Lecture Eight:  Economic Calculation

Sources:   Mises, “Economic Calculation in the Socialist Commonwealth” and Human Action; Hayek, Individualism and Economic Order; Boettke, “Economic Calculation:  The Austrian Contribution to Political Economy” in Advances in Austrian Economics; Rothbard, “The End of Socialism and the Calculation Debate Revisited;” and Steele, “Posing the Problem:  The Impossibility of Economic Calculation under Socialism.

Remember:  this theory is a technical argument about socialism - it is NOT an ideological argument per se (of course there are underlying value judgments - such as that it is a good thing that people's plans are coordinated).

 

Here is the basic question:

Is Socialism Possible?

Remember first the definition of socialism (which is why this term is used quite frequently in this discussion):

 

 

Prior to Mises raising the calculation problem in 1920, the critics of socialism concentrated on the incentive problem:

 

 

According to many socialists – the problem was due to the fact that man’s nature had been formed and could be changed (as per Marx to a large degree):

 

 

 

Although Mises talked about the incentive issue – that was not his main point.

 

Side note:   There is controversy regarding the idea that Hayek’s argument that followed Mises does not add to Mises, but is in fact a different argument.

Basically - Mises - Private property vs. Hayek - knowledge for example.

As you see in the Boettke reading, he disagrees and says they are essentially the same argument.  We will assume that to be true here.

 

 

Assume There is No Incentive Problem

What Mises did was to say, OK, assume there is no incentive problem (we have all become the “socialism man”) – if that is the case, then will socialism be a successful economic system.  His answer was “no.”

 

Let’s look at his famous writing, “Economic Calculation in the Socialist Commonwealth” (1920):

First though – a couple of “definitions” regarding capital that are used by Austrians (from Menger, etc.):

Lower order goods: 

 

Higher order goods:

 

Mises first talked about:

People usually talk about the distribution of consumption goods in the Socialist Commonwealth.

Who is to do the consuming and what is to be consumed by each?  Socialists emphasize equality in terms of consumer goods – we all have the same “equal” distribution.

 

But, Mises said, this is of secondary importance.  Can have exchange among consumption goods under socialism within the narrow limits permitted. 

But the major problem is that no production goods will ever be exchanged and therefore it will be impossible to determine their monetary value.

If we can’t determine that – then the consumer goods to be distributed will be few (there is no way of “economizing” on the use of resources and determined haphazardly by planners – have nothing to do with the wants of the people.)

 

 

Money could never fill in a socialist state the role it fills in a competitive society in determining the value of production goods.  Calculation in terms of money will be impossible.

Hence—it then becomes “impossible in any socialist state to posit a connection between the significance to the community of any type of labor and the apportionment of the yield of the communal process of production.”

So remember – labor is included here!  What should people do?  What should they train to become? There are no answers in socialism.

So let’s delve into his argument:

 

The Nature of Economic Calculation

As we have already discussed (new terms are from Mises): 

it is impossible that there should ever be a unit of subjective use-value (SUV) for goods.  Can’t be “measured.”

With marginal utility (MU) – no unit of value – judgments of value do not measure; they merely establish grades and scales within the mind of the individual.

 

In an exchange economy the objective exchange-value (OEV) enters as the unit of economic calculation (similar to the idea of “social knowledge” that we discussed earlier).

 

OEV=Monetary Price

These are the advantages of this:

1.       It renders it possible to base the calculation upon the valuations of all participants in trade.

“The SUV is not immediately comparable as a purely individual phenomenon with the SUV of others.  It only becomes so in exchange value—which arises out of the interplay of the subjective valuations of all who take part in exchange.”

 

2.       Calculation by exchange – value furnishes a control over the appropriate employment of goods.

 

If she’s not making a , she’ll put resources elsewhere.  Owners of resources, including labor, will go to highest bidder.

 

 

 

3.       Calculations by exchange value makes it possible to refer values back to a unit. … (common unit)

Since goods are mutually substitutable in accordance with the exchange – relations obtaining in the market, any possible good can be chosen – in a monetary economy it is money that is chosen.

 

The Limits of Monetary Calculations

1.       Money is no yard-stick of value!  Value is not measured in money, nor is price.  They merely consist in money.

Money as an economic good is not a stable value – its value is determined by S & D like any other commodity and subject to diminishing marginal utility.

 But these fluctuations are comparatively trivial in regard to its exchange –relations.

(with “good” money)

 

 

2.       Monetary value does not include value outside of exchange relations.

 

The two conditions governing the possibility of calculating value in terms of money:

 

a.

 

 

b.

 

 

If this were not the case, it would not be possible to reduce all exchange relationships to a common denominator.

It’s this common denominator that makes valuation comparisons possible –

For example:  A resource is “worth” this much (say $100,000) in market A and this much (say $200,000) in market B – it is comparable.  But these prices only arise out of exchange.

 

The human mind cannot orientate itself properly among the bewildering mass of intermediate products and potentialities of production.  We must have some “aid to the human mind” for deciding where resources should go. 

 

And in order to gain this “aid” – we need exchange – which means we need private property rights in the means of production!

With private property everybody is a consumer and everybody a producer … and thereby resources flow in economically “correct” directions.  Correct meaning – towards those who value them - meeting more ends and creating more coordination among individuals in society.

 

A socialist economy will have to be a static economy.

 

 

There is only groping in the dark!  There is no trial and error.  There is no entrepreneurial discovery!

 

Responsibility and Initiative in Communal Concerns

 

Remember, Mises said that even without an incentive issue or assuming everyone wants to move resources in such a way to avoid waste, make others better off. 

However, we cannot act “economically” if we are not in a position to understand economizing.  If we don’t have the data necessary to make economizing decisions.

And the entrepreneur’s commercial attitude and activity arises from his position in the economic process and is lost with its disappearance.

Conclusion

So Mises concludes that in order to have a successful economy (where the basic necessities of life are met), we must have:

1.      

 

 

2.      

 

 

3.      

 

Without these we cannot have the incentive to economize or the means to do so (i.e. prices) which have embedded in them the SUV of millions of individuals (i.e. the dispersed knowledge of the social order).

 

So let’s add in Boettke (for an even better understanding – I hope):

 

Economic Calculation:  “the decision-making ability to allocate scarce capital resources among competing uses.”

Boettke sums in up this way (quote):

1.       Without private property rights 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 uses of capital goods.

Again, “without private property rights in the means of production, rational economic calculation is not possible.”

 

Mises (from Human Action):  “Every single step of entrepreneurial activities is subject to scrutiny by monetary calculation.  The premeditation of planned action becomes commercial precalculation of expected costs and expected proceeds.  The retrospective establishment of the outcome of past action becomes accounting profits and losses.”

 

So market prices in capital goods (which we have already learned reflect the subjective value of individual consumers) – determine the potential costs of production – which then determine if a profit will be made or not.

 

Example:  Under socialism – imagine this scenario:  the government owns all means of production.  So it owns a plant that makes hamburger patties.  It also owns the ranches that produce the cows, the truck company that transports the meat, etc.

The “planners” are trying to decide if this is the best use of this plant - the best use of the trucks, of the land that houses the cow ranch.  All they can do is guess.  So therefore, they make hamburgers that nobody wants, and they don’t make hot dogs that a lot of people want.  They use these capital goods in unproductive ways – ways that waste resources.  Even to the point of not being able to meet the basic necessities of life.

 

Hence, they have a "knowledge" problem of where and how to utilize capital resources.

 

 

 

 

Mises’ Four Warnings Against Socialism

1.       Private property and incentives

2.       Monetary prices and the economizing role they play

3.       Profit and loss accounting

4.       Political environment

According to Boettke, “in a fundamental sense, all of these arguments are derivative of an argument for private property.”

Let’s see why:

1.       Private property and incentives:

 

 

2.       Monetary prices and the economizing role they play: 

 

 

3.       Profit and loss accounting: 

 

 

4.       Political environment:       

 

 

So let’s end with one of my favorite quotations from Mises:

“They [socialists] invariably explain how, in the cloud-cuckoo lands of their fancy, roast pigeons will in some way fly into the mouths of comrades, but they omit to show how this miracle is to take place.” (“Economic Calculation in the Socialist Commonwealth”).

 

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