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Why Socialist Calculation Is Always Impossible

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08/28/2019

The Austrian school of economics, marked by its unique causal-realist approach, contributed many important insights to the development of economic science. However, regardless of their profound contribution, the Austrian school has been usually charged as “unscientific” due to the lack of mathematical models in the Austrian analysis. Yet, calculations are being made everywhere in the Austrian framework, since the vital core of their theories is the importance of calculation for economic agents’ actions. Certainly, the concept of the impossibility of a central-planned socialist regime was the most fully elaboration of economic calculations.

The concept of economic calculation was first proposed by Ludwig von Mises in his book Economic Calculation in the Socialist Commonwealth published in 1920. Prior to Mises’s analysis, there were numerous social thinkers who criticized the operation of a socialist economy since for them, such an economy violates the fundamental nature of human beings. Nevertheless, this criticism was purely based on ethical and philosophical grounds. Mises was one of the first, along with Max Weber and Boris Brutzkus, who independently proposed an entirely different analysis from a purely economic perspective. However, Weber somehow constructed an ideal-type psychological model,1 and from which he eventually came to the conclusion that a socialist economy is “wasteful” and “inefficient".2 On the other hand, Brutzkus dealt only with concrete problems of Russia.3 Yet, “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.”4 For Mises, such an economy is not just wasteful and inefficient, it is impossible from a purely theoretical point of view.

Mises’s analysis can be summarized as follow:

1. Without private property in the means of production, there will be no market for the means of production.

2. Without a market for a means of production, there will be no monetary prices established for the means of production.

3. Without monetary prices, reflecting the relative scarcity of capital goods, economic decision-makers will be unable to rationally calculate the alternative use of capital goods.5

Indeed, the problem raised by Mises is that the cental planner is unable to propose a rational economic calculation. In short, it is a calculation problem.

However, Mises’s student, Friedrich Hayek, though he accepted the final conclusion of his mentor, argued that “it does not really touch the heart of the problem.” In his essays collected in Individualism and Economic Order, he proposed another analysis that is developed on his notion of “division of knowledge”:6

1. Knowledge is dispersed, dispersal, and non-unified. Thus, individual knowledge is always imperfect.

2. In a free-market economy, those dispersal knowledge is coordinated through the price system.

3. Under a centrally planned socialist economy, after abolishing the price system, the central planner is not able to possess all knowledge of the whole society.

4. Being unable to possess all necessary knowledge, the central planner thus is not able to rationally calculate the efficiency of alternative uses of capital goods.

For Hayek, the ultimate cause of the calculation problem is indeed the knowledge problem. Within the Austrian circle, some believe that the analysis of Hayek is a consistent development of the Misesian conclusion.7 However, there are reasons to argue that what Mises and Hayek said were actually two different things.

First, as Salerno pointed out in his postscript of Mises’s paper:

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 (p. 21) 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."8

Clearly, in the Misesian paradigm, knowledge was already assumed to be perfectly possessed. Yet, “despite this knowledge, the socialist administrators would be unable to arrive at a useful social appraisement of the means of production in cardinal terms.”9 Furthermore, the calculation problem is based on purely theoretical grounds, but the knowledge problem is simply a practical problem for the operation of a socialist economy. Hence, “economic theory per se can say nothing conclusive about the viability of central planning, and the choice between capitalism and socialism must be purely political.”10

Second, even when the central planner is assumed to possess perfect knowledge about all market participants, it merely means that the planner has qualitative knowledge about the market. On the other hand, economic calculation requires the qualitative information to be transmitted quantitatively, thus making the calculation possible.11 Besides, David Gordon has also pointed out that “just as Mises showed, by his regression theorem, that money can only arise on the market out of a non-monetary goods under barter, so money on the market is needed to transform ordinally ranked subjective values into money prices which are indispensable for imputations of productivity and for economic calculation by entrepreneurs.”12

Finally, as Salerno emphasized, so as to come up with a possible calculation, economic agents need not only present knowledge, or past price, but also future prices, which every market participant needs to appraise because he does not know it directly at the present.13 Still, we can assume that, in a magical way, the central planner somehow obtains not only present knowledge, but also future knowledge, such that they have the ability to foresee exactly what is going to happen in the future. Yet, even given such an assumption, economic calculation is still not possible, not only due to the lack of the price system, but also because the appraisement is always imaginative, existing in the mind of individuals. Salerno’s analysis further emphasized the insight of Mises that appraisement is the factor drawing the distinction between the central planner and the entrepreneur in the market.

The notion of division of knowledge is, undoubtedly, an important contribution of Hayek to the fields of social sciences and thus needed to be recognized. However, putting knowledge on the center of his economic analysis seems to be misleading.

  • 1. Selgin, George A., Praxeology and Understanding: An Analysis of the Controversy in Austrian Economics (Auburn, Alabama: Ludwig von Mises Institute, 1990), p. 18.
  • 2. Hayek, Friedrich A., Collectivist Economic Planning (Routledge & Kegan Paul Ltd. London, 1963), p. 34.
  • 3. Ibid.
  • 4. Ibid., p. 36.
  • 5. Boettke, Peter J., Calculation and Coordination: Essays on Socialism and Transitional Political Economy (Routledge, 2001), p. 31.
  • 6. Hayek, Friedrich A., Individualism and Economic Order (University of Chicago Press, 1948).
  • 7. Boettke, Peter J., Calculation and Coordination: Essays on Socialism and Transitional Political Economy (Routledge, 2001). Lavoie, Don, Rivalry and Central Planning (Cambridge University Press, 1985).
  • 8. Salerno, Joseph T., "Postscript: Why a Socialist Economy is 'Impossible'”, in Mises, Ludwig von, Economic Calculation in the Socialist Commonwealth. (Auburn, Alabama: Ludwig von Mises Institute, [1990] 2012), p. 59.
  • 9. Ibid.
  • 10. Klein, Peter G., The Capitalist and the Entrepreneur: Essays on Organizations and Markets (Mises Institute, 2010), p. 9.
  • 11. Salerno, Joseph T., "Postscript: Why a Socialist Economy is 'Impossible'", pp. 57-61.
  • 12. Murray, Rothbard N., Economic Controversies (Auburn, Alabama: Mises Institute, 2011), p. 190.
  • 13. Salerno, Joseph T., "Postscript: Why a Socialist Economy is 'Impossible'”, pp. 57-61.

Trieu Nguyen is currently a student at Hillsdale College majoring in Economics and Mathematics, and a graduate of Mises University and Vietnam Institute for Economic and Policy Research.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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