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Economic Calculation in the Socialist Commonwealth

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Economic Calculation in the Socialist Commonwealth sent shockwaves though the academic world when it appeared in 1920. Following World War One many scholars were fascinated with the newly formed Soviet Union. Would the USSR live up to the romantic expectations of Marxists? Could some other form of socialism work better? Was capitalism doomed? Ludwig von Mises answered these questions with a resounding no.

Mises identifies THE critical problem in socialist economics- the lack of a means for allocating capital goods. Once the state owns the means of production markets for capital goods disappear. Market prices for capital goods emerge through competitive biding as entrepreneurs estimate the values of different capital goods. If we abandon markets, central planners must still choose between alternative capital goods, but they will not have market prices to guide them. Since all value is in use and is subjective, central planners face an impossible task when they try to ascertain relative values for capital goods. Mises proves that in a dynamic, changing world of subjective value and complex productive processes, markets are an indispensable means of organizing production.

Mises described the calculation problem more fully in his book, Socialism, and Economic and Sociological Analysis. In my own experience, reading the 1920 essay is not enough to understand the full calculation argument. Economic Calculation in the Socialist Commonwealth is, however, and excellent starting place for understanding the problems of socialism. Every socialist should read this essay, along with the more complete version of the calculation critique in "Socialism", and with Hayek's books "Individualism and Economic Order" and "The Road to Serfdom".

In "Economic Calculation in the Socialist Commonwealth", the late Ludwig Von Mises, one of the leading economists of the Austrian School, takes aim at the foundations of Socialism. Von Mises argues that under Socialism, that is the abolition of private property and state control over production, economic calculation is impossible. This short 51 page essay and summary by Professor Joseph T. Salerno of Pace University demonstrates that a socialist economy cannot be rational and thus provides no way to assign resources to their most productive uses. It is too bad this 1920 piece was not read by more intellectuals. We could have avoided 70 years of ruin under communism. His argument is not a moral attack but one of practicality. Even assuming that central planners are honest, selfless, motivated and intelligent individuals, how do they allocate resources and plan production without market signals and a common exchange medium (money) that quantifies these signals? In simplest terms how can central planners make decisions without a feedback loop that conveys scarcity, needs and desires?

Von Mises makes several key points:
1) Monetary calculation is an indispensable tool for choosing the optimum among a vast array of production plans.
2) The "intellectual division of labor" (i.e. demand signals) which emerges when individuals (i.e. property owners) are at liberty to exchange goods and services creates subjective value judgements which are then totaled to derive an objective monetary exchange rate. Prices are just the objective reflection of the sum of millions of individual subjective valuations. Such a process does not exist in a socialist economy where the thought process resides the heads of a few bureaucrats.
3) In a static environment, determining value in the absence of market signals would be difficult enough but in a dynamic environment it would be impossible. Social price structure is continually being destroyed and recreated by a competitive appraisement process.
4) True socialist economies can never exist. The former Soviet Union had a quasi-socialist economy. Although its central planners determined most production, they utilized the appraisement process from market economies (United States, Germany, UK, Japan etc.) to help determine capital structure and production priorities. Therefore, the former Soviet Union and other quasi-socialist countries could only eke out an existence by copying technology, production processes and priorities developed in the advanced capitalist economies. Without these signals, the central planners would have no compass to direct them in an ocean of possible economic decisions. This decision-making problem is especially pronounced when it comes higher-order production goods and services such machinery, research and development and implementation of new technologies.

With these very simple points, he devastates the economic foundation of Socialism. That is why in the former Soviet Union, there were many tractors rusting in fields where thousands of tons of grain rotted away. Why? - Because the central planners could not possibly derive the optimum production of tractors, warehouses, fertilizers, distribution networks, fuel and labor without some way of calculating value. For a moment forget about other problems inherent in Socialism (lack of incentives, corruption, abuse of power, bureaucratic inertia etc.) and just focus on the lack of a rational decision-making process. Decisions in a socialist economy would have to be arbitrary.

Just imagine a little thought experiment. You want to build a railroad. First of all, how do you decide if the railroad should be built at all? Secondly, if you want to build it, where should you build it? How many lines should you run? What type of trains? How do you answer these questions without some type of cost-benefit analysis? How do you calculate cost-benefit without market signals that convey supply and demand? Given the multitude of factors involved with such an endeavor - steel and wood to build the rails, fuel to power the trains, the design and quantity of carriages and the variety of employees needed to operate and maintain the system (all of this in a ever changing environment) - how does one make decisions without converting to the common exchange medium of money? In the absence of a market, what objective value does money have?

In summary, with no free market, there is no pricing mechanism and therefore no economic calculation.

It is unfortunate that one evening of reading could expose the underlying structural flaws inherent in Socialism and yet millions decided not to pay attention.

Von Mises was an influential and important economist of the 20th century, belonging to the Austrian school of thought in economics. A strong supporter of classical liberalism, Mises opposed Socialism passionately, explaining that it is economically impossible to have an efficient economic system through the absence of price signals and the implementation of central planning instead. Mises argued that the absence of price signals makes it impossible to match production with consumption, making efficient resource allocation unworkable. Mises' argument was the beginning of what became a popular price theory in economics.
One has to consider that Socialism in the early 1900s was based on centralizing the economy, either partly or totally. Mises wrote this essay during a period when Lenin and the Bolsheviks had taken over Russia and promoted a state-controlled centralized command economy, promising a "worker's paradise". Hopes were high that Socialism, and particularly the Soviet model that was being created, would bring a brighter society.
Mises' success rests in how he managed to predict the economic inefficiency of the future Socialist systems (especially the Soviet model) by mere economic logic. In 1920 there was no practical example of a Socialist system at work - and therefore no significant example Mises could have used to prove his argument. His argument may look common sense, outdated, or incomplete for the standards of today, however, in the 1920s, it was a fresh and very alive argument that was raised in heated debates concerning economic management.
A classic critique of Socialist economics.

But this book just didn't do as good of a job as it might have in bringing that across.

A good way to start would have been to take several hypothetical socialist markets/ cases and then show what problems might have arisen in making calculations. Instead, the book came across as more a series of floating abstractions.

It was a decent book, just not terribly interesting.