The Economics of Ludwig von Mises: Toward a Critical Reappraisal
What might be called the "orthodox," or textbook, version of the famous economic calculation debate under socialism goes somewhat as follows:
Ludwig von Mises first raised the question of Socialist economic calculation in 1920 by asserting that socialism could not calculate economically because of the absence of a price system for the factors of production. Enrico Barone "then" showed (the fact that he had done so twelve years earlier is laid to accidents of timing and translation) that this was not a theoretical problem because all the equations existed for a solution. F. A. Hayek then retreated to a second line of attack by conceding the "theoretical" solution to economic calculation in a Socialist state but challenging its "practical" possibility. Finally, Oskar Lange, Abba Lerner, and others "demonstrated" the practical solution by advancing the concept of "market" socialism, in which the Planning Board arrives at market clearing prices through trial and error. Q. E. D. and Socialist planning has been salvaged, replete with Lange's ironic tribute to Mises for raising the problem for Lange and other Socialists to solve. If the actual record of Communist economies is brought into the discussion at all, it is usually done as a vindication of the Lange-Lerner thesis in practice.
That there are numerous holes in this neat and triumphal saga should be immediately clear. One example is that the "market socialism" in Yugoslavia and, less so, in the other East European countries has nothing to do with the alleged Lange-Lerner "market"; for while firms in Yugoslavia engage in genuine exchanges and therefore in a genuine price system, the Lange-Lerner Planning Boards were to be central planners who manipulated prices as a pure accounting device and in no sense allowed "markets" at all. Another example is that Barone, in the course of his alleged "theoretical" solution to the problem of Socialist calculation, himself ridiculed the idea that planning by means of his equations was in any sense workable, especially when we consider the continuing economic variability of the technical coefficients involved.*131
But a particularly important flaw in the orthodox story is, as Hayek tried to make clear during the debate, the curious disjunction between the "theoretical" and the "practical." It is not simply that Barone and his mentor Pareto scoffed at the workability of the theoretical equations under Socialist planning. More important is the point that Mises and Hayek were implicitly attacking the relevance of the entire concept of Walrasian general equilibrium from which these equations flowed. For Mises and Hayek there was no disjunction between the "theoretical" and the "practical"; following the Austrian tradition, a theory that necessarily violated practical reality was an unsound theory. The fact that in a changeless world of perfect knowledge and general equilibrium a Socialist Planning Board could "solve" equations of prices and production was for Mises a worse than useless demonstration. Clearly, as Hayek would later develop at length, if complete knowledge of economic reality is assumed to be "given" to all, including a Planning Board, there is no problem of calculation or, indeed, any economic problem at all, whatever the economic system. The Mises demonstration of the impossibility of economic calculation under socialism and of the superiority of private markets in the means of production applied only to the real world of uncertainty, continuing change, and scattered knowledge.
In his monumental Human Action, the 1949 treatise that contained his final rebuttal to his Socialist critics, Mises emphasized the sterility of the mathematical approach:
The mathematical economists...formulate equations and draw curves which are supposed to describe reality. In fact they describe only a hypothetical and unrealizable state of affairs, in no way similar to the catallactic problems in question. They substitute algebraic symbols for the determinate terms of money as used in economic calculation and believe that this procedure renders their reasoning more scientific...
In developing this approach, Hayek engaged in a searching critique of Schumpeter's assertion that socialism suffers from no problem of economic calculation, because, to quote Schumpeter, the"consumers, in evaluating ('demanding') consumers' goods ipso facto also evaluate the means of production..."*133 Hayek pointed out, however, that this easy step would only follow"to a mind to which all these facts were simultaneously known...The practical problem, however, arises precisely because these facts are never so given to a single mind...instead, we must show how a solution is produced by the interactions of people each of whom possesses only partial knowledge." Hayek concluded that"any approach, such as that of much of mathematical economics with its simultaneous equations, which in effect starts from the assumption that people's knowledge corresponds with objective facts of the situation, systematically leaves out what is our main task to explain."*134
Proceeding to an explicit refutation of the Lange-Lerner approach, Mises in Human Action scoffed at the idea that the Socialist managers will be instructed to"play market as children play war, railroad, or school."Specifically, the Socialists leave out the crucial function of shareholding, capital allocation, and entrepreneurship in their concentration on the purely managerial role:
The cardinal fallacy implied in this and all kindred proposals is that they look at the economic problem from the perspective of the subaltern clerk whose intellectual horizon does not extend beyond subordinate tasks. They consider the structure of industrial production and the allocation of capital to the various branches and production aggregates as rigid, and do not take into account the necessity of altering this structure in order to adjust it to changes in conditions. What they have in mind is a world in which no further changes occur and economic history has reached its final stage. They fail to realize that the operations...of the managers, their buying and selling, are only a small segment of the totality of market operations. The market of the capitalist society also performs all those operations which allocate the capital goods to the various branches of industry. The entrepreneurs and capitalists establish corporations and other firms, enlarge or reduce their size, dissolve them or merge them with other enterprises; they buy and sell the shares and bonds of already existing and of new corporations; they grant, withdraw, and recover credits; in short they perform all those acts the totality of which is called the capital and money market. It is these financial transactions of promoters and speculators that direct production into those channels in which it satisfies the most urgent wants of the consumers in the best possible way....
Mises also refuted the idea that a Socialist Planning Board would arrive at correct pricing through trial and error, through clearing the market. While this could be done for already produced consumer goods, for which a market would presumably continue to exist, it would be precisely impossible in he realm of capital goods, where there would be no genuine market; hence, any sort of rational decisions on the kinds and amounts of the production of capital and of consumer goods could not be made. In short, the process of trial and error works on the market because the emergence of profit and loss conveys vital signals to the entrepreneur, whereas such apprehensions of genuine profit and loss could not be made in the absence of a real market for the factors of production.
A common attempt to rebut Mises has been the simple empirical pointing to the existence of central planning in the Soviet Union and the other Communist states. But, in the first place, this argument is a two-edged sword, (1) because of the blatant failures of early War Communism in its abolition of the market, and (2) because the evident failures and breakdowns of central planning have led the Communist countries in East Europe, especially in Yugoslavia, to move rapidly away from socialism toward a genuine, and not a Lange-Lerner type of pseudo, market economy. But, more importantly, Mises pointed out that the Soviet Union and the other Socialist countries are not fully Socialist, since they still operate within a world market environment and are at least roughly able to use world capital and commodity prices on which to base their economic calculations.*136 That Communist planners base their calculations on world market prices is now generally acknowledged and is illustrated by an amusing encounter of Professor Peter Wiles with Polish communist planners:
What actually happens is that 'world prices,' i.e. capitalist world prices, are used in all intra- block trade. They are translated into rubles...and entered in bilateral clearing accounts. To the question, 'What would you do if there were no capitalist world?' came only the answer 'We'll cross that bridge when we come to it.' In the case of electricity the bridge is already under their feet: there has been great difficulty in pricing it since there is no world market.*137
Mises' followers in the debate have continued to develop his basic critique of the impossibility of economic calculation under socialism. Thus, the attempted Lange-Lerner criterion of pricing in accordance with"marginal cost"has been attacked on what are essentially Austrian grounds, namely, that costs are not"given"and objective but are subjective estimates by various individuals of future selling prices and other economic conditions. Thus Hayek wrote that
excessive preoccupation with the conditions of a hypothetical state of stationary equilibrium has led modern economics...to attribute to the notion of costs in general a much greater precision and definiteness than can be attached to any cost phenomenon in real life...[A]s soon as we leave the realm of...a stationary state and consider a world where most of the existing means of production are the product of particular processes that will probably never be repeated; where, in consequence of incessant change, the value of most of the more durable instruments of production has little or no connection with the costs which have been incurred in their production but depends only on the services which they are expected to render in the future, the question of what exactly are the costs of production of a given product is a question of extreme-difficulty which cannot be answered...without first making some assumption as regards the prices of the products in the manufacture of which the same instruments will be used. Much of what is usually termed cost of production is not really a cost element that is given independently of the price of the product but a quasi-rent, or a depreciation quota which has to be allowed on the capitalized value of expected quasi-rents, and is therefore dependent on the prices which are expected to prevail.*138
At another place, Hayek added that Lange and others"speak about 'marginal costs' as if they were independent of the period for which the manager can plan. Clearly, actual costs depend in many instances, as much as on anything, on buying at the right time. In no sense can costs during any period be said to depend solely on prices during that period. They depend as much on whether these prices have been correctly foreseen as on the views that are held about future prices."*139 And Paul Craig Roberts, while writing generally from a different perspective, pointed out that"under real-world conditions characterized by the passage of time, the marginal rule gives no clear guidance to those directed to organize production in accordance with it. Introducing the element of time brings in uncertainty and requires the exercise of judgment. Neither uncertainty nor judgment is present in the formulation of perfect competition from which Lange took his idea of the marginal rule."*140 Moreover, the outstanding critique of the marginal cost as well as of other authoritarian rules imposed on the entrepreneur was by G. F. Thirlby, who pointed out that costs are wrapped up inextricably in subjective estimates by the individual capitalists and entrepreneurs of alternative choices that are forgone, and since these alternatives are usually never undertaken, they can never be"objectively"determined by outside observers.*141
The subjectivist Austrian critique of the modern concept of costs and its relevance to the question of Socialist calculation were neatly summed up by Professor Buchanan:
Confusion arises...when the properties of equilibrium, as defined for markets, are transferred as criteria of optimization in nonmarket or political settings. It is here that the critical distinction between the equilibrium of the single decision-maker and that attained through market interaction, the distinction stressed by Hayek, is absolutely essential...The theory of social interaction, of the mutual adjustment among the plans of separate human beings, is different in kind from the theory of planning, the maximization of some objective function by a conceptualized omniscient being. The latter is equivalent, in all respects, to the problems faced by Crusoe or by any individual decision-maker. But this is not the theory of markets, and it is artificial and basically false thinking that makes it out to be....Shadow prices are not market prices, and the opportunity costs that inform market decisions are not those that inform the choices of even the omniscient planner. These appear to be identical only because of the false objectification of the magnitudes in question....
There is one vital but neglected area where the Mises analysis of economic calculation needs to be expanded. For in a profound sense, the theory is not about socialism at all! Instead, it applies to any situation where one group has acquired control of the means of production over a large area—or, in a strict sense, throughout the world. On this particular aspect of socialism, it doesn't matter whether this unitary control has come about through the coercive expropriation brought about by socialism or by voluntary processes on the free market. For what the Mises theory focuses on is not simply the numerous inefficiencies of the political as compared to the profit-making market process, but the fact that a market for capital goods has disappeared. This means that, just as Socialist central planning could not calculate economically, no One Big Firm could own or control the entire economy. The Mises analysis applies to ay situation where a market for capital goods has disappeared in a complex industrial economy, whether because of socialism or because of a giant merger into One Big Firm or One Big Cartel.
If this extension is correct, then the Mises analysis also supplies us the answer to the age-old criticism leveled at the unhampered, unregulated free-market economy: what if all firms banded together into one big firm that would exercise a monopoly over the economy equivalent to socialism? The answer would be that such a firm could not calculate because of the absence of a market, and therefore that it would suffer grave losses and dislocations. Hence, while a Socialist Planning Board need not worry about losses that would be made up by the taxpayer, One Big Firm would soon find itself suffering severe losses and would therefore disintegrate under this pressure. We might extend this analysis even further. For it seems to follow that, as we approach One Big Firm on the market, as mergers begin to eliminate capital goods markets in industry after industry, these calculation problems will begin to appear, albeit not as catastrophically as under full monopoly. In the same way the Soviet Union suffers calculation problems, albeit not so severe as would be the case were the entire world to be absorbed into the Soviet Union with the disappearance of the world market. If, then, calculation problems begin to arise as markets disappear, this places a free-market limit, not simply on One Big Firm, but even on partial monopolies that eradicate markets. Hence, the free market contains within itself a built-in mechanism limiting the relative size of firms in order to preserve markets throughout the economy. This point also serves to extend the notable analysis of Professor Coase on the market determinants of the size of the firm, or of the relative extent of corporate planning within the firm as against the use of exchange and the price mechanism. Coase pointed out that there are diminishing benefits and increasing costs to each of these two alternatives, resulting, as he put it, in an"'optimum' amount of planning"in the free market system."*143 Our thesis adds that the costs of internal corporate planning become prohibitive as soon as markets for capital goods begin to disappear, so that the free-market optimum will always stop well short not only of One Big Firm throughout the world market but also of any disappearance of specific markets and hence of economic calculation in that product or resource. Coase stated that the important difference between planning under socialism and within business firms on the free market is that the former"is imposed on industry while firms arise voluntarily beasuse they represent a more efficient method of organizing production."*144 If our view is correct, then, this optimal free-market degree of planning also contains within itself a built-in safeguard against eliminating markets, which are so vital to economic calculation.
In fact, we may turn the question around to ask the Socialists: if, indeed, central planning is more efficient than, or even equally efficient to, the free-market economy, then why has central planning never come about through the creation of One Big Firm by the voluntary market process? The fact that One Big Firm has never arisen on the market and that it needs the coercive might of the State to establish such central planning under socialism demonstrates that the latter could not be the most efficient method of organizing the economy.*145
In our expanded form, then, not only is Mises' insight into the irrationality of socialism in an industrial economy confirmed but so also is the self-subsistence and continuing optimality and rationality of the free-market economy.
Notes for this chapter
See Enrico Barone, "The Ministry of Production in the Collectivist State," in Collectivist Economic Planning, ed. Friedrich A. Hayek (London: George Routledge & Sons, 1935), p. 286. See also Trygve J. B. Hoff, Economic Calculation in the Socialist Society (London: William Hodge & Co., 1949), pp. 140-43.
Ludwig von Mises, Human Action (Chicago: Henry Regnery, 1966), pp. 353-56.
Joseph A. Schumpeter, Capitalism, Socialism, and Democracy (New York: Harper & Bros., 1942), p. 175.
Friedrich A. Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 90-91.
Miles, Human Action, pp. 707-9. See also Dominic T. Armentano,"Resource Allocation Problems under Socialism,"in Theory of Economic Systems, ed. W. P. Snavely (Columbus, Ohio: Charles E. Merrill Co., 1969), pp. 127-39. On the importance of the stock market in he free-market economy, see Ludwig M. Lachmann, Capital and Its Structure (London: London School of Economics and Political Science, 1956), pp. 67-71.
On Socialist countries operating within a world market environment, see Mises, Human Acton, pp. 698-99. On the rapid breakdown of War Communism, see Boris Brutzkus, Economic Planning in Soviet Russia Alienation and the Soviet Economy (Albuquerque, N.M.: University of New Mexico Press, 1971), pp. 20-47.
P. J. D. Wiles,"Changing Economic Thought in Poland,"Oxford Economic Papers 9 (June 1957): 202-3.
Friedrich A. Hayek,"The Present State of the Debate,"in Collectivist Economic Planning, pp. 226-27.
Hayek, Individualism and Economic Order, p. 198.
Roberts, Alienation and the Soviet Economy, p. 97.
G. F. Thirlby,"The Ruler"in L.S.E. Essays on Cost, ed. J. M. Buchanan and G. F. Thirlby (London: London School of Economics and Political Science, 1973), pp. 163-200.
James M. Buchanan,"Introduction: L.S.E. Cost Theory in Retrospect,"in L.S.E. Essays on Cost, pp. 4-5, 14-15.
Ronald H. Coase,"The Nature of the Firm,"Economica 4 (November 1937): 384-405; reprinted in American Economic Association, Readings in Price Theory (Homewood, III.: Richard D. Irwin, 1952), p. 335n.
See Murrray N. Rothbard, Man, Economy, and State (Los Angeles Nash Publishing Co., 1970), 2: 547-50, 585.
Ludwig von Mises and the Justification of the Liberal Order, by William Baumgarth
End of Notes
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