Abstract
In this paper I revisit the question of coordination - of plans by prices and other social institutions. Prices contain ambiguous information that requires interpretation. How are they, in spite of this, able to coordinate plans and actions? The answer given in this paper is that they are not - they do not. I suggest that a closer examination of plan-coordination indicates that some plans should not be coordinated, at least as regards their outcomes. Coordination applies to the ‘rules’, the institutions, and not to the outcomes that occur from following them. This follows from the obvious notion that there must be room for creativity. While this may seem like a trivial point, made many times, it is not clear, at least as concerns the role of prices, that it has been fully digested.
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Notes
Metcalfe’s law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system (M2) - first formulated George Gilder (1993). Reed’s law asserts that the benefits of large networks, particularly social networks, can scale exponentially with the size of the network. To see this note that number of possible sub-groups of network participants is 2M − M − 1, where M is the number of members. This grows much more rapidly than either the number of participants, M, or the number of possible pair connections, M(M − 1)/2 (which follows Metcalfe’s law), so that even if the initial utility of groups available to be joined is very small on a peer-group basis, eventually the network effect of potential group membership can increase to become a dominating force (Reed n.d.).
Beckstrom’s law (Beckstrom 2008) is perhaps the most generally conceptually helpful closed-end formulation. This law applies to the net value of any network as a whole. It states that one way to contemplate the value the network adds to each transaction is to imagine the network being shut off and what the additional transactions costs or loss would be. Beckstrom’s Law differs from Metcalfe’s law, Reed's law and other concepts that proposed that the value of a network was based purely on the size of the network. The net present value V of any network k to any individual j is equal to the sum of the net present value of the benefit of all transactions less the net present value of the costs of all transactions on the network over any given period of time t. The value of the entire network is the sum of the value to all users, who are defined as all parties doing transactions on that network.
$$ {\displaystyle \sum {\mathrm{V}}_{\mathrm{i},\mathrm{j},\mathrm{k}}}={\displaystyle \sum_{\mathrm{i}=1}^{\mathrm{T}}{\displaystyle \sum_{\mathrm{j}=1}^{\mathrm{n}}{\displaystyle \sum_{\mathrm{k}=1}^{\mathrm{M}}=\frac{{\mathrm{B}}_{\mathrm{i},\mathrm{j},\mathrm{k}}-{\mathrm{C}}_{\mathrm{i}.\mathrm{j}.\mathrm{k}}}{{\left(1+{\mathrm{r}}_{\mathrm{k}}\right)}^{{\mathrm{t}}_{\mathrm{k}}}}}}} $$where:
Bi,j,k, Ci,j,k = the benefit and cost of transaction i to individual j with respect to network k, respectively.
These are ‘social’ networks and social-network theory would seem to be relevant to this. Groundbreaking work by Granovetter (2005) on the “strength of weak ties” advanced the idea that individuals are more likely to benefit from a network of loose connections, or weak ties, than from a network of strong ties. This emerges from the insight that most of the people with whom we have strong ties also have ties with one another. Therefore, information flowing from these ties is likely to be widely known within the network. This helps to explain how trust can be built up between strangers. A rich body of literature about how individuals cultivate social capital within and (more importantly) across social networks exists (see, for example, Chalmee-Wright and Myers 2008). To my knowledge this literature does not fully incorporate network-effects in explaining how networks arise and converge.
It is a matter of some debate whether, and to what extent, such process are the result of disturbing government policies or are intrinsic to the workings of the free market itself. Such disputes, as important as they are, are difficult, if not impossible, to settle because of the essential complexity of the processes involved. Indeed, policy-making-implementation itself is a complex process.
Over time institutions change. They adapt to changing conditions. How does this affect their role as stable frameworks governing behavior? What happens to rule-following if the rules are changing? Technological shocks may create an environment in which current institutionalized practices need to be amended or extrapolated into new territory. Random changes in behavior may occur that turn out to be beneficial and get ‘selected’ by imitation (Hayek refers to ‘rule-breakers’ Hayek, [1967a] 2014). Or, as Lachmann suggests, some individuals may purposefully initiate changes (Lachmann 1970). Whatever the source of change, what matters is that they do not change often or rapidly. Social rules may be seen at one point in time as relatively stable points while at others as features of the economic systems that are subject to change. Commercial law is necessary for the conduct of economic life and indeed, as we shall emphasize below, facilitates the emergence of unpredictable novelty in economic life, but economic and technological changes of certain types put a strain on aspects of the law that prompt it to change. For example, the emergence of electronic communications has suggested the acceptance of fax signatures and scanned email signatures and has raised difficult legal questions relating to copyright and privacy on the internet. However, so long as the existing set of rules is reliable enough to coordinate people’s plans, an outcome that is orderly will still be generated.
This is a matter that has been the subject of vigorous friendly debate within the modern Austrian school – particularly manifest in the discussion over equilibration between Israel Kirzner and Ludwig Lachmann. My purpose here is not to reprise the debate but to cast the issue in a much wider scope and bring in important recent developments concerning the role of institutions in facilitating value-creating behavior. For a critique of the equilibration perspective of entrepreneurship in the spirit of the view offered here see Buchanan and Vanberg 1991. This article does not, however, address the question of how entrepreneurial failures are handled by the institutional environment (see also Lewin 1997).
Prices are exchange-rates between goods and money. As such they act as constraints on what can be done and as measures of what was done after the fact. Prices are necessarily part of the experience which shapes subsequent action. So, upon perceiving that the price of tin is $x today, and was $x-i yesterday, if tin is important to your production plan, you will try to determine the significance of this change and, relatedly, what this portends. Is this a temporary increase – in which case perhaps you should reduce or postpone your purchase; or is it an indicator of even more increases to come – in which case you should accelerate your purchase? Every price change requires a similar “decoding”.
Competing products are often implicitly also competing networks of product users.
Daniel Klein has considered various possible meanings of the concept of coordination. He distinguishes between two kinds of coordination—mutual coordination and concatenate coordination. Mutual coordination refers to the idea of bottom-up, spontaneous mutual orientation by individuals to each other’s actions. Concatenate coordination appears to be a top-down view of social outcomes on the basis of whether they are coordinated or not. Klein makes the claim that it is this latter view that is exclusively the one used by the classical economists, Adam Smith included, and all others until rather recently. The validity of this claim aside, it is mutual coordination with which we are concerned in this article. (See Klein 2012).
An anonymous referee questions the importance of equilibrium analysis in the first place and notes perceptively, “We experience discoordination continually in our lives, though we don’t think of it this way because we have the ability to reformulate our plans on the fly, so to speak. You go to a store to buy a filet of salmon that you want to grill, but the store has already sold out its salmon. This is an instance of discoordination. But we don’t think of it that way because we quickly select an alternative course of action.” I mostly agree. However, it is surely of significance that “we have the ability to reformulate our plans on the fly” precisely because our reformulating actions are coordinated by the underlying rules of behavior. Absent these, our ability to adapt would be seriously constrained. Further, I would suggest that indeed we are conscious of discoordination when we experience failure. Most significantly, the entrepreneur whose plans fail, is very conscious of failure, a subjective reflection of discoordination.
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Lewin, P. Plan-coordination: Who needs it?. Rev Austrian Econ 29, 299–313 (2016). https://doi.org/10.1007/s11138-015-0312-1
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DOI: https://doi.org/10.1007/s11138-015-0312-1