There are two broadly defined systems of organizing the production and allocation of goods and services in a society. One system is called the market and the other command and control. We all have first-hand experience with both systems since childhood. As kids when we traded stuff with our friends, we were using the market. At home, we were under the command and control system of our parents. Both systems worked in the limited contexts of family and friends. Do they work equally well in when the context is a large, modern-day economy?
Markets are an old invention. It’s a place where people congregate to trade stuff. We exchange things in a marketplace. Simple barter served the purpose for a bit but when the variety of stuff became large and the number of people trading larger yet, some form of money was invented to make trades more flexible. The idea of markets has grown increasingly sophisticated and ultimately markets can be seen as a mechanism – it does not have to be a physical space – where property rights are traded.
Markets are an amazing invention. It’s probably the most amazing machine ever invented. This machine does what no human being can ever do: it computes something that is essential for the proper functioning of the world. Without this machine, modern society would collapse. The input to this machine is very large amounts of information which it somehow computes and then grinds out the output which is also information that is generally called “price.”
The market is a huge computer. But it differs from our familiar electronic computers in that its innards are living breathing human beings. The central processing unit is made up of human brains working in parallel. Depending on the task at hand, millions of “processors” work in parallel to compute the answer. Each of these processors – human brains – has part of the information needed for the machine. That information arises from the knowledge that the processors have, and is private to the individuals because the underlying knowledge is personal. The machine aggregates these private bits of information to create the output which we call “price.”
The market is a huge computer whose output is price. It transforms distributed private knowledge into aggregated public information. How much bread you need today and how much money you have only you know. So also millions of others – both demanders and suppliers of bread – have their own private information related to the production and consumption of bread. The market takes this collection of dispersed information and computes the price which becomes public information. Everyone then combines his private information and the price to determine how much bread to buy or sell.
That’s amazing but it becomes even more amazing when you expand the list of things that the market simultaneously deals with and determines their prices. Not just bread, but it also deals ingredients that go into the making of bread, and everything associated with it such as transportation and storage. But why stop there! In any economy, the number of things run into the millions. All of these prices are calculated simultaneously and seemingly automatically. It’s a stupendous computational task that the market achieves.
Now let’s move on to the other way of doing things – command and control. At home, it is mostly this. Parents command and control what goes on. Who does what, what’s for dinner, when it’s time for bed, and so on. The parents know the preferences of the children, their needs, and they care about the welfare of their children. The parents know more about the nature of the world than the children, and their concern for their children gives them the ability to properly prohibit or allow certain activities. The parents, in other words, exercise paternalistic control over the children.
Command and control works well enough when the scope is limited to people about whose preferences and abilities one is intimately familiar with, and for whom one has deep concern. In such cases, the information required to make correct decisions is limited, and therefore the computational load on the person doing the commanding and controlling is manageable.
But if you go beyond a small number of people involved in a very limited set of activities to where you are dealing with millions of people engaged in thousands of activities, the informational requirements become impossible for any person – or even a large group of people – to manage. Command and control may work in a family but it definitely cannot work in a modern economy with millions of people.
Command and control can of course theoretically work. Suppose you had a superhuman who could exactly mimic the workings of a market mechanism, it would compute all the prices. However, that superhuman cannot do any better than the market. Therefore, the best command and control can theoretically do is what the market does. But in practice, any command and control system will necessarily do worse than the market. This is analytically as well as empirically verifiable.
Why then do some countries choose the command and control system over the market system? Why do they do so even when the command and control system leads them to poverty and underdevelopment?
The answer is actually contained in the words “command” and “control.” Human nature can be relied upon to love command and control. The market mechanism is impersonal and “democratic” – it does not have a boss. Power, and therefore control, is dispersed across all the people. But in the command and control system, power is concentrated in the hands of a select few. With the power to control economic activity comes the opportunity to make things suited to one’s fancy and desires.
The command and control system, though not good for the economy at large, is wonderful for those who get to do the commanding and controlling. In the next bit, I will explore this a little more with reference to India. I think it will explain quite a bit of India’s underdevelopment.