics The Review of Economic Studies V4 N1 72-76
  • Lerner, A 1937 Statics and Dynamics in Socialist Economics The Economic Journal V47 N186 253-270
  • Lerner, A 1938 Theory and Practice in Socialist Economics The Review of Economic Studies V6 N1 71-5
  • Lerner, A 1944 The Economics of Control
  • Lerner, A 1972 The Economics and Politics of Consumer Sovereignty The American Economic Review V62 N ½ 258-266
  • Lerner, A 1977 Marginal Cost Pricing in the 1930s The American Economic Review V67 N1 p235-243
  • MacKenzie, DW, 2006 Oscar Lange and the Impossibility of Economic Calculation, Studia Economicze
  • MacKenzie, DW Social Dividends, Entrepreneurial Discretion, and Bureaucratic Rules
  • MacKenzie, DW Capital and Income in Democratic Socialism
  • MacKenzie, DW Trial and Error in the Socialist Calculation Debate
  • Roberts, Paul Craig (May 1971). "Oskar Lange's Theory of Socialist Planning". Journal of Political Economy 79 (3): p p. 562-577. doi:10.1086/259768. 
  • Rosefielde, Steven (October 1973). "Some Observations on the Concept of 'Socialism' in Contemporary Economic Theory". Soviet Studies 25 (2): p p. 229-243. 
  • Shleifer, Andrei; Robert W. Vishny (1994). "The Politics of Market Socialism". The Journal of Economic Perspectives 8 (2): p p, 165-176. 

Further reading[edit]