The Impossibility of Socialist Economic Calculation
Updated: Oct 28, 2020
Back in 1920 Ludwig von Mises, the greatest of the Austrian School economists, wrote an article called ‘Economic Calculation in the Socialist Commonwealth’.
Back in 1920 Ludwig von Mises, the greatest of the Austrian School economists, wrote an article called ‘Economic Calculation in the Socialist Commonwealth’. In it he demonstrated that central planning cannot work even in theory. He thus cut the wildly fashionable notion of socialist central planning off at the philosophical knees. This was just when the USSR was embarking on its attempt to create the workers’ paradise, spurred on by ‘intellectual yet idiot’ scribblers, academics and politicians nearly everywhere. Would that Mises’s article had headed off the suffering spawned by every socialist central planning experiment over the last hundred years.
Instead it was left to WWII, George Orwell, Aleksandr Solzhenitsyn, 100 million state killings (plus or minus) and hundreds of millions of ruined lives to convince even French intellectuals of the truth in the 1960s. Central planning as practiced by Totalitarian Socialists is a vile utopian turkey. This should not surprise anyone. It is just a manifestation of the original sin of giving some privileged people (‘the state’) the right to use violence against others with legal impunity.
Unfortunately fantasies about using violence to centrally plan people’s lives are alive and well in Democratic Socialist societies. How bizarre is that? They are spread by swollen political, official and academic establishments, and parroted by their bought-and-paid-for Mainstream Media (MSM) allies. All live high on hog off tax bases that their ideas steadily undermine. Not that they understand this. As these illusions spread and are acted upon, they cause ever more resentment, impoverishment and uselessness. Now they are stifling the still formidable regenerative powers of the surviving producers.
Clearly not enough people have got the memo that Mises sent us a century ago.
So, what did Mise attack and how? He was taking aim at Socialist Central Planning as promulgated by Marx. Remember Marx was the socialist founder. Lenin defined communism as merely socialism plus electrification. National socialism (Fascism and Nazism) had yet to appear in 1920. Marx declared that there would be material plenty once wasteful capitalist competition and predation red in tooth and claw ceased. In his brave new world central planning of all activity would take over and achieve undreamt of abundance. If only.
Mises explained the truth of the matter. Liberty is simply decentralisation right down to the level of the individual. Socialism is simply hyper-centralisation. Freedom is an information system which enables people, including entrepreneurs, business managers and investors, to make valid choices about what to do and how to go about it.
It works like this. People bargain freely about the terms on which they will trade things they have in terms of input into producing something. It may be capital, land, resources, ideas, or just their time (labour). They want in return things that other people own.
Everyone looks for deals that they believe will best improve their wellbeing. But deals will only actually be agreed if both sides believe they benefit. Therefore, in a free society all arrangements are intended and believed by participants to create as much wellbeing as is achievable in the world. They are all meant to be win-win deals.
The businessman’s task is to keep on researching networks of potential transactions to find products and production processes that yield an entrepreneurial profit. Say a man wishes to make and sell brooms (‘output’). They seem likely to sell for £10. He contacts possible suppliers of wood, labour, bristles, premises, working capital, machines, insurance etc to put together a schedule of prices for all inputs. He will look for at least one combination of input prices or costs which adds up to less than £10 per broom. If no such combination is found he moves on to the next project.
He may find more than one possible way of making brooms. For example, he might choose between a big broom making machine producing a lot of brooms, or many workers making fewer brooms by hand. His choices will inevitably involve guesswork and risk.
In the words of a friend who is a businessman ‘you do the numbers and if it works you do it.’ And that, my friends, is economic calculation. Millions of people are constantly appraising the information provided by all these countless schedules of prices. Production is being shaped all the time to work with costs which are linked to each individual’s idea of the best deal he can hope for. Despite the inevitable mistakes, production is directed to the uses of resources consistence with the greatest wellbeing in society. Freedom is a functioning self-ordering production decision network.
What has this got to do with Mises’s calculation in a socialist commonwealth? Well in socialist central planning arrangements decisions are taken without reference to prices or rely on prices that have been falsified by intervention. There are no true prices. That is because prices are determined by bargaining between people who own property, including property in themselves (aka their labour or time). When nobody owns any property, no meaningful prices can be agreed for exchanging property ownership claims.
As Mises said, central planners just have nothing to go on. They cannot estimate profitability. Nothing ties production in to what would create wellbeing. The planner cannot even know or care about the population’s entirely subjective evaluation of literally millions of possible actions. How was an East German planner actually to know whether digging coal and smelting iron to produce the ‘iconic’ Trabant car was worth it. Was the coal, steel, power, work and transport that went into a Trabant worth more or less than the car itself. If these inputs were worth more than the output failure was assured.
What happened in practice in the former Soviet Union? All assets were seized. State central planners decided where and how everybody worked. There was no possibility of useful prices for inputs and outputs being available. The system struggled along creating pretend prices. Fortunately, the Soviets could still get some idea of what prices from market prices in the West. The Russians themselves characteristically encapsulated this truth in a joke. Come the revolution, they said, one capitalist country would have to be kept in being just so that everyone else would know that the right price of everything should be.
The Soviet Union survived as long as it did because it could sell valuable resources – often mined by Gulag slave labour - to the West for dollars. Raw material sales and borrowing from western banks propped up things up.
Energy and mineral resources in the Soviet Union were nevertheless spent in building up a centrally planned industrial base. It was all simply value destruction. How can one tell? After decades of just about keeping living standards to around 1913 level the Soviet Union imploded in 1991. The price mechanism reappeared as the central planning system collapsed. In the clear light cast by a restored price mechanism the truth was clear. The total value of Russian manufacturing products was less than the value of the energy and materials costs consumed to make them. All the labour and capital on top was wholly and abjectly wasted. The quickest way to raise living standards in Russia was just to close down the manufacturing sector.
When the Soviet Union collapsed it was littered with unfinished projects. It was supposedly spending 40% of its economic product on investment. But these too were value destroying activities which drained away more of Russia’s resources. In the absence of price information, no good investment decision is possible. And the most important price is a freely determined interest rate, that is to say the time related return on capital, which is the measure of all things.
What does all this mean for those living under Democratic Socialism where so many sectors are dominated by the state. Mises said that socialist organisations in open societies were islands of chaos. They can only retain a semblance of rationality if they can use proper prices generated in the remaining private sector. For activities like railway construction or defence less genuine price discovery is possible. White elephants like the HS2 farce are the result.
There is one key message to take home. Though you would never know it after compulsory education or watching the state tax (‘licence fee’) supported BBC or its state sponsored licensed Mainstream Media (MSM) peers, there is no absolutely no respectable theoretical basis for State Central Planning at all. The man from Whitehall does not and cannot know best. Heavily centralised decision making (socialism) leads to inadequate and destructive decisions.
The idea that Government planning could ever work is a joke and has been for a century ever since Mises’s article.