Lange model

TheLange model(orLange–Lerner theorem) is aneoclassical economic modelfor a hypotheticalsocialist economybased on public ownership of themeans of productionand a trial-and-error approach to determining output targets and achievingeconomic equilibriumandPareto efficiency.In this model, the state owns non-labor factors of production, and markets allocate final goods and consumer goods. The Lange model states that if all production is performed by a public body such as the state, and there is a functioning price mechanism, this economy will be Pareto-efficient, like a hypotheticalmarket economyunderperfect competition.Unlike models of capitalism, the Lange model is based on direct allocation, by directing enterprise managers to set price equal tomarginal costin order to achieve Pareto efficiency. By contrast, in a capitalist economy, private owners seek to maximize profits, while competitive pressures are relied on to indirectly lower the price, this discourages production with high marginal cost and encourageseconomies of scale.

This model was first proposed byOskar R. Langein 1936 during thesocialist calculation debate,and was expanded by economists like H. D. Dickinson andAbba P. Lerner.Although Lange and Lerner called it "market socialism",the Lange model is a form ofcentrally planned economywhere a central planning board allocates investment and capital goods, while markets allocate labor and consumer goods. The planning board simulates a market in capital goods by a trial-and-error process first elaborated byVilfredo ParetoandLéon Walras.^[1]The Lange Model is in practice a type ofcentrally planned economyand not a type ofmarket socialism.

The Lange model has never been implemented anywhere, not even in Oskar Lange's home country,Poland,whereSoviet-type economic planningwas imposed after World War II, precluding experimentation with Lange-style economy.^[2]Some parallels might be drawn with theNew Economic Mechanismor so-calledGoulash CommunisminHungaryunderKádár,although this was not a pure Lange-model system.^[3]

Overview

The model is sometimes called the "Lange–Lerner" model.^[4]Abba Lernerwrote a series of articles that greatly influenced Lange's thinking. For example, Lerner (1938) caused Lange to re-write his 1936 and 1937 articles onmarket socialism,before they were re-published as chapters in a 1938 book. Lerner (1938) influenced Lange's thinking onsocial dividendpayments. Lerner (1944) also argued that investment in the Lange model would inevitably be politicized.

The Lange model was developed in response toLudwig von MisesandFriedrich Hayek'scriticisms of socialismduring thesocialist calculation debate.The critics argued that any body that owns and consolidates a society's means of production cannot acquire the information needed to calculate general equilibrium prices, and that market-determined prices were essential for the rational allocation of producer goods. The Lange model contains principles proposed by neoclassical economistsVilfredo ParetoandLéon Walras.Lange's theory emphasizes the idea of Pareto efficiency: a situation is Pareto-efficient if there is no way to rearrange things to make any individual better off without making anyone worse off. To achieve Pareto efficiency, a set of conditions must be formulated in stages. This idea of deriving conditions to ensure that consumer preferences are in balance with the maximum amount of goods and services produced is emphasized by Walras. The theorem indicates that a socialist economy based on public ownership could achieve one of the principal economic benefits of capitalism - a rational price system - and was an important theoretical force behind the development of the concept ofmarket socialism.

Basic principles

The Lange model suggests three levels of decision-making. The lowest level contains firms and households, the intermediate level contains industrial ministries, and the highest level is the central planning board. The board sets the initial price of consumer goods arbitrarily and informs the producing firms of these prices. The state-owned firms then produce at the level of output wheremarginal costequals price, P = MC, so as to minimize the cost of production. At the intermediate level, industrial ministries determine the sectoral expansion of industry. Households decide how to allocate income and how much labor to supply by choosing between work and leisure.

Institutions

The key institutions of the Lange model include the central planning board (CPB), industrial ministries for each economic sector, and state enterprisesmanaged democraticallyby their employees.

Trial-and-error price adjustments

Because prices are set by the central planning board "artificially" aiming to achieve planned growth objectives, it is unlikely that supply and demand will be in equilibrium at first. To produce the correct amount of goods and services, the Lange model suggests a trial-and-error method. If there is a surplus of a particular good, the central planning board lowers the price of that good. Conversely, if there is a shortage of a good, the board raises the price. This process of price adjustments takes place until equilibrium between supply and demand is achieved.

Central planning board

The central planning board (CPB) has three major functions in the Lange model: First it instructs firms to set price to equal marginal cost, secondly it adjusts prices to attain market-clearing prices for goods and services, and finally, it reinvests the economic profit derived from state enterprises into the economy based on a target rate of growth. The central planning board also distributes social dividends to the population.

Social dividend

Apart from setting prices, the central planning board allocatessocial dividends.Because all non-labor factors of production are publicly owned, the rents and profits of these resources belong to the public. The profits would be used to finance a social dividend scheme based on the individuals' share in the income derived from the socially owned capital and natural resources, providing a complementary source of income for workers alongside their salaries and wages.^[5]

Advantages

The Lange economic model has a number of theoretical advantages. One advantage is public control over investment. The rate of economic growth would be largely state-determined and a major determinant would be investment ratio.

Another advantage argued by Lange was thatexternalitiescould be better accounted for, thanks to the state's ability to manipulate resource prices. Because the state controls all firms, they could easily factor the cost of an externality into the price of a certain resource. Because decisions are made at higher rather than lower levels, it is argued that these decisions are less likely to have undesirable environmental consequences.

Furthermore, because the state usesmarginal cost pricingand determines entry, Langean socialism can avoid monopolies and the accompanying lack ofallocative efficiencyandx-efficiency.

The model claims to solve another main criticism ofcapitalism.Lange believed that his model would reduce cyclical instability because the state would control savings and investment, consequently eliminating a major source of inefficiency, inequality and social instability that arises from violent cyclical shifts under capitalism.

Criticisms

Milton Friedmancriticized the Lange model on methodological grounds. According to Friedman, the model rested on "models of imaginary worlds" rather than "generalizations about the real world", making the claims of the model immune to falsification. He also criticized the model on ethical grounds, pointing out that governments would be quick to shut down or seize firms that do not align with targets mathematically proposed by the system, thus limiting true economic freedom.^[6]Other criticisms include how the Lange model assumes that market data is static and can be 'given' to central planners and that humans are passive and neutral in their preferences.^[7]

References

^Hodgson, G. M. (1998). "Socialism against markets? A critique of two recent proposals".Economy and Society.27(4): 407–433.doi:10.1080/03085149800000027.
^Yunker, James A. (1995). "Post-Lange Market Socialism: An Evaluation of Profit-Oriented Proposals".Journal of Economic Issues.29(3): 683–717.doi:10.1080/00213624.1995.11505705.JSTOR 4226984.
^Wolf, Thomas. "The Lessons of Limited Market-Oriented Reform" (1991), The Journal of Economic Perspectives, Vol. 5, No. 4 (Autumn, 1991), pp. 45-58
^Bator, Francis M. (August 1958). "The Anatomy of Market Failure".The Quarterly Journal of Economics.72(3): 351–379.doi:10.2307/1882231.JSTOR 1882231.
^On the Economic Theory of Socialism,by Lange, Oskar. 1936. The Review of Economic Studies, Vol. 4, No. 1: "It seems, therefore, convenient to regard the income of consumers as being composed of two parts: one part being the receipts for the labour services performed and the other part being a social dividend constituting the individual's share in the income derived from the capital and the natural resources owned by society."
^Milton Friedman, 'Lange on Price Flexibility and Employment',Essays in Positive Economics.
^Duddy, Craig (2021)."A Critique of the Lange Model".SSRN.doi:10.2139/ssrn.3870418.SSRN 3870418.

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