Hourly Billing is a "Shadow Price" | AccountingWEB

Hourly Billing is a "Shadow Price"

Ok, this is an esoteric post, so feel free to skip it unless you have a mordant interest in what the failure of communism and central planning have in common with hourly billing.

Back in October I read a great book, Red Plenty, by Francis Spufford, British Fellow of the Royal Society and teacher of writing at Goldsmiths College.

The book is all about how the post-Stalin USSR was going to usher in era of prosperity, under the leadership of Nikita Khrushchev, with the magic of the "planned economy" run by apparatchiks, whom Stalin referred to as "The engineers of human souls."

But how?

Austrian economist Ludwig von Mises argued that a centrally planned economy would never be able to replace market prices since the calculations involved would outstrip the capacity of even supercomputers, let alone fallible human beings.

But there was a group of Soviet economists who argued that a market was nothing more than a mathematical device for allocating goods and services to the highest bidder, which you could reduce entirely into equations--the materialist fallacy, or even, the McKinsey fallacy: What you can measure you can manage.
Karl Marx concurred, arguing that markets were not very important, since they merely reflected the labor that was embedded in commodities.

Oskar Lange, an economist from Warsaw, even argued that the marketplace was a "primitive pre-electronic calculator" that in the age of the vacuum was an anachronism, moving at the speed of "a babushka in a headscarf."

The problem of capitalism is that it cannot calculate optimum prices for an entire economy at once. Soviet economists believed they could.

But how?

Shadow prices, an idea developed by Leonid Vitalevich Kantorovich (1912-1986), mathematician and economist, who was the USSR's nearest equivalent to John von Neumann, and the only Soviet economist to win the Nobel Prize for Economics.

Here is how Francis Spufford explains what replaces the subjective value of consumers (pages 164-65):

What we need is a planning system that counts the value of production rather than the quantity. But that, in turn, requires prices that express the value of what's produced.

The value to whom?

Not just the value to the producer, or even to the consumer, because that only gives you capitalism again, surging to and fro, doing everything by trial and error.

It's got to be the value to the whole system; the amount it helps with what the whole economy is trying to do in the present plan period. And it turns out that a set of prices exist which will do that. 

But--in order to work, they have to be active. They have to keep changing along with the changing possibilities of the economy...

So, in order to get them [we need] one big connected cybernetic system. With software...written by great minds.

So how are these "shadow prices" computed?

Here is how Spufford explains Kantorovich's concept (page 380):

[Shadow prices]: The multipliers on which Kantorovich's solution to optimization problems depended.

Essentially, they were opportunity costs: they represented the cost of choosing one particular arrangement of production in terms of the amount of production foregone by choosing it.

Their ideological significance lay in the way that, without making any reference to demand or to markets, Kantorovich had discovered a demand-like logic in the structure of production itself.

In his scheme, it was the volume of planned output that was to be maximized, not the customer's satisfaction, but he had still introduced the idea that utility of the output to somebody should be the guide to how production was configured.

Sound familiar?

This is the billable hour!

I can't count how many times I've heard that the billable hour is a "market price" since it represents the "opportunity cost" to the firm, as well as being within a band of competitive hourly rates among the competition.

Neither of which has anything whatsoever to do with value to the customer!

Spufford doesn't refer to his book as a novel, but rather as a Russian fairytale.

One could say the same about the billable hour. It simply has no correlation with value to the customer.

It's the Trabant of our times, no different than the now-defunct USSR's shadow prices.

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VeraSage Institute is the most revolutionary think tank for professional knowledge firms-we challenge the professions to break free of practice methods that hurt the professions, undermine their purposes, and fail their clients. Among our quests: burying the billable hour and archaic timesheets; pricing on purpose; recognizing that professionals are knowledge workers, not machines; and improving the professions for posterity.

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