A coordination problem

We’ve seen that economies can in principle produce a surplus of goods. But this is a mere technical possibility. We’ve said nothing, yet, about social institutions (like firms, households, coordination mechanisms etc.) that might realise this potential.

The omission is partly deliberate because before examining specific kinds of economic institutions we first need to understand some of the fundamental material constraints that face any set of economic institutions.

We’ll discuss one such constraint now, which is the problem of producing just the right amount of different goods and services. An economy needs to mix together different activities together in the right proportions, otherwise it might produce too much of some things, and not enough of other things. A capitalist, or socialist, or some future kind of economy, all face the problem of coordinating the scale of production of different activities across the entire economy.

To illustrate this problem, let’s consider the now familiar example of a simple economy that produces corn, sugar and iron, and reproduces a working population. Let’s say it currently has the following technology:

Figure 1. A small economy that produces corn, sugar and iron. Workers consume corn and sugar.

Notice that worker households consume 0.1 units of corn and 0.1 units of sugar in order to reproduce a unit of their labouring capacity (let’s say 1 days worth). This is the real demand from worker households. (We’d say “real wage” but that assumes a specific institutional setup, so we’ll avoid this terminology for now). We’ll merely state they in fact consume this bundle of goods. (We don’t know if they want to consume this bundle, or are forced to etc.)

We’ll set the initial stock levels for this economy as:

Figure 2. The initial stocks in this economy.

In other words, we begin with some (as yet unknown) number of workers who collectively have 1 days worth of labouring capacity ready to supply. And, ready to hand, have preexisting stocks of corn, iron and sugar (1 units worth of each).

Let’s get producing!

First, lets reproduce the workforce. They need to eat.

How many workers need feeding? To keep the numbers small let’s say there are 5 workers. And, in a single day, they in total consume 0.5 units of corn and 0.5 units of sugar, which reproduces 5 days worth of labouring capacity (as per the technology in Figure 1). So our stocks of corn and sugar have dropped to 0.5 each.

But the workers don’t simply consume all day. They also work. In fact, they produce some corn, sugar and iron. How much should they produce?

Well, they are simple folk, just like us, and therefore prefer to keep things simple. They decide to always produce 1 unit of corn, 1 unit of sugar and 1 unit of iron during the working day. Nice, easy numbers all round!

They’ve decided on a specific scale of production, which we shall call the activity levels of the economy. The levels are:

Figure 3. The activity levels in this economy. 5 workers collectively produce 1 unit of each commodity.

The “activity level” of workers is just the number of workers in the economy (the economy reproduces 5 workers every day). And these workers have decided to produce 1 unit of each commodity each day. (I like to imagine activity levels are the heights of 3d rectangles (like the rectangles in the image for this post), which are planted on the nodes in Figure 1. The higher the rectangle the greater the scale of production at that node.)

During a day the workers consume and reproduce their working capacity. And each day they produce 1 unit of corn (which uses-up some corn and iron and labour), and 1 unit of sugar (which uses-up some corn, sugar and labour) and 1 unit of iron (which uses-up some iron and labour). (For the precise amounts see Figure 1).

Imagine they engage in this level of activity, day after day, repeatedly. What happens? Here are the stock levels after 100 days of activity:

Figure 4. After 100 days we see that the 5 workers reproduce themselves (the stock of working capacity is basically stable). However, the corn and sugar stocks are increasing, and the iron stocks are decreasing.

At these activity levels the economy over-produces corn and sugar, and under-produces iron. Can this continue indefinitely?

Figure 5. After another 600 days or so the stocks of iron exhaust. But to produce corn we need iron inputs. So corn cannot be produced, and we immediately see the corn stocks begin to dwindle.

The answer is no: the economy has hit a crisis of over and under-production. The workers at this point cannot produce iron or corn (since they need iron inputs for both) and so start drawing down on their corn stocks without replacement. They continue to over-produce sugar. But eventually they will run out of food altogether, at which point all production stops.

What went wrong? After all, we know that this technology is capable of producing a surplus in all goods.

The reason for the crash is that the activity levels of the economy were unbalanced. The economy needs to supply the workers’ consumption. But the decision to produce 1 unit of corn, sugar and iron each — was wrong. These particular activity levels cannot satisfy the real demand.

The mere technical possibility of producing a surplus doesn’t mean a surplus will actually get produced. For viable, long-term production the population must apply the available techniques at the right scale, and ensure their economic activities are coordinated.

In this example, the population wasted too much of their working day producing corn and sugar, and failed to devote sufficient time to producing iron.

So what are the correct activity levels that will satisfy the real demand? And how can particular economic institutions discover the correct levels, and then ensure they are followed? And what happens if real demand changes? In other words, how do real economies continually solve and re-solve the problem of economic coordination?

Next, I probably will start examining how capitalist economies partially solve the problem of economic coordination. That will take many separate blog posts.

(For those interested in theory that delves deeper into identifying material constraints that apply to all possible economic setups, I (heartily) recommend Luigi Pasinetti’s book:

Pasinetti, L. L., 1993. Structural economic dynamics – a theory of the economic consequences of human learning. Cambridge University Press, Cambridge.)


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