Opinion: Fatal flaws of Socialism – The knowledge problem

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🎧 The Knowledge Problem: Why No One Can Plan an Economy

Chris Cargill asks if government is given the power to decide what gets produced, where people work, which businesses survive, and how resources are distributed, what happens when someone disagrees?

Chris Cargill
Mountain States Policy Center

Imagine someone gives you a seemingly simple job: You are now responsible for deciding what should be stocked at every grocery store in your state. At first, it might not sound impossible. People need milk, eggs, bread, meat, vegetables, cereal, and all the other things you see when you walk through a supermarket. With enough spreadsheets, computers, and smart people helping you, perhaps you could figure it out.

Chris Cargill

Then the questions start.

How many gallons of whole milk should a store in Boise order this week? How many cartons of oat milk? Should a supermarket in Spokane stock more hamburger or chicken? How many avocados will customers in Missoula want on the weekend before the Super Bowl? How much more bottled water should stores order when a heat wave is forecast? What happens when a snowstorm closes a highway, a disease affects the chicken population, or a popular TikTok recipe suddenly causes thousands of teenagers to start buying an ingredient most of them had never heard of two weeks earlier?

And remember, you aren’t simply deciding what people want. You also have to figure out where everything will come from. Someone has to grow the wheat, milk the cows, manufacture the cereal boxes, produce the plastic containers, drive the trucks, stock the shelves, repair the refrigerators, and perform thousands of other jobs you probably never think about when you walk into a store. Suddenly, running the grocery stores doesn’t sound so simple.

Now expand your assignment. Instead of grocery stores in one state, you’re responsible for every store in America. And not just groceries. You must determine how many shoes should be manufactured, how many apartments should be built, how much steel factories should produce, how many laptops college students will buy, how many replacement parts auto shops will need, and how much electricity every city should generate.

You have just encountered one of the most important ideas in economics: the knowledge problem.

The basic insight is surprisingly straightforward. An economy is simply too complicated for any individual, committee, government agency, or computer system to know everything necessary to plan it from the top down. The information required to make good economic decisions is scattered among millions of people, and much of that information changes constantly. That creates one of socialism’s most fundamental problems.

The economist Friedrich Hayek famously explored this problem in his 1945 essay, “The Use of Knowledge in Society.” Hayek’s point wasn’t that government officials are unintelligent or malicious. In fact, the problem would remain even if we assembled the smartest, most honest people in the country and placed them in charge of the economy. They would still lack information that exists only in the minds and experiences of millions of other people.

Consider a restaurant owner who notices that customers have suddenly stopped ordering one entrée and started ordering another. A farmer discovers that one section of a field is producing less wheat because of unusually dry soil. A construction company learns that a particular type of lumber is becoming harder to find. A teenager working at an ice cream shop realizes that customers are suddenly asking for a flavor the store doesn’t carry.

None of those observations is particularly important by itself. Put millions of them together, however, and they form the constantly changing information that makes an economy work.

No government survey could collect all of it. Even if it could, much of the information would be outdated by the time it reached the people making decisions. Preferences change, technologies improve, supplies disappear, new products emerge, weather changes, businesses close, and entrepreneurs discover better ways of doing things.

A market economy deals with this problem by allowing decisions to be made by the people closest to the information. The restaurant owner changes the menu. The farmer changes crops. The construction company finds another supplier. The ice cream shop tries a new flavor. Nobody in Washington needs to approve those decisions, and that’s the point. Markets also possess a remarkable mechanism for transmitting information between people who may never meet one another: prices.

Suppose a major drought dramatically reduces the wheat harvest. You don’t need to know where the drought occurred, how many acres were affected, or which farmers lost crops. As wheat becomes scarcer, its price will tend to rise. That higher price sends signals throughout the economy. Bakeries may look for ways to use less wheat. Consumers may choose different foods. Farmers elsewhere now have a stronger incentive to grow more wheat because they can receive a higher price for it.

Thousands of people adjust their behavior without anyone ordering them to do so.

Prices work in the opposite direction as well. Imagine someone develops a cheaper way to manufacture computer memory. Manufacturers can produce more of it at lower cost, competition pushes prices downward, and suddenly companies discover new uses for technology that previously would have been too expensive. This is why prices are much more than numbers on a tag. They carry information about scarcity, demand, opportunity, and value.

When governments attempt to replace market prices with politically determined prices, they don’t simply change what something costs. They interfere with the information system that tells producers what to make and consumers what is scarce. History gives us a chance to see what happens next.

For much of the twentieth century, the Soviet Union attempted one of history’s most ambitious experiments in central economic planning. Instead of allowing millions of consumers and businesses to determine what should be produced through markets, government agencies developed enormous economic plans specifying production throughout the economy.

Planners had to determine how much steel factories should manufacture, how many shoes companies should produce, how much food farms should grow, and countless other decisions normally made by individuals and businesses. The problem wasn’t simply that planners occasionally made mistakes. Every business makes mistakes. The deeper problem was that planners were being asked to know things that no central authority could realistically know.

Suppose a government factory was ordered to produce thousands of pairs of shoes. Meeting the production quota might be the factory manager’s primary measure of success, even if consumers didn’t particularly like the shoes. A private company facing competition has a very different problem. If customers don’t like its shoes, they can buy someone else’s. The company either improves or loses money.

That distinction matters because markets contain a feedback mechanism. Every purchase tells producers something about what consumers value. Every unsold product tells them something too. Profits encourage businesses to expand successful ideas, while losses tell them that resources might be better used elsewhere. Central planning weakens that feedback. The result across centrally planned economies was often a strange combination of shortage and waste: too little of the things people desperately wanted and too much of things they didn’t.

One of the best explanations of this phenomenon doesn’t involve an enormous factory or a complicated computer. It involves a pencil. In 1958, economist Leonard Read published a famous essay called I, Pencil. He asked readers to consider how many people were involved in producing something as ordinary as the pencil sitting on a desk.

Someone harvested the cedar. Someone produced the graphite. Someone mined the materials used in the metal band. Someone produced the rubber for the eraser. Other people built the machines used in the factories, generated the electricity, transported the materials, maintained the roads, and eventually delivered the finished pencil to a store.

Thousands of people contributed to the process, yet almost none of them knew one another. More remarkably, probably no single person involved knew how to produce the entire pencil from beginning to end. There was no “pencil czar” directing the operation. Prices and voluntary exchange coordinated it.

Now replace the pencil with an iPhone, an airplane, or the enormous supply chain required to stock a modern supermarket. The complexity becomes almost unimaginable. This is the part of the knowledge problem that’s easy to miss. Modern prosperity doesn’t depend on a handful of brilliant people knowing everything. It depends on millions of ordinary people knowing small things and being free to act on what they know.

A reasonable young reader might wonder whether technology has changed Hayek’s argument. After all, governments in the Soviet era didn’t have smartphones, cloud computing, real-time inventory systems, or artificial intelligence. Couldn’t today’s technology collect enough data to make central planning work?

Technology certainly makes economic forecasting and logistics dramatically better. Walmart, Amazon, UPS, airlines, and countless other businesses use enormous amounts of data to predict demand and coordinate complicated operations.

But there is an important difference between what those companies do and central planning.

Businesses operate inside markets. They receive constant feedback from customers and competitors. If Amazon predicts that people desperately want Product A and customers instead choose Product B, Amazon discovers its mistake quickly. Money changes hands, inventories change, competitors react, and the company adjusts.

More importantly, much of the knowledge that drives an economy doesn’t exist as data until someone acts on it. Nobody could have entered “future demand for TikTok” into a government computer before TikTok existed. Nobody could perfectly predict which college student will develop the next breakthrough technology, which restaurant concept customers will love, or which product millions of people will suddenly decide they no longer want.

Innovation is partly about discovering things nobody knew beforehand. Computers can process enormous amounts of information. They cannot eliminate the fundamental problem that the future contains information that has not yet been created. Think again about that grocery store from the beginning.

When you walk through the doors, you see tens of thousands of products assembled from across the country and around the world. Almost everything is where you expect it to be. When a product becomes popular, stores order more. When customers stop buying something, stores eventually stop stocking it. When shortages develop, prices and profits encourage suppliers to find alternatives.

Nobody planned the entire system. Millions of people planned tiny pieces of it. That’s the genius of markets. They don’t require anyone to know everything. Instead, they allow people to use the information they actually possess and communicate that information to everyone else through prices, profits, losses, and voluntary exchange.

Socialism asks government to make far more of those decisions collectively. The problem isn’t necessarily the intentions of the people doing the planning. The problem is the impossible amount of knowledge the task requires. Markets certainly make mistakes. Companies misjudge customers. Investors lose money. Entrepreneurs launch products nobody wants. But those failures contain valuable information, and competition creates pressure to correct them. Central planning makes mistakes too. The difference is that when one central authority makes a mistake, millions of people may be forced to live with it.

That is the second fatal flaw of socialism: No one knows enough to plan an economy. And that leads naturally to an even bigger question. If government is given the power to decide what gets produced, where people work, which businesses survive, and how resources are distributed, what happens when someone disagrees?

That’s where an economic question becomes a question about freedom.

Chris Cargill is the president of Mountain States Policy Center, an independent free market think tank based in Idaho, Montana, Wyoming and Washington. Online at mountainstatespolicy.org.