with Maxwell Siegrist
In “Economic
Calculation in the Socialist Commonwealth”, Ludwig Von Mises makes a
clarion call for what we now call the Socialist Calculation debate:
“Without economic calculation, there can be no economy” (Mises, 14). The
paper is a forceful argument meant to counter socialists of his day
who, in his opinion paint too glamorous of a picture of how “[r]oast
pigeons will in some way fly into the mouths of the comrades, but […]
omit to show how this miracle will take place.” (Mises, 2). Mises builds
on his central claim by dividing goods between production goods and
consumption goods. The production goods he labels as the higher order
and the consumption goods he describes as the lower order. In his
argument, Mises focuses on the higher order goods to make his case
against the possibility of calculation in a socialist economy. Small
individual exchange can happen at the consumption good or lower order
level, but production good or higher level coordination needs proper
valuation to give production goods meaning: “The human mind cannot
orientate itself properly among the bewildering mass of intermediate
products and potentialities of production without such aid. It would
simply stand perplexed before the problems of management and location”
(Mises, 13). For Mises, trade could simply happen between cigars and
cigarettes, but someone has to know how many cigar factories the economy
will need in comparison to cigarette factories. Using the labor theory
of value as his guide, Mises argues that the higher coordination is
impossible because the price system is needed to make the consumer
decisions and heterogeneous labor inputs makes it impossible to even
derive a single unit which to use as the foundation of value: “The
second defect in calculation in terms of labor is the ignoring of
different qualities of labor” (Mises, 20).
Many
socialist theorists disagree with the conclusions of Mises, including
contemporary economists such as Oscar Lange and Abba Lerner and
continues to this day with academic economist such as Theodore Burczak
as they seek to show that Mises was mistaken and that socialism can work
in the details. The debate is not academic for these earlier
writers — capitalism was a system of great waste and privation. For
example, Oskar Lange, writing in support of socialism and against the
capitalist modes claimed “Under capitalism the distribution of the
ownership of the ultimate productive resources is a very unequal one, a
large part of the population owning only their labor power,” and that
“Only a socialist economy can distribute incomes so as to attain the
maximum social welfare” (Lange 1937, 123).
To
Oskar Lange, in his “Economic Theory of Socialism: Part One,” the
fundamental issue of calculation problem identified by Mises does not
exist. In fact, Lange does not see the common ownership of the
productive machinery as society being an impediment to free choice in
consumer goods: “The fact of public ownership of the means of production
does not in itself determine the system of distributing consumers’
goods and of allocating people to various occupations, nor the
principles guiding the production of commodities,” continuing, “In the
socialist system as described we have a genuine market” (Lange 1936,
60). Lange then shows how a socialist market might work. He uses the
framework of the neoclassical marginalists to show that the equilibrium
process could be met by a central planning board using the trial and
error method, ever changing the prices in the economy to do the same
work the market and the price system do in a capitalist economy. As
Lange notes, “The administrators of a socialist economy will have
exactly the same knowledge, or lack of knowledge, of the production
functions as the capitalist entrepreneurs have” (Lange 1936, 55). Once
these prices are set up, then “all managers of plants, industries, and
resources do their accounting on the basis of the prices fixed by the
Central Planning Board” (Lange 1936, 63). Lange acknowledges that the
price setting is not a one-time event and mistakes could happen.
However, “any mistake my by the Central Planning Board in fixing Prices
would announce itself in a very objective way: by a physical shortage or
surplus of the quantity of the commodity or resources in question, and
would have to be corrected in order to keep production running smoothly”
(Lange 1936, 64). The process could continue in a never-ending cycle;
so while there is no market as in the capitalist mode, it is replaced:
“The Central Planning Board performs the functions of the Market” (Lange
1936, 64). As Austrian economist Don Lavoie notes in his book examining
the Socialist Calculation debate, “there was a remarkably wide
consensus that Mises was wrong” (Lavoie, 13) and that the defenders of
socialism successfully explained how a socialist version of the market
mechanism would work.
Friedrich
von Hayek was not convinced that Lange’s ideas won and argued that the
Central Planning Board would not be enough. An economy has many
entrepreneurs, but if there was only one board they could have the same
chance of making a mistake in production as any private entrepreneur
would have. Distributed knowledge is what would make the system work:
“the sort of knowledge with which I have been concerned is knowledge of
the kind which by its nature cannot enter into statistics and therefore
cannot be conveyed to any central authority in statistical form” (Hayek
1945, 524). For Hayek the Central Planning Board looks at the economy as
a whole, but loses focus on the small things- minor differences that
were held as knowledge much closer to the point of production.
Hayek
believed full control of production was impossible. He thought anyone
possessing the ability to know exactly what each consumer needs to reach
optimization was impossible as well. Hayek saw both the micro and macro
effects of socialism; he lived through the after effects of the first
war in Europe and then saw the Depression and rise of Nazism and
Stalinism leading to a second war in Europe. He was also active of the
theoretical debates starting with Mises which persisted for two decades.
We argue that Hayek solved the Socialist Calculation Debate as begun by
Mises, though extent of settlement needs to be examined. We also argue
that Hayek’s argument was extended by free market economists such as
Mises and Coase and that sections of Lange’s countering work lend
support to Hayek’s specific attacks on the possibilities of calculation
in a socialist economy.
Hayek’s
argument must first be addressed by the concept of knowledge within
economic systems — both who knows information and what the information
entails. In a free market society, a farmer will grow and produce
soybeans, and sell them at the market price. Does this farmer know the
exact quantities needed to produce and the asking price each year? Hayek
would argue he would not, but the farmer’s lack of foreknowledge is no
detriment. Since the farmer’s production is privately owned, any excess
or shortage of soybeans can be used to his discretion. Hayek believed
that social coordination is key to reach a properly functioning economy
and the most knowledge obtained will lead to the most efficient
coordination. But in a centrally planned board, as Mises stated:
“[Consumption goods] will be apportioned according to individual needs,
so that he gets most who needs most, or whether the superior man is to
receive more than the inferior, or whether the superior man is to
receive more than the inferior, or whether a strictly equal distribution
is envisaged as the ideal, or whether service to the State is to be the
criterion, is immaterial to the fact that, in any event, the portions
will be meted out by the State” (Mises, 4–5). Central Planning Boards
will limit the accessibility of knowledge to other managers in the
system to maintain the “equilibrium.”
Lange
argues socialist states will use retroactive knowledge to determine
price and quantities for all goods. Even with full retroactive
knowledge, the board cannot forecast what is to come. As Ronald Coase,
in his work examining how firms interact in the market, explains, “the
fact of uncertainty means that people have to forecast future wants”
(Coase, 400). Hayek sees two problems with Lange’s structure. The first
problem is that in the use of knowledge such as prices, technology,
preferences, etcetera are pieces of knowledge that are constantly
evolving. In the socialist system, the Central Planning Board retrieves
the knowledge, processes the knowledge, and then disperses the knowledge
to managers. As Hayek put it, the planning “will in some measure have
to be based on knowledge which, in the first instance, is not given to
the planner but to somebody else, which somehow will have to be conveyed
to the planner” (Hayek 1945, 520). The second, and more important
problem, is that all the knowledge — which is essential for a properly
functioning socialist system — is dispersed and cannot possibly be fully
obtained. Hayek states the problem is never concentrated, “but solely
as the dispersed bits of incomplete and frequently contradictory
knowledge which all the separate individuals possess” (Hayek 1945, 519).
Hayek recognized that the system does not need to obtain all knowledge
to make calculations, only that which is necessary. Stiglitz built off
the point that although we will not use all knowledge presented, it will
not go unused, or “the benefits of information increase with the scale
of its production (utilization)” (Stiglitz, 1456). The argument that
knowledge is held widely and not in a concentrated manner is the
strongest blow against the Central Planning Board of Lange. For Lange,
the Board sets prices and lets the economy run and then resets prices
when there is a surplus or shortage. Hayek asks how we can even know
there is a surplus or shortage without an independent price mechanism.
When
it came to pricing calculations, Hayek recognized the thought processes
that needed to occur. Due to the processes, he believed that
centralized systems were dishonest and mechanical. Mises does not
believe prices can exist in a socialist economy and “it is impossible in
fact to gauge the relationship between expenditure and income” (Mises,
4). In the free market, the pricing mechanism relies on the level of
production which coincides with consumer preferences.
Hayek
cannot take full credit for the general settlement of the calculation
debate. In fact, Lange himself helped support the capitalist claim; not
in theory but in practice. Twice in Lange’s “Theory of Socialism” he
implies that a socialist economy does not work. The first is when
describing the market for capital goods, and the distribution of wages
in relation to occupation. Lange said that social dividend cannot
interfere with the distribution of the labor market, where “the marginal
product of services of labour in different industries and occupations
proportional to the marginal disutility of working in those industries…”
(Lange 1936, 64). Hayek would claim that the distribution would lead to
a stagnant economy because people must work hard for profits, and if
there are no incentives in place, growth will not occur. The second is
his thought on the process of transitioning to a socialist system, where
the Central Planning Board must change all at once. Lange implies that
if the execution is not done perfectly, then the system will fail: “In
the best case the constant friction between the supervising government
agencies and the entrepreneurs and capitalists would paralyse business.
After such an unsuccessful attempt the socialist government would have
either to give up its socialist aims or to proceed to socialisation”
(Lange 1937, 133). A system lacking robustness in the transition to a
market socialism platform does not help support the socialist argument
since it implies the knowledge difference between the entrepreneurs and
the central planning board, highlighting the importance of the
distributed knowledge in the individual economic actors.
Hayek’s
career was in part defined defending the free market at the expense of
socialism. In the earlier “Road to Serfdom” (Hayek 1944), Hayek notes
that socialism and centrally planned systems arise when the worst actors
forcibly come to power and thus end up on top. Hayek explained the rise
as such:
In
order to achieve their ends the planners must create power — power over
men wielded by other men — of a magnitude never before known. Their
success will depend on the extent to which they achieve such power.
Democracy is an obstacle to this suppression of freedom which the
centralized direction of economic activity requires. Hence arises the
clash between planning and democracy. (Hayek 1944, 40).
Hayek
takes a liberal stance on planning, which supports his idea of free
market knowledge. The issue he addresses is “whether we should create
conditions under which the knowledge and initiative of individuals are
given the best scope so that they
can plan most successfully; or whether we should direct and organize
all economic activities according to a ‘blueprint’, that is,
‘consciously direct the resources of society to conform to the planners’
particular views of who should have what’” (Hayek, 45). The idea is
that private firms need to plan, based off the knowledge that is
available to them, to determine the level of production or even the size
of their firm.
Hayek’s
insights were extended by other writers. Ronald Coase, similar to
Stiglitz, was another economist who further supported Hayek’s ideas of
free markets when he established the concept of private firms in his
writing, The Nature of the Firm. Coase
went further into this point by stating that the level of production is
directly influenced by the pricing mechanism, therefore economic
calculation needs to exist for proper planning to occur. As he put it,
“the most obvious cost of ‘organising’ production through the price
mechanism is that of discovering what relevant prices are” (Coase, 390).
This point directly supports Hayek’s theory of knowledge: we need
knowledge to determine production, which then affects economic
calculation. Extending that point, Coase recognized that we will never
possess the adequate knowledge to achieve long run outlooks, or “the
longer the period of the contract is for the supply of the commodity or
service, the less possible, and indeed, the less desirable it is for the
person purchasing to specify what the other contracting party is
expected to do” (Coase, 391). Through the anarchy of the market and the
pricing mechanism a more rational level of output will exist than it
possibly could be with the Central Planning Board.
Hayek’s
influence is still felt today. Socialist thinkers have to take the
Hayekian knowledge problem into account as they theorize about the
potential organization of a socialist society in the twenty-first
century. Theodore Burczak, writing in “Socialism After Hayek” concludes
that it is “prudent for practical socialists to be open for
market-friendly, evolutionary proposals […] that promise to move us to
more extensive worker appropriation and the expansion of capabilities
equality.” (Burczak, 146). A socialism taking Hayek into account is one
that devolves from the workers with a world to win than if they lose
their chains to one where there are more worker co-ops. Not to denigrate
the idea but it is not one that arouses the passions and imagination.
Noting
the continuing influence of the Hayekian argument and current attempts
to struggle with a new socialism, we can say the Socialist Calculation
Debate is settled. Though the left wing theorists had a good argument on
the marginalists’ terms, the issue that Mises raised was ultimately not
the problem. Hayek showed that it could not be solved at the
higher-level that Mises identified not because the price mechanism
breaks down with production goods. Instead the issue is one of
information, and how it is spread thin and diffuse across various
economic actors. Lange’s market socialism theory did not work, and we
can observe from our historical vantage that all the states that tried
to center the socialist method of planning either did it incompletely or
failed entirely. The dreams of Lange still live out there but even
having the data collection or computing technique to simultaneously
solve all the equations would not be enough to make the socialist
economy work based on the informational challenges Hayek identified.
Hayek was not the only economist to settle the debate. He was assisted
by economists of his time on both sides. Their theories in conjunction
with his helped mold what was to become the outcome of the calculation
debates. Knowledge, illustrated by Hayek and Mises, allows for
individuals to react to changes in preferences. They argue the
centralization of knowledge takes away the primary function of a pricing
system. However, Hayek, in accordance with Coase, does recognize the
benefits of government intervention and a level of planning. Planning
within privately owned firm is the utilization of the freely accessible
knowledge, which is used to influence the pricing mechanism.
Works Cited
Burczak, Theodore A. Socialism after Hayek. Ann Arbor: University of Michigan Press, 2006.
Coase, Ronald H. “The Nature of the Firm.” Economica 4, no. 16 (November 1937): 386–405. Accessed March 15, 2018. JSTOR.
Hayek, Friedrich. “The Road to Serfdom.” (1945). Institute of Economic Affairs. Accessed March 15, 2018. https://iea.org.uk/publications/research/the-road-to-serfdom.
Hayek, Friedrich A., “The Use of Knowledge in Society,” American Economic Review, Vol. 35, №4. (Sep., 1945): 519–530.
Lange, Oskar, “On the Economic Theory of Socialism: Part One,” The Review of Economic Studies, Vol. 4, №1 (Oct., 1936): 53–71
Lange, Oskar, “On the Economic Theory of Socialism: Part Two,” The Review of Economic Studies, Vol. 4, №2 (Feb., 1937): 123–142
Lavoie, Don. Rivalry and central planning: the socialist calculation debate reconsidered. Arlington, VA: Mercatus Center, 2015.
Stiglitz, J. E. “The Contributions of the Economics of Information to Twentieth Century Economics.” The Quarterly Journal of Economics, vol. 115, no. 4, 2000, pp. 1441–1478., doi:10.1162/003355300555015.
Von
Mises, Ludwig, Economic Calculation in the Socialist Commonwealth (1920
[1990]): 1–46. The present translation was first published in F.A.
Hayek, ed., Collectivist Economic Planning (London: George Routledge
& Sons, 1935; reprint, Clifton, N.J.: Augustus M. Kelley, 1975).
