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The Lange model 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 elabored by Vilfredo Pareto and Léon Walras.
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.
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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.
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
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
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.
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.
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.
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.
The Lange model has been criticized by various economists, both socialist and non-socialist.
Economist Paul Craig Roberts has criticized Lange's theory of socialist planning, saying that it is only an effort at market simulation and is not the socialist alternative it claims to be, but merely an imitation of capitalism. Roberts argues that the Lange model abandons the intentions of socialist planning because it disregards the horizontal and co-operative prerequisites of socialist organization. He claims that the model includes only commodity production as an organizational structure and defines socialism only 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.
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 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. 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.
The model is sometimes referred to as the "Lange–Lerner" model. 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 payment. Lerner (1944) argued that socialist investment would be politicized.
- Economic equilibrium
- Market socialism
- Marginal cost
- Neoclassical economics
- Planning (economics)
- Socialist calculation debate
- Socialist economics
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- 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."
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