Mises as Social Rationalist Pt IV: Use of Calculation versus Use of Knowledge: The Social Function of Prices
Editors note: One of the most important analysis of Ludwig von Mises's social theory and his views on the origins of human society has been Dr. Joseph Salerno's Ludwig von Mises as a Social Rationalist. This essay sparked an important debate among scholars within the Austrian school of the ideological differences between Ludwig von Mises and F.A. Hayek, enriching our understanding of the work of both great scholars.
For the benefit of readers, we will publish during this week in six separate parts. Part I. Part II. Part III. The complete essay can be found here.
In Mises's view, then, human society is a profoundly rational phenomenon, a product of the capacity of the human intellect to conceive cardinal numbers and manipulate them in arithmetic operations, To assert therefore that the primary function of the market's price system is to effectuate "the use of knowledge in society " is to seriously misconceive the nature of the social problem. The problem of society is first and foremost one of calculating the outcome of purposive action undertaken within the framework of the division of labor. As the only possible tool of calculable action, money prices do not merely permit people to utilize their individual "knowledge of particular circumstances of time and place" to enhance the efficiency with which goods are produced in society, prices render possible the very existence of social production processes. For Mises, therefore, the market provides for far more than a "division of knowledge," it produces "the intellectual division of labor that consists in the cooperation of all entrepreneurs, landowners, and workers as producers and consumers in the formation of market prices. [W]ithout it, rationality, i.e., the possibility of economic calculation, is unthinkable" (1985b, p. 75).
In fact Mises presents a penetrating critique of the Walrasian view that, in the plans of producers, prices substitute for knowledge of the economic data or, rather, for entrepreneurial understanding and appraisement of future variations of these data. Mises's critique is grounded on the incontrovertible fact that "The prices of the market are historical facts expressive of a state of affairs that prevailed at a definite instant of irreversible historical time" (Mises 1966, p. 223). As such, realized prices can never serve as an unambiguous guide to production; which is always aimed at supplying a market of the more or less remote future involving a different configuration of the economic data. Indeed, if producers were certain that the data underlying future markets would never differ from those determining the present or immediately past state of the market, they could completely dispense with prices and calculation and simply perform the same productive activities over and over again. For, as Mises reminds us, "the main task of economic calculation is not to deal with the problems of unchanging or only slightly changing market situations and prices, but to deal with change" (1966, p. 212). Ironically, a world in which prices (of previously consummated exchanges) convey knowledge upon which to base future-oriented production decisions is a world in which the price system is, as Mises might say, "supererogatory and otiose."
In the real world of action and change, on the other hand, "Exchange ratios are subject to perpetual change because conditions which produce them are perpetually changing. The value that an individual attaches both to money and to various goods and services is the outcome of a moment's choice" (Mises 1966, p. 217). The result, according to Mises, is that "The planning businessman cannot help employing data concerning the unknown future; he deals with future prices and future costs of production" (1966, p. 224). Moreover, since past prices are not causally linked to the emergence of future prices, they cannot embody knowledge relevant to the drafting of present production plans. This is an irrefutable conclusion of praxeological analysis, the neglected negative implication of Mises's regression theorem.
In drafting their plans entrepreneurs look first at the prices of the immediate past which are mistakenly called present prices. Of course, the entrepreneurs never make these prices enter into their calculations without paying regard to anticipated changes. The prices of the immediate past are for them only the starting point of deliberations leading to forecasts of future prices. The prices of the past do not influence the determination of future prices. It is, on the contrary, the anticipation of future prices of the products that determines the state of prices of the complementary factors of production. The determination of prices has, as far as the mutual exchange ratios between various commodities are concerned, no direct causal relationship whatever with the prices of the past [emphasis mine; 1966, p. 336].
In a qualifying footnote to this passage, Mises notes that, in the case of the exchange ratio between money and other economic goods, the emphasized statement does not apply. This is a reference to Mises's regression theorem, according to which the money unit's past purchasing power is a causal factor in the determination of its current purchasing power (1966, p. 336 fn. 2).
It is clear therefore that in Mises's view the information yielded by the price system does not obviate entrepreneurial forecasting and interpretative understanding of the constellation of data underlying the markets of the future. What role then does the knowledge of past prices play in today's decisions about the allocation of resources? According to Mises, past prices are useful to entrepreneurs in "appraising'' the future prices that will emerge in the wake of forecast data changes. Or, put another way, yesterday's prices do not "economize knowledge" but save on the mental effort expended by the entrepreneur in striving to "understand" the effects of anticipated change on tomorrow's price structure, the elements of which serve as the cardinal numbers in today's economic calculations. Recourse to their experience of past prices eliminates the need for entrepreneurs to mentally reconstruct ab initio the price structure and the pattern of resource allocation every time there occurs an anticipated shift in the data requiring the calculation of new production decisions. Entrepreneurial appraisement is enormously simplified when it may proceed by estimating the effects of anticipated variations of the data on a preexisting price structure. As Mises writes:
Numbers applied by acting man in economic calculation do not refer to quantities measured but to exchange ratios as they are expected — on the basis of understanding — to be realized on the markets of the future to which alone all acting is directed and which alone counts for all acting is directed and which alone counts for acting man. ... As acting is always directed toward influencing a future state of affairs, economic calculation always deals with the future. As far as it takes past events into consideration, it does so only for the sake of an arrangement of future action. ...
The prices of the past are for the entrepreneur, the shaper of future production, merely a mental tool. The entrepreneurs do not construct afresh every day a radically new structure of prices or allocate anew the factors of production to the various branches of industry. They merely transform what the past has transmitted in better adapting it to the altered conditions. How much of the previous conditions they preserve and how much they change depends on the extent to which the data have changed. ... In order to see his way in the unknown and uncertain future man has within his reach only two aids: experience of past events and his faculty of understanding. Knowledge about past prices is a part of this experience and at the same time the starting point of understanding the future [1966, pp. 210, 337].
As one component of experience, past prices are therefore an important, but by no means indispensable, auxiliary for entrepreneurial understanding of the future course of prices. However, since it is, in the final analysis, future prices which concern entrepreneurs, Mises concludes that economic calculation and rational allocation of resources could still take place even in the event of a complete obliteration of the memory of past prices:
If the memory of all prices of the past were to fade away, the pricing process would become more troublesome, but not impossible as far as the mutual exchange ratios between various commodities are concerned. It would be harder for the entrepreneurs to adjust production to the demand of the public, but it could be done nonetheless. It would be necessary for them to assemble anew all the data they need as the basis of their operations. They would not avoid mistakes which they now evade on account of experience at their disposal. Price fluctuations would be more violent at the beginning, factors of production would be wasted, want-satisfaction would be impaired. But finally, having paid dearly, people would again have acquired the experience needed for a smooth working of the market process [1966, p. 337].
Let me summarize Mises's position on the social function of prices and the acquisition and use of knowledge in society. The price system is not — and praxeologically cannot be — a mechanism for economizing and communicating the knowledge relevant to production plans. The realized prices of history are an accessory of appraisement, the mental operation in which the faculty of understanding is used to assess the quantitative structure of price relationships which corresponds to an anticipated constellation of the economic data. Nor are anticipated future prices tools of knowledge; they are instruments of economic calculation. And economic calculation itself is not the means of acquiring knowledge, but the very prerequisite of rational action within the setting of the social division of labor. It provides individuals, whatever their endowment of knowledge, the indispensable tool for attaining a mental grasp and comparison of the means and ends of social action. As Mises says: "It is not the task of economic calculation to expand man's information about future conditions. Its task is to adjust his actions as well as possible to his present opinion concerning want-satisfaction in the future" (1966, p. 214).