Economic Calculation in the Socialist Commonwealth
by Ludwig von Mises (1920)
Postscript: Why a Socialist Economy is "Impossible" by Joseph T. Salerno
In "Economic Calculation in a Socialist Commonwealth," Ludwig von Mises demonstrates, once and forever, that, under socialist central planning, there are no means of economic calculation and that, therefore, socialist economy itself is "impossible" ("unm?glich")--not just inefficient or less innovative or conducted without benefit of decentralized knowledge, but really and truly and literally impossible.
At the same time, he establishes that the necessary and sufficient conditions of the existence and evolution of human society is liberty, property, and sound money: the liberty of each individual to produce and exchange according to independently formed value judgments and price appraisements; unrestricted private ownership of all types and orders of producers' goods as well as of consumers' good; and the existence of a universal medium of exchange whose value is not subject to large or unforeseeable variations.
Abolish all, or even one, of these institutions and human society disintegrates amid a congeries of isolated household economies and predatory tribes. But not only does abolition of private ownership of the means of production by a world embracing socialist state render human social existence impossible: Mises's analysis also implies that socialism destroys the praxeological significance of time and nullifies humanity's uniquely teleological contribution to the universe.
Because Mises's critique of socialism has been the subject of significant misinterpretation by his followers as well as his opponents, his argument, as it is presented in this article, should be restated.
The Calculation Argument
(1) Mises's pathbreaking and central insight is that monetary calculation is the indispensable mental tool for choosing the optimum among the vast array of intricately-related production plans that are available for employing the factors of production within the framework of the social division of labor. Without recourse to calculating and comparing the benefits and costs of production using the structure of monetary prices determined at each moment on the market, the human mind is only capable of surveying, evaluating, and directing production processes whose scope is drastically restricted to the compass of the primitive household economy.
The practically unlimited number of alternative plans for allocating the factors of production and the overwhelming complexities of their interrelationships stem from two related facts about our world. First, our world is endowed with a wide variety of relatively "nonspecific" resources, which to a greater or lesser degree are substitutable for one another over a broad range of production processes. Second, since human action itself implies the ineradicable scarcity of time as well as of resources, there always exists an almost inexhaustible opportunity to accumulate capital and lengthen the economy's structure of production, thus multiplying beyond number the technical possibilities for combining the factors of production.
Given, therefore, the infinitude of the relationships of complementarity and substitutability simultaneously subsisting among the various types of productive resources, a single human mind--even if it were miraculously endowed with complete and accurate knowledge of the quantities and qualities of the available factors of production, of the latest techniques for combining and transforming these factors into consumer goods, and of the set of all individuals' value rankings of consumer goods--would be utterly incapable of determining the optimal pattern of resource allocation or even if a particular plan was ludicrously and destructively uneconomic. Not only would this perfectly knowledgeable person be unable to devise a rational solution of the problem, he or she would be unable to even achieve a full intellectual "survey" of the problem in all its complexity.
Thus, as Mises [p.17] says, "...the mind of one man alone--be it never so cunning, is too weak to grasp the importance of any single one among the countlessly many goods of a higher order. No single man can ever master all the possibilities of production, innumerable as they are, as to be in a position to make straightway evident judgments of value without the aid of some system of computation."
(2) What is needed, then, to produce the cardinal numbers necessary for computing the costs and benefits of production processes is what Mises [p. 19] calls the "intellectual division of labor" which emerges when private property owners are at liberty to exchange goods and services against money according to their individual value judgments and price appraisements. Thus in a market society every individual mind is accorded a dual role in determining the quantities of monetary calculation. In their consumer roles, all people make monetary bids for the existing stocks of final goods according to their subjective valuations, leading to the emergence of objective monetary exchange ratios which relate the values of all consumer goods to one another.
In light of the system of consumer goods' prices thus determined, and of the existing knowledge of the technical conditions of production, entrepreneurs seeking to maximize monetary profit bid against one another to acquire the services of the productive factors currently available and owned by these same consumers (including those in entrepreneurial roles). In this competitive process, each and every type of productive service is objectively appraised in monetary terms according to its ultimate contribution to the production of consumer goods. There thus comes into being the market's monetary price structure, a genuinely "social" phenomenon in which every unit of exchangeable goods and services is assigned a socially significant cardinal number and which has its roots in the minds of every single member of society yet must forever transcend the contribution of the individual human mind.
(3) Since the social price structure is continually being destroyed and recreated at every moment of time by the competitive appraisement process operating in the face of ceaseless change of the economic data, there is always available to entrepreneurs the means of estimating the costs and revenues and calculating the profitability of any thinkable process of production.
Once private property in the nonhuman means of production is abolished, however, as it is under socialism, the appraisement process must grind to a halt, leaving only the increasingly irrelevant memory of the market's final price structure. In the absence of competitive bidding for productive resources by entrepreneurs, there is no possibility of assigning economic meaning to the amalgam of potential physical productivities embodied in each of the myriad of natural resources and capital goods now in the hands of the socialist central planners.
Even if planners observed the money prices which continued to be generated on an unhampered market for consumer goods, or substituted their own unitary scale of values for those of their subject consumers, there would still be no possibility for the central planners to ever know or guess the "opportunity cost" of any social production process. Where actors, in principle, are not in a position to compare the estimated costs and benefits of their decisions, economizing activities, by definition, are ruled out.
A society without monetary calculation, that is, a socialist society, is therefore quite literally a society without an economy. Thus, contrary to what has become the conventional interpretation by friend and foe alike, Mises (pp. 21and 26) was not indulging in rhetorical hyperbole but drily stating a demonstrable conclusion of economic science when he declared in this article: "Without economic calculation there can be no economy. Hence in a socialist state wherein the pursuit of economic calculation is impossible, there can be--in our sense of the term--no economy whatsoever ... Socialism is the abolition of rational economy."
(4) Socialism will have particularly devastating effects on the economy's capital structure. Without a unitary expression for time preferences in monetary terms, central planners will never know whether the investment of current resources in the higher stages of production, which yield physically heterogeneous and noncommensurable outputs, will generate an overall production structure whose parts fit together or whose intended length is adjusted to the amount of capital available. Thus higher-order technical processes will be undertaken whose outputs cannot be used in further production processes because the needed complementary producer goods are not available.
In the Soviet Union, for example, in the midst of a dire undersupply of food products, new and unused tractors stand rusting in fields of unharvested grain, because there does not exist sufficient fuel to power them, labor to operate them, or structures to house them. One of the most important consequences of the fact that centrally planned economies exist within a world market economy is that the planners can observe and crudely copy capitalist economies in deciding which technical processes can coexist in a reasonably coherent capital structure. Had the entire world, rather than isolated nations, existed under central planning for the last half century, the global capital structure would long since have crumbled irretrievably to dust and humanity been catapulted back to autarkic primitivism.
(5) Thus, from the first, Mises emphasized the point, which was conveniently ignored by hostile and disingenuous critics: that the existence of the Soviet Union and other centrally-controlled economies is no refutation of his thesis regarding the impossibility of socialist economy. Their gross inefficiency notwithstanding, these economies in fact do eke out a precarious existence as parasites on the social appraisement process and integrated capital structure produced by the surrounding world market. As Mises (p. 20) points out, neither these economies nor nationalized enterprises within capitalist economies are genuinely socialistic, because both entities
are so much dependent upon the environing economic system with its free commerce that they cannot be said to partake ...of the really essential nature of a socialist economy.... In state and municipal undertakings technical improvements are introduced because their effect in similar private enterprises, domestic and foreign, can be noticed, and because those private industries which produce the materials for these improvements give the impulse for their introduction. In these concerns the advantages of reorganization can be established, because they operate within the sphere of a society based upon the private ownership of the means of production and upon the system of monetary exchange, being thus capable of computation and account.
(6) But Mises does not stop with the demonstration that socialism must eradicate economizing activity within the social nexus; he also traces out its implications for the development of the human mind. With the dissolution of social production that inevitably ensures upon the imposition of a world-embracing socialist state, humanity is reduced in short order to dependence upon economic activities carried on in relative isolation. The primitive production processes suitable to autarkic economies do not require economic calculation using cardinal numbers nor do such simple processes offer much scope for purely technical calculation. No longer dependent upon arithmetic operations to sustain itself, the human mind begins to lose its characteristic ability to calculate.
Mises's analysis of the effects of socialism also has another momentous implication. With the impossibility of building up and maintaining a capital structure in the absence of monetary calculation, human economy under socialism comes to consist of super-short and repetitive household processes utilizing minimal capital and with little scope for adjustment to new wants. The result is that time itself--in the praxeological sense of a distinction between present and future--ceases to play a role in human affairs. Men and women, in their capitalless, hand-to-mouth existence, begin to passively experience time as the brute beasts do--not actively as a tool of planning and action but passively as mere duration. Humanity as a teleological force in the universe is therefore necessarily a creation of the inextricably related phenomena of calculation and capital. In a meaningful sense, then, socialism not only exterminates economy and society but the human intellect and spirit as well.
Mises vs. the Hayekians
(1) It is of utmost importance to recognize that, in his original article as well as all later writings on the subject, Mises unswervingly identified the unique and insoluble problem of socialism as the impossibility of calculation--not, as in the case of F.A. Hayek, as an absence of an efficient mechanism for conveying knowledge to the planners. This difference between Mises and Hayek is reflected in their respective conceptions of the social function of competition as well as in their responses to the claims of the later market and mathematical socialists. Actually, Mises anticipated and refuted both groups in his original article. Nonetheless, Mises's position on these issues is today generally ignored or conflated with Hayek's.
(2) For Mises, the starting point for entrepreneurial planning of production in a market economy is the experience of the present (actually immediately past) price structure of the market as well as of the underlying economic data. Knowledge of past market prices by the entrepreneur does not substitute for qualitative information about the economy, as Hayek seems to argue, but is necessarily complementary to it. The reason, for Mises, is that it is price structures as they emerge at future moments of time that are relevant to unavoidably time-consuming and therefore future-oriented production plans. But entrepreneurs can never know future prices directly; they are only able to appraise them in light of their "experience" of past prices and of their "understanding" of what transformations will take place in the present configuration of the qualitative economic data. Whether or not one prefers to characterize entrepreneurial forecasting and appraisement as a procedure for "discovery" of knowledge, as Hayek does, what is important is that for Mises it is the indispensable starting point of the competitive process and not its social culminant.
In other words, the forecasting and appraisement of future price structures in which discovery of new knowledge may be said to play a role is a precompetitive and nonsocial operation, that is, it precedes and conditions competitive entrepreneurial bidding for existing factors of production and is carried on wholly within the compass of individual minds. The social function of competition, on the other hand, is the objective price appraisement of the higher-order goods, the sine qua non of entrepreneurial calculation of the profitability of alternative production plans. Competition therefore acquires the characteristic of a quintessentially social process, not because its operation presupposes knowledge discovery, which is inescapably an individual function, but because, in the absence of competitively determined money prices for the factors of production, possession of literally all the knowledge in the world would not enable an individual to allocate productive resources economically within the social division of labor.
(3) Mises thus assumes in all his writings on the subject that the planners have full knowledge of consumer valuations of final goods as well as of the various means available for producing these goods under known technological conditions. For example, Mises [pp. 23] writes, "The administration may know exactly what goods are most urgently needed.... It may also be able to calculate the value of any means of production by calculating the consequence of its withdrawal in relation to the satisfaction of needs." Despite this knowledge, the socialist administrators would be unable to arrive at a useful social appraisement of the means of production in cardinal terms. This can only occur where there exists private ownership and exchange of productive resources, which generate catallactic competition among independent producers resulting in the imputation of meaningful money prices to the resources.
(4) Anticipating the future arguments of market socialists, Mises reasons that any attempt to implement monetary calculation by forcing or inducing managers of socialist enterprises to act as profit-maximizing (or even more absurdly, price-and- marginal-cost-equalizing) entrepreneurs founders on the fact that these managers do not have an ownership interest in the capital and output of their enterprises. Consequently, the bids they make against one another in seeking to acquire investment funds and purchase productive resources must result in interest rates and prices that are wholly and inescapably arbitrary and useless as tools of economic calculation.
The meaninglessness of these so-called "parametric prices" of market socialism, and their failure to replicate the price structure of the market, derives from the circumstance that they are wholly conditioned by the system of rewards and penalties and other arrangements instituted by the monopoly owners of the factors of production (the planners) to guide the behavior of their managers. But this system of managerial incentives is itself a construct of the individual human mind, which would first have to solve for itself the problem of valuing the factors of production before it could even hope to devise the proper (but now superfluous) incentive structure.
(5) Hayek and his followers are skeptical regarding how quickly and effectively dispersed knowledge of the changing economic circumstances can be incorporated into the socialist price system. But for Mises's analysis, this is quite beside the point. Regardless of how well-informed the socialist managers are, their bids in the "market" for factors of production, to which the central planners are supposed to adjust the price parameters of the system, emerge from an arbitrary set of directives from the planners themselves and not from competition among private property owners. The prices could be no more useless for the task of economic calculation, if the planners eschewed the elaborate and wasteful charade of orchestrating a pseudo-market and simply picked them out of a hat.
(6) From the Misesian point of view, moreover, the shortcomings of the prices of market socialism do not stem from the fact that such prices are supposed to be treated as "parametric" by the managers, as has been curiously argued recently by some of Mises's followers. The problem is precisely that such prices are not genuinely parametric from the point of view of all members of the social body. The prices which emerge on the free market are meaningful for economic calculation because and to the extent that they are determine by a social appraisement process, which, though it is the inevitable outcome of the mental operations of all consumers and producers, yet enters as an unalterable external factor in the buying and selling plans of every individual actor.
(7) In the 1930s, Hayek and the British Misesian Lionel (later Lord) Robbins made a fateful and wholly unwarranted concession to those who contended that the methods of mathematical economics could be successfully bent to yield a solution for the socialist calculation problem. In response to the argument that prices of the factors of production would emerge from the solution of a set of simultaneous equations which incorporated the given data of the economic system, Hayek and Robbins argued that in "theory" this was true but in "practice," highly problematic.
The reason for its impracticality, according to Hayek and Robbins, is that, in the real-world economy, consumer wants, available resources, and technology are subject to continual and unforeseeable change. Therefore, by the time the planners had assembled the vast amount of information needed to formulate the massive equation system and succeeded in solving it (manually or mechanically, since there were no high-speed computers in the 1930s), the system of prices which emerged would be completely inapplicable to the current economy, whose underlying data had changed rapidly and unpredictably in the meantime.
Unfortunately, the Hayek-Robbins response was construed by most economists to mean that the theoretical debate over socialist calculation had come to an end with the concession from the Misesian side that socialism could calculate after all, though perhaps a day late in practice. Moreover, some modern Austrian economists, in a belated effort to reclaim the theoretical high ground, reconstructed the case against socialism along lines suggested by Hayek's later articles on knowledge and competition, which, for all their subtle and compelling argumentation, are disturbingly quasi-Walrasian, seemingly disregarding the lapse of time between present and future prices. The result has been an unacknowledged but momentous retreat from the original and unrefuted Misesian critique emphasizing the absolute impossibility of economic calculation without market prices to a categorically different Hayekian position criticizing the relative inefficiency of non-market mechanisms for discovery, communication, and use of knowledge in the allocation of productive resources.
(8) In sharp contrast to the Hayek-Robbins rejoinder and the reconstructed Austrian position, Mises's neglected refutation of the mathematical socialists, which is outlined in his original article (pp. 25-26) and elaborated upon in Human Action, does not deviate in the slightest from the fundamental and crucial calculation perspective. Thus Mises assumes that the economic data underlying an existing market economy are suddenly and forever frozen and revealed to newly appointed central planners.
With brilliant insight, Mises demonstrates that, even with Hayekian knowledge problems thus banished from consideration, the planners would still be unable to calculate the optimal or any pattern of deployment for the factors of production. The reason is that the existing capital structure and acquired skills and locations of the labor force are initially maladjusted to the newly prevailing equilibrium configuration of the data. The planners therefore would be forced to decide how to allocate the flow of productive services among the myriads of potential technical production processes and labor retraining and relocation projects so as to secure the optimal path of adjustment to equilibrium for the existing stocks of capital goods, labor skills, and housing. The bewildering complexity of this allocation decision rests on the fact that the planners will be confronted with altered conditions at every moment of time during this disequilibrium transition process, since the quantities and qualities of the available productive services themselves are in constant flux due to the circumstance that they originate in the very stocks of physical assets and labor skills that are being progressively transformed.
(9) Complicating this problem beyond conception is the added fact that the leveling of incomes under the new socialist regime and the inevitable fluctuation of current incomes attending the transformation of the production structure would effect a continual revolution in the structure of consumer demands during the transition period. Mises [p. 26] is surely not overstating his case when he concludes that "... the transition to socialism must ... change all economic data in such a way that a connecting link with the final state of affairs in the previously existent competitive economy becomes impossible. But then we have the spectacle of a socialist economic order floundering in the ocean of possible and conceivable economic combinations without the compass of economic calculation."
Even if mathematics, therefore, yields a consistent set of prices for the given data of equilibrium, this solution is inapplicable to the calculation problems of the dynamic approach to equilibrium. In this situation, use of such prices to allocate resources does not allow the economy to achieve equilibrium, at any rate, before the capital structure and the entire system of social production is demolished.
Thus Mises's original thesis stands on its own against all counterarguments and without any need for qualification or emendation: without private ownership of the means of production, and catallactic competition for them, there cannot exist economic calculation and rational allocation of resources under conditions of the social division of labor. In short, socialist economy and society are impossible.
(1) But though Mises's thesis may remain valid, is it sill relevant in a world in which socialist planned economies have collapsed like a house of cards? The answer is a resounding "yes," for Mises's argument [p. 20] implies that "Every step that takes us away from private ownership of the means of production and from the use of money also takes us away from rational economics."
The never-ending growth of the bloated, rapacious, unjust, and unlovely American and other Western-style welfare states involves an ongoing series of such steps. Looking at it from another angle, the blessedly defunct planned economies of Eastern Europe, as noted above, were far from being genuinely socialist economies in the Misesian sense, because of their ability to trade in and observe the capital complementarities and prices of the world market. They were, and the Soviet Union, China, and others still are, gigantic monopoloid entities that suppress internal markets for capital goods yet maintain subjective and objective relationships with the world market order which enables them to crudely calculate their actions.
As the parasitic welfare state expands its power of monetary inflation and of regulating and intervening into its host "mixed" economy, we can expect productive activities to become more chaotic and guided less and less by socially-determined market prices. In fact, long before a state of complete socialization is achieved, economy and society will begin to disintegrate amid failure of markets to clear, increasing barter, less efficient sizes and forms of business organizations, misallocation, and technical inefficiency of productive resources and disastrous declines of gross capital investment, labor productivity, and living standards. The dangers currently threatening to plunge sectors of the U.S. economy into calculational chaos can be illustrated with a few examples.
(2) Let us consider inflation. One of the most important factors operating to restrain governments of the United States and other mixed economies from reinstituting the inflationary monetary policies which brought us the double-digit rates of price increase of the 1970s is the coexistence of closely integrated global capital markets and independent national fiat currencies issued by central banks jealous of their prerogatives. Any nation that attempts a highly inflationary monetary policy courts the prospect of a rapidly depreciating exchange rate for its currency, a "flight" of investors from its domestic capital market, and a stratospheric climb in interest rates. In the current jargon, monetary authorities, even of large nations such as the United States, have "lost control of domestic interest rates."
Now, there is a much ballyhooed movement afoot to effect greater international "coordination" of monetary and fiscal policies or even to introduce a supranational central bank empowered to issue its own fiat currency. At bottom, such proposals seek to loosen the restraints on monetary inflation at the domestic level and allow politicians and bureaucrats and their allowed special interests to surreptitiously extract an expanding flow of lucre or "welfare" from the productive sectors of their economies.
More importantly from our point of view, these international monetary arrangements greatly increase the threat of hyperinflation and the consequent disintegration of the world market economy. Moreover, even if it were reined in before hiving off into hyper-inflationary currency collapse, a bout of galloping inflation in an economy with a highly developed and complex capital structure would drastically falsify monetary calculation and cause capital consumption and a drastic plunge in living standards.
(3) Another area in which we face the prospect of calculational chaos is health care. By wildly subsidizing and stimulating the demand for health care services of selected special interest groups beginning in the mid-1960s, the United States government precipitated a never ending and catastrophic upward-spiral of health care costs.
In addition, the irrational and labyrinthine structure of regulations and prohibitions imposed by government on the industry has massively distorted resource allocation, restricted supply, and further driven up the costs of medical care. The tragic but predictable result of such intervention is that many of the unsubsidized members of society have been effectively priced out of the market for health care. The simple and humane solution to this tragedy is to quickly terminate these antisocial subsidies and dismantle the destructive regulatory structure, permitting the competitive price appraisement and resource allocation process too operate unimpeded.
But, of course, the internal dynamic of the welfare state is never to retrench and risk disaffection of its pampered and powerful constituencies, for example, the American Medical Association, the American Association for Retired Persons, the entrenched bureaucracies of nonprofit hospitals, and so on. And so we face the prospect of "national health care insurance" which is a euphemism for the thoroughgoing socialization of the health care sector, with its resultant shortages, further suppression of competitive incentives, and deterioration of quality. But this is simply another example of the mad logic of the welfare state: since the government produces nothing that is valuable in terms of social appraisement, it can only supply welfare to some by siphoning off the resources and destroying the economic arrangements that support the welfare of others. In attempting to repair the politically unpopular destruction of its earlier policies, it is driven to further isolated acts of destruction until it arrives, with cruel and ultimate irony, at the policy for the systematic destruction of society and human welfare, that is, socialism.
(4) Finally, we have environmental policies, which are becoming progressively broader in scope and more draconian in enforcement. To the extent that such policies go beyond the protection of individual rights and property--and they are now far, far beyond this point--they become antisocial and destructive of capital and living standards. In fact, in many if not in most cases, it is the obliteration of economic productivity per se which is intended and which constitutes the in-kind welfare subsidy to the well-heeled and well-organized minority of upper-middle class environmentalists.
This is true, for example, of environmental regulations that prohibit development activities for the vast majority of Alaskan land and along much of the California coastline as well as of recent calls for suppressing development of Amazon rain forest and coercively maintaining the entire continent of Antarctica forever wild. Needless to say, thoroughgoing and centralized land use regulations, which some fanatical environmentalists are calling for, is tantamount to the abolition of private property in national resources and business structures. The connection between environmentalism and socialism is even stronger when we realize that what socialism brings about unintentionally--the abolition of humanity as a teleological force shaping nature to its purposes--is precisely the aim of the radical environmentalist program.
The significance of Mises's 1920 article extends far beyond its devastating demonstration of the impossibility of socialist economy and society. It provides the rationale for the price system, purely free markets, the security of private property against all encroachments, and sound money. Its thesis will continue to be relevant as long as economists and policy-makers want to understand why even minor government economic interventions consistently fail to achieve socially beneficial results. "Economic Calculation in the Socialist Commonwealth" surely ranks among the most important economic articles written this century.
Joseph T. Salerno
Associate Professor of Economics
Lubin Graduate School of Business