Lange-Lerner-Taylor theorem
Encyclopedia
The Lange Model is an economic model which combines public ownership
and a trial and error approach to determine output and equilibrium. The state owns non-labor factors of production and consumer goods are allocated by market. In economic theory, the Lange Model states that an economy in which all production is performed by the state, but in which there is a functioning price mechanism, has similar properties to a market economy
under perfect competition
, in that it achieves Pareto efficiency
. Proposed by Oskar R. Lange in 1936, the Lange Model is the most famous theoretical model of market socialism
. While this is considered to be the first model of market socialism, other variants of the model exist. In addition, several other economists, including H.D. Dickinson and Abba P. Lerner
contributed to Lange’s model. This model was developed in response to Ludwig von Mises
and Friedrich Hayek
’s criticisms of socialism, stating that the state does not have the knowledge to calculate general equilibrium prices, and that market prices were essential for the state to allocate resources. The Lange Model contains underlying principles from the writing of 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. This theorem indicates that a socialist state 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
.
is equal to price, MC=P, and where the cost of production is minimized. At the intermediate level, industrial authorities 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. However, because prices are set by the central planning board "artificially" in order to achieve planned 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 supply surplus of a particular good occurs, the central planning board lowers the price of that good. If there is a shortage of a 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. This argument relies heavily on the government's pursuit of efficiency.
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 state-owned, the distribution of the rents and profits of these resources becomes a decision of the state. If these profits are distributed in the form of public services, it is the allocation decision of the highest decision-making power. Should the allocation be investment, that decision is made by the central planning board in conjunction with the industrial authorities. The state has significant power over the magnitude and direction of investment, with the central planning board maintaining considerable central control over the economic system. Lange argued that investment funds should be allocated to equalize marginal rates of return in different applications.
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.
Finally, the Lange model claims to solve another main criticism of capitalism
. Lange believed that his model would reduce cyclical instability because states control savings and investment, consequently eliminating a major source of inefficiency, inequality and social strife that arises due to violent cyclical shifts under capitalism.
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. Roberts argues that the Lange model abandons the intentions of socialist planning disregards the hierarchical 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.
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 market capitalism.
Economists Don Lavoie
and Israel Kirzner
claim that Lange proposed an illegitimate simulation of markets. Markets cannot function without genuine rivalry in real markets, and between actual entrepreneurs. Simulated markets cannot match real markets.
Economist DW MacKenzie claims that the Lange 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.
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.
Finally, the Lange model should be thought of 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.
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.
Socialism
Socialism is an economic system characterized by social ownership of the means of production and cooperative management of the economy; or a political philosophy advocating such a system. "Social ownership" may refer to any one of, or a combination of, the following: cooperative enterprises,...
and a trial and error approach to determine output and equilibrium. The state owns non-labor factors of production and consumer goods are allocated by market. In economic theory, the Lange Model states that an economy in which all production is performed by the state, but in which there is a functioning price mechanism, has similar properties to a market economy
Market economy
A market economy is an economy in which the prices of goods and services are determined in a free price system. This is often contrasted with a state-directed or planned economy. Market economies can range from hypothetically pure laissez-faire variants to an assortment of real-world mixed...
under perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
, in that it achieves Pareto efficiency
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...
. Proposed by Oskar R. Lange in 1936, the Lange Model is the most famous theoretical model of market socialism
Market socialism
Market socialism refers to various economic systems where the means of production are either publicly owned or cooperatively owned and operated for a profit in a market economy. The profit generated by the firms system would be used to directly remunerate employees or would be the source of public...
. While this is considered to be the first model of market socialism, other variants of the model exist. In addition, several other economists, including H.D. Dickinson and Abba P. Lerner
Abba P. Lerner
Abba Ptachya Lerner was an American economist.Lerner was born on October 28, 1903 in Bessarabia . He grew up in a Jewish family, which emigrated to Great Britain when Lerner was three years old. Lerner grew up in the London East End. From the age of sixteen he worked as a machinist, a teacher in...
contributed to Lange’s model. This model was developed in response to Ludwig von Mises
Ludwig von Mises
Ludwig Heinrich Edler von Mises was an Austrian economist, philosopher, and classical liberal who had a significant influence on the modern Libertarian movement and the "Austrian School" of economic thought.-Biography:-Early life:...
and Friedrich Hayek
Friedrich Hayek
Friedrich August Hayek CH , born in Austria-Hungary as Friedrich August von Hayek, was an economist and philosopher best known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought...
’s criticisms of socialism, stating that the state does not have the knowledge to calculate general equilibrium prices, and that market prices were essential for the state to allocate resources. The Lange Model contains underlying principles from the writing of Vilfredo Pareto
Vilfredo Pareto
Vilfredo Federico Damaso Pareto , born Wilfried Fritz Pareto, was an Italian engineer, sociologist, economist, political scientist and philosopher. He made several important contributions to economics, particularly in the study of income distribution and in the analysis of individuals' choices....
and Léon Walras
Léon Walras
Marie-Esprit-Léon Walras was a French mathematical economist associated with the creation of the general equilibrium theory.-Life and career:...
. 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. This theorem indicates that a socialist state 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
Market socialism
Market socialism refers to various economic systems where the means of production are either publicly owned or cooperatively owned and operated for a profit in a market economy. The profit generated by the firms system would be used to directly remunerate employees or would be the source of public...
.
Basic Principles of the Lange Model
The Lange model suggests three levels of decision making. The firms and households represent the lowest level, with industrial ministries as the intermediate level, while the highest decision making level 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 firms would then produce at the level of output where marginal costMarginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
is equal to price, MC=P, and where the cost of production is minimized. At the intermediate level, industrial authorities 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. However, because prices are set by the central planning board "artificially" in order to achieve planned 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 supply surplus of a particular good occurs, the central planning board lowers the price of that good. If there is a shortage of a 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. This argument relies heavily on the government's pursuit of efficiency.
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 state-owned, the distribution of the rents and profits of these resources becomes a decision of the state. If these profits are distributed in the form of public services, it is the allocation decision of the highest decision-making power. Should the allocation be investment, that decision is made by the central planning board in conjunction with the industrial authorities. The state has significant power over the magnitude and direction of investment, with the central planning board maintaining considerable central control over the economic system. Lange argued that investment funds should be allocated to equalize marginal rates of return in different applications.
Advantages of the Lange Model
An advantage is state 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
Allocative efficiency
Allocative efficiency is a theoretical measure of the benefit or utility derived from a proposed or actual selection in the allocation or allotment of resources....
and x-efficiency
X-inefficiency
X-inefficiency is the difference between efficient behavior of firms assumed or implied by economic theory and their observed behavior in practice. It occurs when technical-efficiency is not being achieved due to a lack of competitive pressure...
can be avoided under Langean socialism.
Finally, the Lange model claims to solve another main criticism of capitalism
Capitalism
Capitalism is an economic system that became dominant in the Western world following the demise of feudalism. There is no consensus on the precise definition nor on how the term should be used as a historical category...
. Lange believed that his model would reduce cyclical instability because states control savings and investment, consequently eliminating a major source of inefficiency, inequality and social strife that arises due to violent cyclical shifts under capitalism.
Criticisms of the Lange Model
Economist Paul Craig RobertsPaul Craig Roberts
Paul Craig Roberts is an American economist and a columnist for Creators Syndicate. He served as an Assistant Secretary of the Treasury in the Reagan Administration earning fame as a co-founder of Reaganomics. He is a former editor and columnist for the Wall Street Journal, Business Week, and...
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. Roberts argues that the Lange model abandons the intentions of socialist planning disregards the hierarchical 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.
Recently the economist Joseph Stiglitz has criticized the theorem for replicating many of the alleged errors of neoclassical economics
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...
. 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 market capitalism.
Economists Don Lavoie
Don Lavoie
Don C. Lavoie was an Austrian school economist. He worked at the Cato Institute. He wrote two books on the problem of economic calculation. His first book on this subject was Rivalry and Central Planning . This book stressed the importance of the process of competitive rivalry in markets...
and Israel Kirzner
Israel Kirzner
Israel Meir Kirzner is a leading economist in the Austrian School.-Early life:The son of a well-known rabbi and Talmudist, Kirzner was born in London, England and came to the United States via South Africa.-Education:After studying with the University of Cape Town, South Africa in 1947-48 and...
claim that Lange proposed an illegitimate simulation of markets. Markets cannot function without genuine rivalry in real markets, and between actual entrepreneurs. Simulated markets cannot match real markets.
Economist DW MacKenzie claims that the Lange 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.
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.
Finally, the Lange model should be thought of 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
Market socialism
Market socialism refers to various economic systems where the means of production are either publicly owned or cooperatively owned and operated for a profit in a market economy. The profit generated by the firms system would be used to directly remunerate employees or would be the source of public...
, before they were re-published as chapters in a 1938 book. Lerner (1938) influenced Lange's thinking on social dividend
Social dividend
A social dividend is a proposal for allocating surplus value, or economic profits, generated by publicly-owned enterprises in a socialist economic system...
payment. Lerner (1944) argued that socialist investment would be politicized.
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.
External links
- Oskar Lange and the Impossibility of Economic Calculation by D.W. MacKenzie
- Capital and Income in Democratic Socialism by D.W. MacKenzie
- Trial and Error in the Socialist Calculation Debate by D.W. MacKenzie