Resource Optimization vs Surplus Distribution: The Case For Modern State Economic Planning

(A punched card from the mid-20^th century, used for data input, output and storage)

Modern Monetary Theory (MMT) has finally hit the popular media circuit, generating widely divergent and, sometimes, passionate responses. And rightly so. The flaws of our understanding of how the monetary transmission mechanism works, and its actual flaws, indeed, were clearly exposed during the 2008 financial crisis. While MMT was a theory already present before 2008, it started to become popular really after the crisis. And while it may not bring anything substantially new to the table, it has managed to combine and focus our economic thinking to the issue at hand in a novel way. It has, therefore, been very beneficial in extending the discourse of how to reform the monetary system to serve the economy better.

Macro Hive’s John Butler has written a good critique of MMT in two parts, here (part 1) and here (part 2). While acknowledging MMT’s flaws, I still find myself largely in its camp, coming from a big picture view of how ‘money’ should be created and distributed in the economy and, in that light, taking a different view on the concept of ‘government’ planning vs the ‘free market’ trial and error approach.

My basic premise is the following: since the end of the Bretton Woods Agreement and the full abdication of gold from the process of economic management, the ‘free market’ has done an outstanding job in resource optimization but has failed to distribute properly the surplus thereby created. MMT has brought to the surface this failure and should be credited in keeping the discussion going on how the state, through the Treasury and CB, can be more involved in the economic management process.

The Context Behind MMT

One of the main critiques of MMT is that ‘there is no free lunch’. That is unsurprising since the entire study of economics is largely based on the principle that resources are scarce, i.e. economists try to find how best to optimize resources in an environment of scarcity. Barring mining asteroids or accessing deep space, resources are indeed not unlimited on Earth. However, the spectrum between scarcity and abundance is vast, and it is equally wrong to abide by each of these extremes. Also, one needs to take into account the demand side of the equation: yes, supply is limited because Earth is final; but if demand is also restricted (population declines, etc.), supply may take ‘a really long time’ to extinguish and so may become ‘unlimited’ for all intents and purposes.

To a certain extent, and very generally speaking, humanity lived in a permanent state of scarcity in the hunter-gatherer era, and a permanent state of abundance thereafter. The turning point came with the discovery of agriculture: all of a sudden, society developed a surplus of resources which allowed it to change to a more sedentary lifestyle, build cities, advance culture, science, art etc. The eternal problem since then, though, has always been not in creating that surplus, but in distributing it and, eventually, maintaining it. There may have been enough for everybody, but if inequality was allowed to rise beyond a certain point, wars followed which did not necessarily result in a more equal distribution but in destroying that surplus. This led to sometimes prolonged periods of scarcity until society managed to build up its surplus again. The Dark Ages in Europe after the collapse of the Roman Empire is good example of this.^[1]

At these early stages, long after the conflict had passed, when surplus distribution was more equal, peace reigned that allowed for technological advancements and breakthroughs. This further increased the surplus and probably brought about a level of prosperity which may indeed have felt as if there was abundance. The period of Pax Britannica in the 19^th century and the Western world after WW2 are two most recent examples of this.^[2]

How we manage the economy in conditions of relative scarcity and abundance should be different. What I mean here is that under the former, our focus should be on resource optimization; meanwhile, in the latter, we should be optimizing surplus distribution. The way we should do both is through the process of money creation which is nothing more than distributing incentive tokens of production and consumption for keeping track of economic activity.

For most of early recorded history fiat state money creation had been the norm (the ledger in the rocks of who owed whom and how much). Periodically, when the state abused this accounting, other means of money was adopted (ones which could not be tampered with so easily, such as Yap stones, for example). Ironically, when this other money was adopted, activity dropped simply because the process of recording became cumbersome and less efficient. Gold and other precious metals only came into use as money when travellers from different states needed to engage in an exchange and naturally did not trust each other (i.e. had different accounting systems). Gold’s characteristics – easy to transport, difficult to tamper with – became a big advantage in these exchanges.

In more modern times, gold and other precious metals became the cornerstone of fiat state money creation: money tokens were created backed by gold availability only – the idea being the same – to limit the accounting abuse. While this was a noteworthy, positive development, its side effects were not that dissimilar to what had happened in the past: economic activity would be largely dependent on the flow of gold. This inevitably led to some unnecessary economic contractions. Pure fiat state money creation, though, was not necessarily all bad. The Roman Republic and China under the Song Dynasty are examples of when fiat state money creation led to economic prosperity.

Most people assume that we went back to fiat state money creation after the end of the Bretton Woods Gold Standard. Except that we didn’t, really. What we did in the early 1970s was link money creation to debt origination and transfer the privilege of money creation to the private banking system. This was a very positive and important step in the evolution of the process of money creation: not only did we assure a certain sort of disciplined money creation approach but also one directly linked to economic activity.

Unfortunately, there are negative side effects of this process as well. First, compounding positive interest rates means increasingly money needs to be created just to pay the interest on the old loans. To offset this obvious inefficiency, we eventually got to 0% and even negative rates (sadly, only on sovereign and some corporate debt, with consumer loans still carrying in some cases, like credit cards, even double digit interest rates). Second, loan origination gradually started shifting towards unproductive activities, like real estate, resulting in declining productivity and slower economic growth. Third, the natural rise of the overall debt stock eventually led to what Richard Koo called ‘balance sheet recession’,^[3] a state of play where the private sector has no appetite for more debt, and, instead of focusing on profit maximization, has debt minimization as a goal. In this kind of environment, if money is created as debt, the money creation process can stall and so overall economic activity will fall down as well. In some sense, with private debt to GDP declining in Europe, Japan and the US, we have been experiencing a kind of ‘debt fetters’ very similar to the ‘golden fetters’ of the past.^[4]

The process of debt-based fiat private money creation lasted until about 2008: it was until then that the private banking system created money on the back of extending loans (loans create deposits). Since then, but especially since the Covid-19 crisis, loans have created a smaller and smaller percentage of the total deposits, the majority of which have been created on the back of the Fed’s QE or the Treasury’s direct spending (click here for my previous note on inflation is a supply-side phenomenon where I discuss that).

This is the context of how MMT really got into play. In a sense, with MMT, we would be giving back to the state the privilege of creating money. Given the history of money creation above, proponents of the theory have had a mountain to climb to convince their critics that this is not going to be abused. MMT fully recognizes that there must be a disciplined approach to state money creation (the limiting factor being inflation, and, ultimately the availability of real resources); but, to my knowledge, they have not proposed a viable model of monitoring economic activity in real time.

The problem with modern fiat state money creation is not so much actual abuse of the process, where in the past monarchs would intentionally debase money in a vain attempt to fund some extravagancy or war, but the actual lack of economic insight which should coincide with money creation. Most modern societies now have solid institutional infrastructure which, to a large extent, prevents abuse of power through checks and balances (though that may be also changing, unfortunately, for the worse). But without having a direct pulse on the economy (as in credit creation), it is indeed difficult to guess how much money should be created at any point in time.

So the question, really, is whether the state can design a system of economic data gathering, management, and analysis in real time which can then be linked to fiat state money creation. I think it can be done (I previously have written about it)^[5] and it has indeed been attempted in the past (see below). The general pushback to this idea, and one which John Butler indeed raises in his critique of MMT, is that our world has become too complex to be modelled by a central authority. That indeed may have been the case in the past, but technological advances (IoT, 5G, etc.) are allowing us more and more options in decentralized real-time economic data gathering. With the help of the blockchain, which is nothing other than a giant ledger of economic activity, we can now analyse that data. Then, with the help of a central, independent, all-overseeing policy-decision making entity, we can supply the medium of exchange (CBDC) on demand.

State Planning Failed Not in Resource Optimization But in Surplus Distribution

The problem of economic calculation under state planning is at the heart of Austrian economic thinking. It was first proposed by Ludwig von Mises in his 1920 article ‘Economic Calculation in the Socialist Commonwealth’. Von Mises argues that economic planning leads to inefficient allocation of resources because of insufficient information. The free market, on the other hand, properly reflects the demand and supply of resources through price equilibriums reached by independent agents.

I don’t necessarily disagree with that, even though there is plenty of scope for criticism – probably the main one being that in real life there is never just one equilibrium but several states of equilibria. In addition, many prices in modern times are ‘administered’ through ‘quasi’ monopolies (look at Amazon and how it uses ‘central planning’ in its distribution system). But the main contention of this kind of thinking is with the idea of whether markets are indeed needed in a state of ‘near complete abundance’.^[6] Even von Misses acknowledged such a theoretical possibility in his original paper (see above):

‘The static state can dispense with economic calculation. For here the same events in economic life are ever recurring; and if we assume that the first disposition of the static socialist economy follows on the basis of the final state of the competitive economy, we might at all events conceive of a socialist production system which is rationally controlled from an economic point of view.’

By going through the Soviet experience of the 1960-70s, my focus here is more on how the use of advanced technology can substantially improve the process of centrally planned economic activity.

The Soviet models of resource optimization in the 1960s and 1970s were very sophisticated for their time: in the late 1950s, Kitov proposed the first ever national computer network for civilians; in the early 1960s, Kantorovich invented linear programming (and got the Nobel prize in Economics); shortly after, Glushkov introduced cybernetics. 

Kitov’s idea was for civilian organizations to use functioning military computer complexes for economic planning (whenever the latter are idle, for example during the night). Kantorovich brought in linear programming which substantially improved the efficiency of some industries (he is the central character in a very well-written book about the Soviet planning system called ‘Red Plenty’). Glushkov combined these two ideas and his OGAS (The All-State Automated System for the Gathering and Processing of Information for the Accounting, Planning and Governance of the National Economy), which was intended to become a real-time, decentralized, computer network of Soviet factories. The idea was very similar to a version of today’s permissioned blockchain: the central computer in Moscow would grant authorizations, but users could then contact each other without going through the capital.

The Soviet planning system failed not necessarily because it would not work (limited though it was in terms of computational power and availability of data) but because of politics: Khruschev, who had taken over after WW2 and denounced the brutality of Stalin, was ousted by Brezhnev. The early researchers were pushed aside (in fact, those Brezhnev years were characterized by fierce competition among scientists for preferential political treatment). One could say that the Soviets’ model of resource optimization failed because it was not socialist enough (compared to how the internet took root in the US on the back of well-regulated state funding and collaboration amongst researchers). In other words, the 1970s Soviet Union was a political rather than a technical failure. 

I should know, I guess. I grew up in one of the Soviet satellites. My father was in charge of a Glushkov-style information data centre within a large fertilizer factory. When we were kids, we used to build paper houses with the square punched cards he would sometimes bring home from work. Later on, when I became a teenager, my father would teach computer programming as an extracurricular activity in my local school (I never learned how to program; I preferred to spend my time playing Pacman instead!). At that time, Bulgaria used to produce a PC, Pravetz (a clone of Apple II), which was instrumental in the economy of all the countries within the Soviet sphere of influence.

By the time I was graduating from high school, though, things had begun deteriorating significantly: even though everyone had a job, ‘no one was working’ and there was not much to buy as the shops lacked even the essentials. Upon graduation, and shortly after the Iron Curtain fell down, I left to study in America. 

Eventually, I ended up spending much more time in the ‘trial and error’ economy of the developed world, working at the heart of the ‘free market’ in New York and London. I am certainly not unique in that sense, as many people have done this exact same thing, but the experience does allow me to make an observation about the merits of the planned economy vs the free market.

My point is the following. The problem of the planned economy was not so much technical resources optimization, but, ironically, one of proper distribution of the surplus. The Soviet system did not exactly create an extreme inequality, like the one there is now in America (even though some people at the top of the Party did get exorbitantly rich). However, instead of using the production surplus for bettering the life of the population in the present, politicians continued to obsess over further re-investment for the future. There was, perhaps, a justification for that, but it was purely ideological: a military industrial competition with America – nothing to do with reality on the ground.

So, while the Soviets were perhaps winning that competition (Sputnik, Gagarin, Mir, etc.), the plight of the common people was not getting better. And while they couldn’t simply go into the street and protest or vote the ruling party out, they expressed their anger by simply pretending to work. Of course, that eventually hurt them more as the surplus naturally started dwindling, productivity collapsed, and the quality of the finished products deteriorated. The question is, given a chance, could the planned optimization process have worked? If Glushkov’s decentralized network with minimum input from humans had been developed further, would the outcome now be different?

There is a lesson here somewhere for us. For example, both China/Asia and the West have created massive surpluses using the two opposing optimization solutions. And both are running the risk of squandering that surplus, in a similar fashion to the Soviet Union of the 1980s, if they don’t start distributing it to the population at large for general consumption. In both cases, this means transferring more income to labour: in China, away from the state (corporates); in America, away from the capital (owners). But because of the differences at the core of the two systems, it is easier for China to do this through planning; in America, the optimization process of the free market, unfortunately, ensures that the capital vs labour inequality goes further to the extreme.

This brings us back to our starting point. MMT is a natural extension of economic and political forces at play since the 1970s. It is a response to the inability of the free market to allocate the surplus which it has so brilliantly created, through efficient resource optimization, up to now. If we don’t reconsider our options, we are running the risk of squandering it all and ending up maybe even further back than where we started after Bretton Woods collapsed.

1. Natural disasters, illnesses etc., which devastate the factors of production, have the same effect on the economy as wars and revolutions. ↑
2. What happens in these periods is a steady decline in interest rates as surpluses keep building up. In fact, on a long enough timeframe, global interest rates have been declining ever since Babylonian times, with the only spikes being in periods of wars, etc., which destroy the resource surpluses. ↑
3. “The world in balance sheet recession: causes, cures and politics”, Richard Koo, Nomura Research Institute, 2011. ↑
4. “Golden Fetters: The Gold Standard and the Great Depression, 1919-1939”, Barry Eichengreen, 1996. ↑
5. “Blockchain: helicopter money on demand”, Anton Tonev, Davey Jose, HSBC, 2015. ↑
6. “An Essay on Marxism”, Joan Robinson, 1996. ↑