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When Does Economic Calculation Become Necessary?

November 12, 2004

Ludwig von Mises is famous, among other things, for contending that a large-scale socialist economy cannot exist. As he put it, "without calculation, economic activity is impossible." He said that the absence of real (i.e., market) prices, in a fully socialist economy, would leave its planners without the means to perform the sort of calculation that the owners, managers, and bookkeepers in a capitalist concern engage in every day.

In a market economy, producers rely on the results of such calculations to determine if consumers approved of how they acquired and used their inputs, in which case their books show a profit, or if they would have preferred that those resources had been devoted to some other use, indicated by the errant producers suffering a loss. Mises held that any attempt to create an advanced economy in which there were no money prices for goods, completely eliminating the market process, could only result in "planned chaos."

Mises's claim flummoxed many of his critics. They noted that, however badly one may believe the economy of the Soviet Union or Communist China performed, it was clearly not impossible to have a socialist economy, since, after all, there they were, continuing to exist for many decades.

Mises, of course, was aware of the existence of countries that called themselves socialist. But he never regarded them as a counter-examples to his thesis, because not one of them had an economy that met the socialist ideal: all of them used money, kept books, charged interest, paid wages based on the value of the worker's product rather than on his "need," and all of them remained embedded in the worldwide market economy, enabling the state's economic planners to calculate on the basis of genuine market prices. (See the work of Peter Boettke for a detailed account demonstrating that the U.S.S.R. was not really a socialist country.)

Many people have said that the collapse of the Soviet Union proved that Mises was correct. But, of course, if its survival for seventy years did not prove him wrong, then it is hard to see how its eventual demise could have proved him right. And I do not believe that Mises himself, had he lived to see the events of the late 1980s and early 1990s, would have cited them as proof of his claim. He was not predicting how long a state that intervened extensively in its economy could last. Instead, he was demonstrating that any effort to fully realize the socialist ideal would not result in an economy at all, but in a catastrophe.

However, Mises left part of his theory somewhat vague. He knew that money prices and economic calculation were not universal aspects of human existence. People had survived on the earth, living together in groups, for ages without their aid. He addressed that fact by asserting that it was only advanced societies that needed those tools, and that primitive groups were able to get by without them. For example, in Human Action, he writes :

"There is no need to dwell upon the primitive conditions of the household economy of self-sufficient farmers. These people performed only very simple processes of production. For them no calculation was needed, as they could directly compare input and output. If they wanted shirts, they grew hemp, they spun, wove, and sewed. They could, without any calculation, easily make up their minds whether or not the toil and trouble expended were compensated by the product. But for civilized mankind a return to such a life is out of the question."

The question he left unanswered is, at what point does a society pass from being "primitive" -- able to survive successfully without economic calculation -- to being "advanced" – in need of calculation to maintain its population and levels of culture and material well-being? Or as Bryan Caplan, in his online essay "Why I Am Not an Austrian Economist," put it:

"Does Crusoe's one-man socialism become 'impossible' when Friday shows up?  Hardly. What if 100 people show up? 1000? Mises' distinction between a modern economy and Crusoe's, and why the economic calculation argument applies only to the former… shows that Mises has underlying quantitative assumptions in spite of his strictures against them. He is making a quantitative judgment that the lack of calculation would not greatly worsen Crusoe's economy, but would devastate a modern economy."

I believe that recent discoveries about the origins of writing allow us to tentatively formulate Mises's distinction more precisely, thereby addressing Caplan's complaint. Along the way, a link between the development of economic calculation and that of another major human invention becomes plausible. Here, I am only suggesting this distinction as a possible way of marking the border between those societies that do and those that do not need to engage in economic calculation. Much more research would need to be done in the area before my suggestion could be considered as adequately demonstrated. Nevertheless, the minimal evidence I have already encountered is so suggestive that I believe it warrants publication, especially since propagating it might encourage the needed research.

In the early centuries of the fourth millennium BC, the area of southern Mesopotamia known as Babylonia was so wet that it was mostly uninhabitable. But somewhere around 3500, the climate of the region gradually became drier. Initially, this transformed Babylonia into an area where numerous watercourses divided significant patches of arable land, making it nearly ideal for practicing the sort of farming that had already been developed in nearby regions. Settlers rapidly moved in to take advantage of the new circumstances, and Babylonia soon had a higher density of human population than anyplace else in Mesopotamia.

The concentration of settlement encouraged an increased division of labor and the invention of new methods of production, evidenced in what has been unearthed of both the area's pottery and its architecture dating from that time. But the climactic change did not halt there, as the amount of rainfall in Babylonia continued to decrease. Over a period of several decades, conditions changed from one where most of the dry land was easily irrigated from a nearby, natural water source, to one where only a few major watercourses ran through the area, leaving large areas without a natural source of water.

At first, the population of the area simply became more concentrated around the remaining waterways. However, soon enough such a solution apparently proved inadequate, as archaeologists detect the construction of manmade canals. The complexity of Babylonia's structure of production increased correspondingly.

It is around that time that clay tokens, their shape reflecting the goods being traded, first make their appearance. Soon, it was realized that numbers could be recorded more abstractly. However, these primitive records still didn't differentiate between a herd of 100 adult goats and one of 50 adults and 50 kids. So new symbols were developed to record information such as who had performed the tally and details about the nature of the particular goods in question. The German archaeologist Hans J. Nissen (1998) asserts that, once such a step had been taken, "it was possible to carry out something like the simplest form of bookkeeping."

Before too long, the Babylonians had created a set of symbols with which they could record anything they could say in their language, so that a series of scratches in a clay tablet could convey pretty much the same information about a transaction as a person who took part in it could verbally relay to his friend. At that point, we consider their invention to be a genuine system of writing.

It is salient that, as Nissen notes, the earliest texts "describe almost exclusively economic processes." Furthermore, it was the increasing complexity of the economic activities in Babylonia that made "the inadequacy of the earlier methods [of recording transactions] very directly felt, [so that] after the idea of writing arose… its value was immediately recognized."

Postgate, Wang and Wilkinson (1995) agree with Nissen on the evidence from Mesopotamia. The evidence from the other places where writing developed is more ambiguous. For a long time, many experts held that writing originated in Egypt, China, and Mesoamerica for ceremonial rather than utilitarian purposes. But recent finds and a re-thinking of the significance of older ones suggests otherwise.

For one thing, as Postgate, Wang and Wilkinson (1995) note, the fact that most archeological finds of early writing, outside of Mesopotamia, have been ceremonial does not mean that most early writing was. As they put it, "for inscriptions which are meant to last, expensive and durable materials are chosen, for ephemeral and utilitarian texts cheap and perishable materials are used."

Nevertheless, enough new evidence has come to light that the authors can claim, for example, "unambiguous examples of early writing [in Egypt]… again… fulfill an essentially economic-administrative role… The accounting potential for writing was both recognized and utilized by the early Egyptian rulers." In summarizing their findings across all the early civilizations that developed writing, they claim "recent evidence suggests… a utilitarian, administrative origin."

The history of the early stages of several civilizations suggests to me that a society comes to need economic calculation when the economic activity within it begins to exceed the ability of any one person to retain all of the important details of what is occurring within his head. Furthermore, at roughly the same time, a culture first develops the art of writing, as a necessary complement to economic calculation. Finally, it is the growing need to track and tally economic activities that is the chief impetus in the development of writing.

As I cautioned above, I only regard the above as tentative proposals, requiring much more research before they could be taken as proved. However, should further investigation support them, then not only would they serve to clarify Mises's distinction between "primitive" societies, which can do without economic calculation, and "advanced" societies, which cannot, but they would also re-enforce the importance he placed on calculation, since it was the twin sibling of writing, which is universally recognized as one of humanity's great achievements.

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Gene Callahan is studying at the London School of Economics. He is the author of Economics for Real People. Send him  MAIL, and see his Mises.org  Daily Articles Archive. He would like to thank Sudha Shenoy for her many helpful comments on earlier drafts of this article. Post Comments on the blog.

Bibliography

Boettke, P., 1990, The Political Economy of Soviet Socialism: The Formative Years, 1918-1928, Kluwer Academic Publishers: Boston.

Mises, L., 1981 [1922], Socialism: An Economic and Sociological Analysis, trans. J. Kahane, available online at http://www.econlib.org/library/Mises/msStoc.html.

Mises, L., 1949, Human Action: A Treatise on Economics, available online at http://mises.org/page/1470/Human_Action.

Nissen, H., 1998, The Early History of the Ancient Near East: 9000-2000 BC, trans. E. Lutzeier with K. Northcott, University of Chicago Press: Chicago.

Postgate, N., T. Wang, and T. Wilkinson, 1995, "The evidence for early writing: utilitarian or ceremonial?" Antiquity, Volume 69, Number 264.


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