OLDRICH KYN

PRICES IN  ECONOMIC SYSTEMS

From the Discussion at the CESES Conference in Florence 1966

Il sistema dei prezzi nell'est Europeo, Franco Angeli Editore,

I should like to speak on two problems; the first is the problem of prices, and I have more questions for Mr. Pashkov, since I did not receive satisfactory answer to the question I asked him yesterday. The second problem is the problem of different types of economic mechanism based on the considerations of Mr. Zaubermann, Zielinski, Lipinski and others.

The question I would like to ask professor Pashkov is whether he can tell us in more detail, what methodology was used in computing production prices. From what has been said I have only understood, that the newly computed prices will be production prices, since profit will be allocated proportionally to capital. But it is not clear to me how the prices for millions of individual products will be calculated.

I should like to demonstrate on the experience of Czechoslovakia what problems are connected with centralized price setting of all prices. Let us suppose we have 2 to 3 million individual commodities which must have their prices set. We can follow the traditional method by which price reforms were carried out in the past or the more modern method making use of computers. This new method is being used in the present price reform taking place in Czechoslovakia.

In the past price reforms took place approximately every five years. The calculation of new prices took about three to four years and thus practically filled out the entire period between the reforms. The traditional method of calculation was roughly as follows: first the prices of primary products such as coal, iron ore, etc. were calculated. On their basis the prices of derived products such as electricity, steel etc. were calculated and on their basis in turn, the prices of further commodities, such as machine-tools etc. The process of price calculation took place in successive stages up to the calculation of prices of the final products. This seems quite rational, but the problem is in feed-backs. As everyone knows, there exist in the national economy a great number of complex feed-backs. For instance the production of coal, electricity, etc. requires the use of the products of the machine-building industry. Therefore the correct price for coa1, iron ore etc. Cannot be calculated without knowing the price of machines. Since the traditional method could not take these feed-backs into account, price thus calculated cannot be considered as real production price. To achieve more correct prices it would be necessary to repeat the calculation several times, i.e. to do several iterations. But each iteration means a new calculation for two to three, millions products. Even if each iteration takes only two years and five or six iterations were sufficient for finding correct prices, the whole process would take too long. We have therefore come to conclusion that such a method is not adequate for the calculation of real production prices. Our experience has also taught us that after each general reform of prices, the results were quite out-of-date because in the meantime conditions had changed, and under new conditions, they were not real production prices any more.

The second method of computing prices, that is the one using electronic computers takes less time, but it is impossible to prepare a program for a computer, which would compute two to thee millions prices. With the use of electronic computers we must reduce the number of commodities for which prices are computed. According to our experience with the help of computers the duration of price reform can be shortened from two or four years to half a year or one year. But we obtain only average price indices for aggregate groups of commodities.

So neither does this method give us real and exact production prices for individual commodities. Our experience thus tells us that none of the known methods makes it possible to calculate individual prices exactly and sufficiently fast.

The economic reform now being introduced to Czechoslovakia rests upon the renewal of the market mechanism. But the existing price system is greatly distorted and prices are far from equilibrium. If we want to renew the market mechanism and efficient functioning of the economy we must reach equilibrium prices as soon as possible. If in the present situation prices were set free, large price movements would be set in motion, which would subsequently lead to large shifts in demand with the result that chaos and steep inflationary development would. take place. The success of the economic reform is therefore dependent on whether a central price reform (which we hope will be the last) will be able to produce prices at least not too distant from equilibrium. The renewed functioning of the market mechanism could then be expected to adapt individual prices to equilibrium level. I am of the opinion that without the market mechanism it is impossible to achieve equilibrium or "rational" prices in the national economy.

I should now like, to return to the second question; that is the problem of different types of economic mechanism. I think that the issue professor Zauberman posed is of great interest, but it represents only one approach to the definition of economic mechanisms. I would prefer another approach to this problem. My models are of course simplifications, but I believe that they do illuminate real economic processes, as well as purely theoretical models of the Lange-Lerner type.

Allow me to draw the following diagram, which shows two blocks production and consumption (figure 1.) The problem of any economic mechanism is to achieve mutual coordination of decision-making in production and consumption so that a steady flow of goods from producers to consumers takes place.

Figure 1.

We usually have the following requirements for coordinated decision-making

1. achievement of economic equilibrium and

2. attaining efficiency or such allocation of scarce resources among various industries and technologies, as to give the consumer maximum satisfaction.

To achieve coordination of decision-making and attain certain degree of the above mentioned requirements, there must exist between production and consumption (and of course, between the various elements within each block) a feed-back system of information. We can distinguish various types of economic mechanism according to how these feed-backs are mutually connected.

Let us first take into consideration a free market mechanism, which is only one of the number of various possible types of economic mechanism. Figure 2. shows how informational feed-backs are mutually connected.

Figure 2.

In this case market functions as an automatic regulator, which on the one side acquires information on production and consumption by the channels "supply" and "demand" and on the other side by the channels "prices" passes information to the producers and consumers. If we presuppose, that the producers act in accord with the theory of firm and the consumers with the theory of consumer‘s behavior, we can even construct a mathematical model which would demonstrate the conditions of general economic equilibrium and conditions necessary to ensure the stability of the system. In any case the channels of information "supply" "demand" and "prices" and the functioning of the market lead to a certain coordination of decision-making of producers and consumers. This coordination is, of course, not perfect, so that the function of free market mechanism has many well known shortcomings, which have been criticized many times. The most important of these shortcomings are: 1) the time lag, in the transmission of information can lead to instability and oscillations of the whole system and thus to economic fluctuations; b) monopoly conditions can lead to a departure prom Pareto’s optimum and thus to inefficient use of scarce resources; c) the functioning of the system in itself leads to such a distribution of national income, which can according to certain criteria, be considered as unjust.

Another type of economic mechanism is represented by figure 3. This is a so called "command economy" system, which is more or less synonymous with "direct centralism" in the terminology used by Mr. Zauberman..

Figure 3.

In this system all information from producers and consumers is first concentrated in central organ on the basis of which a plan is worked out, which is then given to the producers in the form of a "command", The plan set up by the central organ states the volume of production as well as prices and other economic indicators. It is true, that this system does away with some of the shortcomings of the former system, but it too has several shortcomings. The following are especially important; a) insufficient capacity for processing information at the center makes it impossible to achieve smooth coordination and results in continuous economic disequilibria. b) centrally set prices do not reflect sufficiently the scarcity of resources in relation to consumer preferences and therefore the criteria for the allocation of scarce resources are lost; c) the slow and cumbersome functioning of the planning apparatus and the elimination of entrepreneurial activity causes slow technological progress and make insufficient use of innovations These three shortcomings of a centralized system have been especially evident in the economy of Czechoslovakia during the last several years. Analyses of the causes of stagnation, inefficiency and falling behind world development in the sphere of technology have shown, that the causes lie in the type of economic mechanism in existence until now.

The third type of mechanism I should like to mention, is the model presented by Oskar Lange in his book "On the Economic Theory of Socialism".

Figure 4.

In Lange‘s model the decision-making on the vo1ume of production and consumption is decentralized. The producers act according to the theory of firm, the consumers act according the theory of consumer behavior. The only element which is centra1ized is the setting of prices. The central organ incessantly gathers information about the variation between supply and demand and changes prices accordingly, so that general economic equilibrium is maintained.

If we compare this model with a model of free market, we see a number of similarities. The only difference is in the fact that prices are not arrived at by a spontaneous process, but that the central organ simulates the market. I do not believe this model to be superior to the model of free market, because as we have seen its most important shortcoming was the time lag in the transmission of information and in Lange’s model it is impossible, to achieve better and faster transmission of information. It is impossible to imagine that the large volume of information about supply and demand of all goods and all prices be processed by the center effectively. Notice that this model contains no planning, the central organ takes action ex post and no prognosis of future development is made.

Finally I should like to show how we in Czechoslovakia see, the possibility of combining planning with the functioning of the market mechanism, which is the basic idea behind the economic reform now taking place.

Figure 5.

Coordination of economic decision-making takes place here in two ways a) by the market mechanism which functions in a manner similar to the functioning of the free market b) by a planning organ which prepares long term plans for the development of the economy. The main part of day-to-day coordination is done by the market, which is flexible and is capable of forcing producers to adapt themselves quickly to the changing demand of consumers. The shortcoming of the free market are done away with by the fact, that the system is supplemented by the planning organ. To make planning and market mechanism mutually compatible, the central organ must never give commands concerning production and prices but should only provide information necessary for decentralized decision-making, and by indirect methods influence decision-making in such a way as to assure that economic development is in accordance with the goals that the society has set for itself. According to the opinion of a number of Czechoslovak economists, such a combination of the market mechanism and the plan, is necessary for achieving optimum and the smooth functioning of the economy, especially for the following reasons: a) the plan provides information about the probable development of the national economy necessary for making economic decisions, which the market in itself cannot provide. The risk of wrong decisions especially about investment is reduced to a minimum and so economic fluctuations can be eliminated, b) the market provides the planning organ with correct criteria of efficiency, without which optimal planning is impossible; c) the center has sufficient power to enforce social preferences , just distribution of national income etc. by indirect methods.