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Socialist Calculation

Tags History of the Austrian School of EconomicsOther Schools of ThoughtPricesPrivate Property

08/16/2010Friedrich A. Hayek

[This article is excerpted from chapter 7 of Individualism and Economic Order.]

Without some such central control of the means of production, planning in the sense in which we have used the term ceases to be a problem. It becomes unthinkable. This would probably be agreed by the majority of economists of all camps, although most other people who believe in planning still think of it as something that could be rationally attempted inside the framework of a society based on private property.

In fact, however, if by "planning" is meant the actual direction of productive activity by authoritative prescription of either the quantities to be produced, the methods of production to be used, or the prices to be fixed, it can be easily shown not that such a thing is impossible, but that any isolated measure of this sort will cause reactions that will defeat its own end, and that any attempt to act consistently will necessitate further and further measures of control until all economic activity is brought under one central authority.

It is impossible within the scope of this discussion of socialism to enter further into this separate problem of state intervention in a capitalistic society. It is mentioned here only to say explicitly that it is excluded from our considerations. In our opinion well-accepted analysis shows that it does not provide an alternative that can be rationally chosen or that can be expected to provide a stable or satisfactory solution of any of the problems to which it is applied.1

But here, again, it is necessary to guard against misunderstanding. To say that partial planning of the kind we are alluding to is irrational is, however, not equivalent to saying that the only form of capitalism that can be rationally advocated is that of complete laissez-faire in the old sense. There is no reason to assume that the historically given legal institutions are necessarily the most "natural" in any sense.

The recognition of the principle of private property does not by any means necessarily imply that the particular delimitation of the contents of this right as determined by the existing laws are the most appropriate. The question as to which is the most appropriate permanent framework that will secure the smoothest and most efficient working of competition is of the greatest importance and one that, it must be admitted, has been sadly neglected by economists.

But, on the other hand, to admit the possibility of changes in the legal framework is not to admit the possibility of a further type of planning in the sense in which we have used the word so far. There is an essential distinction here that must not be overlooked: the distinction between a permanent legal framework so devised as to provide all the necessary incentives to private initiative to bring about the adaptations required by any change and a system where such adaptations are brought about by central direction. It is this, and not the question of the maintenance of the existing order versus the introduction of new institutions, which is the real issue.

In a sense both systems can be described as being the product of rational planning. But in the one case this planning is concerned only with the permanent framework of institutions and may be dispensed with if one is willing to accept the institutions that have grown in a slow historical process, while in the other it has to deal with day-to-day changes of every sort.

There can be no doubt that planning of this sort involves changes of a type and magnitude hitherto unknown in human history. It is sometimes urged that the changes now in progress are merely a return to the social forms of the pre-industrial era. But this is a misapprehension. Even when the medieval guild system was at its height, and when restrictions to commerce were most extensive, they were not used as a means actually to direct individual activity. They were certainly not the most rational permanent framework for individual activity that could have been devised, but they were essentially only a permanent framework inside which current activity by individual initiative had free play.

With our attempts to use the old apparatus of restrictionism as an instrument of almost day-to-day adjustment to change, we have already gone much further in the direction of central planning of current activity than has ever been attempted before. If we follow the path on which we have started, if we try to act consistently and to combat the self-frustrating tendencies of any isolated act of planning, we shall certainly embark upon an experiment that until recently had no parallel in history. But even at this stage we have gone very far.

If we are to judge the potentialities aright, it is necessary to realize that the system under which we live, choked up with attempts at partial planning and restrictionism, is almost as far from any system of capitalism that could be rationally advocated as it is different from any consistent system of planning. It is important to realize in any investigation of the possibilities of planning that it is a fallacy to suppose capitalism as it exists today is the alternative. We are certainly as far from capitalism in its pure form as we are from any system of central planning. The world of today is just interventionist chaos.

Classical political economy broke down mainly because it failed to base its explanation of the fundamental phenomenon of value on the same analysis of the springs of economic activity that it had so successfully applied to the analysis of the more complex phenomena of competition. The labor theory of value was the product of a search after some illusory substance of value rather than an analysis of the behavior of the economic subject.

The decisive step in the progress of economics was taken when economists began to ask what exactly were the circumstances that made individuals behave toward goods in a particular way. To ask the question in this form led immediately to the recognition that to attach a definite significance or value to the units of different goods was a necessary step in the solution of the general problem that arises everywhere when a multiplicity of ends compete for a limited quantity of means.

The omnipresence of this problem of value wherever there is rational action was the basic fact from which a systematic exploration of the forms, under which it would make its appearance under different organizations of economic life, could proceed. Up to a certain point, from the very beginning, the problems of a centrally directed economy found a prominent place in the expositions of modern economics. It was obviously so much simpler to discuss the fundamental problems on the assumption of the existence of a single scale of values consistently followed than on the assumption of a multiplicity of individuals following their personal scales that in the early chapters of the new systems the assumption of a Communist state was frequently used — and used with considerable advantage — as an expository device.2

But it was used only to demonstrate that any solution would necessarily give rise to essentially the same value phenomena — rent, wages, interest, etc. — that we actually observe in a competitive society, and the authors then generally proceeded to show how the interaction of independent activities of the individuals produced these phenomena spontaneously, without inquiring further whether they could be produced in a complex modern society by any other means.

The mere absence of an agreed common scale of values seemed to deprive that problem of any practical importance. It is true that some of the earlier writers of the new school not only thought that they had actually solved the problem of socialism but also believed that their utility calculus provided a means that made it possible to combine individual utility scale into a scale of ends objectively valid for society as a whole. But it is now generally recognized that this latter belief was just an illusion and that there are no scientific criteria that would enable us to compare or assess the relative importance of needs of different persons, although conclusions implying such illegitimate interpersonal comparisons of utilities can still be found in discussions of special problems.

But it is evident that, as the progress of the analysis of the competitive system revealed the complexity of the problems that it solved spontaneously, economists became more and more skeptical about the possibility of solving the same problems by deliberate decision.

It is perhaps worth noting that as early as 1854 the most famous among the predecessors of the modern "marginal utility" school, the German Herman Heinrich Gossen, had come to the conclusion that the central economic authority projected by the Communists would soon find that it had set itself a task that far exceeded the powers of individual men.3 Among the later economists of the modern school, the point in which Gossen had already based his objection, the difficulty of rational calculation when there is no private property, was frequently hinted at.

It was particularly clearly put by Professor Edwin Cannan, who stressed the fact that the aims of socialists and Communists could only be achieved by "abolishing both the institution of private property and the practice of exchange, without which value, in any reasonable sense of the word, cannot exist."4 But, beyond general statements of this sort, critical examination of the possibilities of a socialist economic policy made little headway, for the simple reason that no concrete socialist proposal of how these problems would be overcome existed to be examined.5

It was only early in the present century that at last a general statement of the kind we have just examined, concerning the impracticability of socialism by the eminent Dutch economist, N.G. Pierson, provoked Karl Kautsky, then the leading theoretician of Marxian socialism, to break the traditional silence about the actual working of the future socialist state and to give in a lecture, still somewhat hesitantly and with many apologies, a description of what would happen on the morrow of the Revolution.6 But Kautsky only showed that he was not even really aware of the problem that the economists had seen.

He thus gave Pierson the opportunity to demonstrate in detail, in an article that first appeared in the Dutch Economist, that a socialist state would have its problems of value just as any other economic system and that the task socialists had to solve was to show how in the absence of a pricing system the value of different goods was to be determined. This article is the first important contribution to the modern discussion of the economic aspects of socialism, and, although it remained practically unknown outside of Holland and was only made accessible in a German version after the discussion had been started independently by others, it remains of special interest as the only important discussion of these problems published before World War I.

It is particularly valuable for its discussion of the problems arising out of the international trade between several socialist communities.7 All the further discussions of the economic problems of socialism that appeared before the first World War confined themselves more or less to the demonstration that the main categories of prices, as wages, rent, and interest, would have to figure at least in the calculations of the planning authority in the same way in which they appear today and would be determined by essentially the same factors. The modern development of the theory of interest played a particularly important role in this connection. After Böhm-Bawerk,8 it was particularly Professor Gustav Cassel who showed convincingly that interest would have to form an important element in the rational calculation of economic activity.

But none of these authors even attempted to show how these essential magnitudes could be arrived at in practice. The one author who at least approached the problem was the Italian economist Enrico Barone, who in 1908, in an article on the "Ministry of Production in the Collectivist State," developed certain suggestions of Pareto's.9 This article is of considerable interest as an example of how it was thought that the tools of mathematical analysis of economic problems might be utilized to solve the tasks of the central planning authority.10

When, with the end of the war of 1914–1918, socialist parties came into power in most of the states of central and eastern Europe, the discussion on all these problems necessarily entered a new and decisive phase. The victorious socialist parties had now to think of a definite program of action, and the socialist literature of the years immediately following World War I was for the first time largely concerned with the practical question of how to organize production on socialist lines.

These discussions were very much under the influence of the experience of the war years when the states had set up food and raw material administrations to deal with the serious shortage of the most essential commodities. It was generally assumed that this had shown that not only was central direction of economic activity practicable and even superior to a system of competition but also that the special technique of planning developed to cope with the problems of war economics might be equally applied to the permanent administration of a socialist economy.

Apart from Russia, where the rapidity of change in the years immediately following the revolution left little time for quiet reflection, it was mainly in Germany and even more so in Austria that these questions were most seriously debated. Particularly in the latter country whose socialists had long played a leading role in the intellectual development of socialism, and where a strong and undivided socialist party had probably exercised a greater influence on its economic policy than in any other country outside Russia, the problems of socialism had assumed enormous practical importance.

It may perhaps be mentioned in passing that it is rather curious how little serious study has been devoted to the economic experiences of that country in the decade after the First World War, although they are probably more relevant to the problems of a socialist policy in the Western world than anything that has happened in Russia. But, whatever one may think about the importance of the actual experiments made in Austria, there can be little doubt that the theoretical contributions made there to the understanding of the problems will prove to be a considerable force in the intellectual history of our time.

Among these early socialist contributions to the discussions, in many ways the most interesting and in any case the most characteristic for the still very limited recognition of the nature of the economic problems involved, is a book by Otto Neurath that appeared in 1919, in which the author tried to show that war experiences had revealed that it was possible to dispense with any considerations of value in the administration of the supply of commodities and that all the calculations of the central planning authorities should and could be carried out in natura, i.e., that the calculations need not be carried through in terms of some common unit of value but that they could be made in kind.11

Neurath was quite oblivious of the insuperable difficulties that the absence of value calculations would put in the way of any rational economic use of the resources and even seemed to consider it as an advantage. Similar strictures apply to the works published about the same time by one of the leading spirits of the Austrian Social Democratic Party, Otto Bauer.12 It is impossible here to give any detailed account of the argument of these and a number of other related publications of that time. They have to be mentioned, however, because they are important as representative expression of socialist thought just before the impact of the new criticism and because much of this criticism is naturally directed or implicitly concerned with these works.

In Germany discussion centered round the proposals of the "socialization commission" set up to discuss the possibilities of the transfer of individual industries to the ownership and control of the state. It was this commission or in connection with its deliberations that economists like Emil Lederer and Eduard Heimann and the ill-fated Walther Rathenau developed plans for socialization that became the main topic of discussion among economists.13

For our purpose, however, these proposals are less interesting than their Austrian counterparts, because they did not contemplate a completely socialized system but were mainly concerned with the problem of the organization of individual socialized industries in an otherwise competitive system. For this reason their authors did not have to face the main problems of a really socialist system. They are important, nevertheless, as symptoms of the state of public opinion at the time when and in the nation in which the more scientific examination of these problems began.

One of the projects of this period deserves perhaps special mention not only because its authors are the inventors of the now fashionable term planned economy but also because it so closely resembles the proposals for planning now [1935] so prevalent in Great Britain. This is the plan developed in 1919 by the economics and labor minister, Rudolf Wissel, and his undersecretary of state, W. von Moellendorf.14 But interesting as their proposals of organization of individual industries are and relevant to many of the problems discussed in England at the present moment as is the discussion to which they gave rise, they cannot be regarded as socialist proposals of the kind discussed here but belong to the halfway house between capitalism and socialism, discussion of which for reasons mentioned above has been deliberately excluded from the present essay.

The distinction of having first formulated the central problem of socialist economics in such a form as to make it impossible that it should ever again disappear from the discussion belongs to the Austrian economist Ludwig von Mises. In an article on "Economic Calculation in a Socialist Community," which appeared in the spring of 1920, he demonstrated that the possibility of rational calculation in our present economic system was based on the fact that prices expressed in money provided the essential condition that made such reckoning possible.15 The essential point on which Professor Mises went far beyond anything done by his predecessors was the detailed demonstration that an economic use of the available resources was only possible if this pricing was applied not only to the final product but also to all the intermediate products and factors of production, and that no other process was conceivable that would in the same way take account of all the relevant facts as did the pricing process of the competitive market.

Together with the larger work in which this article was later incorporated, Professor Mises's study represents the starting point from which all the discussions of the economic problems of socialism, whether constructive or critical, which aspire to be taken seriously must necessarily proceed.

While Professor Mises's writings contain beyond doubt the most complete and successful exposition of what from then onward became the central problem, and while they had by far the greatest influence on all further discussions, it is an interesting coincidence that about the same time two other distinguished authors arrived independently at very similar conclusions.

"Professor Mises's study represents the starting point from which all the discussions of the economic problems of socialism, whether constructive or critical, which aspire to be taken seriously must necessarily proceed."

The first was the great German sociologist Max Weber, who in his posthumous magnum opus, Wirtschaft und Gesellschaft, which appeared in 1921, dealt expressly with the conditions that in a complex economic system made rational decisions possible. Like Mises (whose article he quotes as having come to his notice only when his own discussion was already set up in print), he insisted that the in natura calculations proposed by the leading advocates of a planned economy could not provide a rational solution of the problems that the authorities in such a system would have to solve.

He emphasized in particular that the rational use and the preservation of capital could be secured only in a system based on exchange and the use of money, and that the wastes due to the impossibility of rational calculation in a completely socialized system might be serious enough to make it impossible to maintain alive the present populations of the more densely inhabited countries:

The assumption that some system of accounting would in time be found or invented if one only tried seriously to tackle the problem of a moneyless economy does not help here: the problem is the fundamental problem of any complete socialization and it is certainly impossible to talk of a rationally "planned economy" while in so far as the all-decisive point is concerned no means for the construction of a "plan" is known.16

A practically simultaneous development of the same ideas is to be found in Russia. Here, in the summer of 1920, in the short interval after the first military successes of the new system, when it had for once become possible to utter criticisms in public, Boris Brutzkus, a distinguished economist mainly known for his studies in the agricultural problems of Russia, subjected to a searching criticism, in a series of lectures, the doctrines governing the action of the Communist rulers.

These lectures, which appeared under the title "The Problems of Social Economy under Socialism" in a Russian journal and were only many years later made accessible to a wider public in a German translation,17 show in their main conclusion a remarkable resemblance to the doctrines of Mises and Max Weber, although they arose out of the study of the concrete problems that Russia had to face at that time and although they were written at a time when their author, cut off from all communication with the outside world, could not have known of the similar efforts of the Austrian and German scholars. Like Professor Mises and Max Weber, his criticism centers round the impossibility of a rational calculation in a centrally directed economy from which prices are necessarily absent.

Although to some extent Max Weber and Professor Brutzkus share the credit of having pointed out independently the central problem of the economics of socialism, it was the more complete and systematic exposition of Professor Mises, particularly in his larger work on Die Gemeinwirtschaft, that has mainly influenced the trend of further discussion on the Continent. In the years immediately succeeding its publication a number of attempts were made to meet his challenge directly and to show that he was wrong in his main thesis and that even in a strictly centrally directed economic system values could be exactly determined without any serious difficulties. But, although the discussion on this point dragged on for several years, in the course of which Mises twice replied to his critics,18 it became more and more clear that, in so far as a strictly centrally directed planned system of the type originally proposed by most socialists was concerned, his central thesis could not be refuted.

Much of the objections made at first were really more a quibbling about words caused by the fact that Mises had occasionally used the somewhat loose statement that socialism was "impossible," while what he meant was that socialism made rational calculation impossible. Of course any proposed course of action, if the proposal has any meaning at all, is possible in the strict sense of the word, i.e., it may be tried. The question can only be whether it will lead to the expected results, that is, whether the proposed course of action is consistent with the aims that it is intended to serve.

Insofar as it had been hoped to achieve by means of central direction of all economic activity at one and the same time a distribution of income independent of private property in the means of production and a volume of output that was at least approximately the same or even greater than that procured under free competition, it was more and more generally admitted that this was not a practicable way to achieve these ends.

But it was only natural that, even where Professor Mises's main thesis was conceded, this did not mean an abandonment of the search for a way to realize the socialist ideals. Its main effect was to divert attention from what had so far been universally considered as the most practicable forms of socialist organization to the exploration of alternative schemes.

It is possible to distinguish two main types of reaction among those who conceded his central argument. In the first place, there were those who thought that the loss of efficiency, the decline in general wealth that will be the effect of the absence of a means of rational calculation, would not be too high a price for the realization of a more just distribution of this wealth. Of course, if this attitude is based on a clear realization of what this choice implies, there is no more to be said about it, except that it seems doubtful whether those who maintain it would find many who would agree with their idea.

The real difficulty here is, of course, that for most people the decision on this point will depend on the extent to which the impossibility of rational calculation would lead to a reduction of output in a centrally directed economy compared with that of a competitive system. Although in the opinion of the present writer it seems that careful study can leave no doubt about the enormous magnitude of that difference, it must be admitted that there is no simple way to prove how great that difference would be. The answer here cannot be derived from general considerations but will have to be based on a careful comparative study of the working of the two alternative systems and presupposes a much greater knowledge of the problems involved than can possibly be acquired in any other way but by a systematic study of economics.19

The second type of reaction to Professor Mises's criticism was to regard it as valid only as regards the particular form of socialism against which it was mainly directed and to try to construct other schemes that would be immune to that criticism. A very considerable and probably the more interesting part of the later discussions on the Continent tended to move in that direction.

  • 1. Cf. Ludwig von Mises, Kritik des Interventionismus (1929), trans. and republished as A Critique of Interventionism (1977).
  • 2. Cf. particularly Friedrich von Wieser, Natural Value (London, 1893).
  • 3. Herman Heinrich Gossen, Entwicklung der Gesetze des menschlichen Verkehrs und der daraus fliessenden Regeln für menschliches Handeln (Braunschweig, 1854), p. 231.
  • 4. Edwin Cannan, A History of the Theories of Production and Distribution (1893; 3rd ed., 1917), p. 395. Professor Cannan has later also made an important contribution to the problem of the international relation between socialist states. Cf. his essay on "The Incompatibility of Socialism and Nationalism," in The Economic Outlook (London, 1912).
  • 5. A completely neglected attempt to solve the problem from the socialist side, which shows at least some realization of the real difficulty, was made by Georg Sulzer, Die Zukunft des Sozialismus (Dresden, 1899).
  • 6. An English translation of this lecture, originally given in Delft on April 24, 1902, and soon afterward published in German, together with that of another lecture given two days earlier at the same place, was published under the title, The Social Revolution and On the Morrow of the Social Revolution (London, 1907).
  • 7. An English translation of Pierson's article is contained in the volume on Collectivist Economic Planning to which the present essay formed the introduction.
  • 8. In addition to his general work on interest, his essay on "Macht und ökonomisches Gesetz" (Zeitschrift für Volkswirtschaft. Sozialpolitik und Verwaltung [1914]) should be specially mentioned, since in many ways it must be regarded as a direct predecessor of the later critical work.
  • 9. Vilfredo Pareto, Cours d'économie politique, (Lausanne, 1897), vol. 2, p. 364ff.
  • 10. An English translation of Barone's essay forms the Appendix to the volume on Collectivist Economic Planning.
  • 11. Otto Neurath, Durch die Kriegswirtschaft zur Naturalwirtschaft (Munich, 1919).
  • 12. Otto Bauer, Der Weg zum Sozialismus (Vienna, 1919).
  • 13. Rathenau was assassinated in 1922.
  • 14. This plan was originally developed in a memorandum submitted to the cabinet of the Reich on May 7, 1919, and later developed by Rudolf Wissel in two pamphlets, Die Planwirtschaft (Hamburg, 1920) and Praktische Wirtschaftspolitik (Berlin, 1919).
  • 15. "Die Wirtschaftsrechnung im sozialistischen Gemeinwesen," Archiv für Sozialwissenschaften und Sozialpolitik, vol. 58, no.1 (April 1920), reproduced in an English translation in Collectivist Economic Planning. Most of this article has been embodied in the more elaborate discussion of the economic problems of a socialist community in part II of Professor Mises's Gemeinwirtschaft (Jena, 1922; 2nd ed., 1932); English trans. by J. Kahane under the title Socialism (London, 1936).
  • 16. Max Weber, Wirtschaft und Gesellschaft ("Grundriss der Sozialökonomik," vol. 3 [Tübingen, 1921]), pp. 55–56.
  • 17. The original title under which these lectures appeared in the winter of 1921–22 in the Russian journal Ekonomist was "Problems of Social Economy under Socialism." They were later reprinted in the original Russian as a pamphlet that appeared in Berlin in 1923, and a German translation under the title Die Lehren des Marxismus im Lichte der russischen Revolution was published in Berlin in 1928. This essay, together with a discussion of the development of economic planning in Russia, appeared in an English translation in Boris Brutzkus, Economic Planning in Soviet Russia (London, 1935).
  • 18. Ludwig von Mises, "Neue Beitrage zum Problem der sozialistischen Wirtschaftsrechnung," Archiv für Sozialwissenschaften, vol. 51 (1924), and "Neue Schriften zum Problem der sozialistischen Wirtschaftsrechnung," Archiv für Sozialwissenschaften, vol. 60 (1928).
  • 19. It is perhaps necessary in this connection to state explicitly that it would be wholly inconclusive if such a comparison were made between capitalism as it exists (or is supposed still to exist) and socialism as it might work under ideal assumptions — or between capitalism as it might be in its ideal form and socialism in some imperfect form. If the comparison is to be of any value for the question of principle, it has to be made on the assumption that either system is realized in the form that is most rational under the given condition of human nature and external circumstances that must of course be accepted.

Friedrich A. Hayek

F. A. Hayek (1899–1992) is undoubtedly the most eminent of the modern Austrian economists, and a founding board member of the Mises Institute. Student of Friedrich von Wieser, protégé and colleague of Ludwig von Mises, and foremost representative of an outstanding generation of Austrian School theorists, Hayek was more successful than anyone else in spreading Austrian ideas throughout the English-speaking world. He shared the 1974 Nobel Prize in Economics with ideological rival Gunnar Myrdal "for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena."  Among mainstream economists, he is mainly known for his popular The Road to Serfdom  (1944).