I stuck around St Petersburg
When I saw it was a time for a change
Killed the czar and his ministers
Anastasia screamed in vain
--Rolling Stones

Every now and then it's useful to remind ourselves of the basic economic problem that all societies face. Individuals have needs. Some of these needs are fundamental to human existance, such as food and drink. Other needs promote a more interesting existence, such as transportation and high definition TVs.

Production of goods and services to fulfull these needs requires conversion of society's resources into tangible and intangible outputs. A few issues complicate production, however. Resources are scarce--they exist in limited quantities. Productive capacity for converting resources into outputs varies among individuals in a society. Finally, the needs of individuals are constantly changing.

The basic economic problem, then, is how to efficiently allocate scarce resources in order to meet society's needs given the dynamics of the situation.

One approach for solving the problem is to put a small group of individuals in charge of making all these decisions. These 'central planners' determine types and quantities of resources needed for production, who will be involved in production, and types and quantities of output obtained. Although central planners may make this determination directly through production scheduling, they can also influence the economic process indirectly by fixing prices or by some other monetary or fiscal policy mechanism.

If the central planners are all knowing and if economies are simple and stable, then this approach could efficiently solve the problem. These are big ifs, however. It has long been recognized that, even under favorable circumstances, decision-makers are 'boundedly rational' and constrained by their cognitive capacities (March & Simon, 1958). The planners may also be less than benevolent in their motivations. Desire for power, influence, or greed may create an agency problem (Jensen & Meckling, 1976) between the planners and the constituencies who are dependent on the planners' judgement.

Complex, dynamic economic contexts only magnify these issues. Even if the planners correctly make all decisions in one period, they have to keep getting things right as the economy evolves. Unfortunately, evidence suggests that bureaucrats are often incapable of modifying courses of action even in the face of evidence that they should do so (Staw, 1981).

Yet, despite a large body of both theoretical and practice evidence suggesting the inadequacies, societies continue to lean on central planning for solving economic problems. And, lest U.S. citizens be tempted to think that central planning is something that is done somewhere else, they would be wise to consider domestic institutions like the Federal Reserve. The Fed governors essentially represent a group of bureaucrats charged with determining the 'correct' price of money and credit. Central planning personified.

Despite arguments to the contrary presented by many politicians, the growing size and complexity of our global economic situation suggests that the timing could not be worse for a central planning mindset.

References

Jensen, M.C. & Meckling, W. 1976. Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3: 304-360.

March, J.G. & Simon, H.A. 1958. Organizations. New York: Wiley.

Staw, B.M. 1981. The escalation of commitment to a course of action. Academy of Management Review, 6: 577-587.