History of the Economic Calculation Debate, Part 2: The Impossibility of a Socialist Economy

The Quasi-market solution:

The proponents of the quasi-market solution suggest the formation of an artificial market. The same way the manager of a corporation strives to make profits for its shareholders, under socialism the product of the managers labor would be distributed to the community instead of owners of stocks. They want the central planner to act as if he is a profit seeking entrepreneur.

This proposal must be humiliating for the original defenders of central planning, it is the admission that the profit system is indispensable when it comes to the rational allocation of resources. Mises says:

"It is therefore nothing short of a full acknowledgement of the correctness and irrefutability of the economists' analysis and devastating critique of the socialists' plans that the intellectual leaders of socialism are now busy designing schemes for a socialist system in which the market, market prices for the factors of production, and catallactic competition are to be preserved

…

The socialists cannot help admitting their crushing final defeat. They no longer claim that socialism is matchlessly superior to capitalism because it brushes away markets, market prices, and competition. On the contrary. They are now eager to justify socialism by pointing out that it is possible to preserve these institutions even under socialism”[1]

Under the market system the managers are bound by the shareholders, they continue to operate the firm at the discretion of the ones that provide the capital. In so far as the shareholders allow the firm to be operated by any particular manager they are risking their own financial assets, they may acquire profits or bring losses to themselves. Nevertheless it would be foolish to assume that the great bulk of problems that require economic calculation are managerial problems.

At the center of the market system lies the entrepreneur, not the manager. Capital must be withdrawn from particular lines of production and allocated to others, new firms must be formed and inefficient ones must be sized down. This requires the existence of stock exchange, loans and speculation all of which would be abolished under a socialist economy (at least in the form that it exists in the free market).

Faced with this difficulty the socialists might offer an alternative: The central planner should allocate all the capital at his disposal to the projects that will return the highest profits, similar to a bank.

This would result in the direction of capital to the most risky projects and least cautious managers. We may repeat that under capitalism shareholders have their own assets at stake, they do not simply allocate their funds to projects with the highest return but they perform a balancing act between the risks and the rewards of their investment. These people want to “play market as children play war”.

Some socialists have proposed the introduction of “bonuses” as incentives for firms that have successfully produced goods or services.[2] This yet again suffers from the assumption that the central planners know beforehand which production processes are the “correct” ones.

The socialist state cannot let individuals control the withdrawal and reallocation of capital to different industries, this would quickly return the country back to the detested capitalist system. In a very underrated section entitled “Capitalism the only solution” Mises traces the way in which the central planner can find a solution to the problem of rational allocation of resources. This neglected piece of writing really penetrates to the heart of the problem:

The first step would be to divide the socialist community into number of different parts and assign each part a manager. Every manager will be fully responsible for his operations, if he wastes resources the burden of loss falls on him, society will not compensate him for the mistakes he has made. If he squanders all the means of production under his care he becomes an ordinary citizen like everyone else, if he is successful the profit accrues on him.

If the personal responsibility of every manager is to be legitimate his operations must be separated from the ones of other managers. Everything he receives from other managers in the form of raw materials or partly manufactured goods will be his burden and everything he delivers to other managers or citizens will be credited to him. He must be free to choose what materials he will buy and what he will produce, if this is not the case he cannot be held responsible for wasting resources.

On the other hand the citizens must have the same rights as the managers when buying goods from them or selling to them their labor. Citizens will reward the managers if the goods they produce satisfy their wants and sell their labor to the highest bidder which will be a part of the burden the managers bear. If he uses too many laborers he will incur losses.

By such an arrangement each manager can be full responsible for his doings. His domain in which he contributes to the community is strictly separate and can be distinguished from those of other managers. It is clear that the managers must be permitted to extend or contract their section depending on the prevailing consumer preferences. They must be able to give the means of production they possess to the highest bidder among other managers who need it more urgently. As usual what they give will be credited to them and what they receive will be debited to the recipient.

“But we need not carry the analysis further. For what are we confronted with but the capitalist order of society.”

Oskar Lange:

Oskar Lange is the most famous out of the “market socialists” that have responded to Mises’ challenge. It is considered that Lange has successfully refuted Mises, this could not be further from the truth. His main arguments can be found in a two-part article published in 1937 named “On the Economic Theory of Socialism”. Lange thought it would be possible to simulate the final state the market process will lead to without private ownership of the means of production using “parametric prices” determined by the central planner. According to Lange prices have 2 different meanings:

“It may mean either price in the ordinary sense, i.e. the exchange ratio of two commodities on a market, or it may have the generalized meaning of ‘terms on which alternatives are offered.’ Wicksteed says, ‘Price, then, in the narrower sense of “the money for which a material thing, a service, or a privilege can be obtained,” is simply a special case of “price” in the wider sense of the terms on which alternatives are offered to us. It is only prices in the generalized sense which are indispensable to solving the problem of allocation of resources.”

The fact that the term price can be used in a broader sense, terms on which alternatives are offered, does not mean that real market prices can be substituted for arbitrary parametric prices set by the central planner. As we have stated before, the problem is not that the central planner would suddenly be unable to perform arithmetic operations with given numerical values but the meaningfulness and the origination of the values themselves. It is impossible to distinguish the “parametric” function of prices from the “non-parametric” function.

Hayek acknowledges Lange’s naivete:

“That the ‘alternatives which are offered to us’ become known to us in most instances only as money prices is Mises’ chief argument. To turn this against him is an inexcusable legerdemain of which a thinker not prejudiced by political preconceptions should be incapable”

and

“The whole of Mises’ argument is precisely that, though the theoretician will recognise that the increase of the output of some good will usually be possible only ‘at the price’ of reduction of the output of some other good, without market prices nobody will know how large that ‘price’ is”[3]

Lange continues:

“The economic problem is a problem of choice between alternatives. To solve the problem three data are needed: (1) a preference scale which guides the acts of choice; (2) knowledge of the ‘terms on which alternatives are offered;’ and (3) knowledge of the amount of resources available. Those three data being given, the problem of choice is soluble. It is obvious that a socialist economy may regard the data under 1 and 3 as given, at least in as great a degree as they are given in a market economy.”

Here Lange is begging the question, one of the main contentions of Austrians with the market socialists is that the necessary information cannot be known to the central planner. We cannot simply assume away the problems that will inevitably have to be dealt with in a socialist economy. How does he attempt to acquire this information? His reasoning follows as:

“The data under (1) may be either given by the demand schedules of the individuals or be established by the judgement of the authorities administering the economic system. The question remains whether the data under (2) are accessible to the administrators of a socialist economy. Professor Mises denies this. However, a careful study of price theory and of the theory of production convinces us that the data under (1) and under (3) being given, the ‘terms on which alternatives are offered’ are determined ultimately by the technical possibilities of transformation of one commodity into another, i.e., by the production functions”

What must first be recognized in this paragraph is that Lange bases his assertions on neo-classical Walrasian price theory and theory of production. Although Walras did not believe the necessary information can be “given”, this demonstrates the danger in obsessing over mathematical equations and equilibrium theory. “It is not simply that, as Mises indicates, “economic equilibrium theory” is an irrelevant intellectual game, but also (and this is much more serious) that it corrupts even brilliant scientific minds by obliging them to start from unrealistic assumptions and leading them inexorably to erroneous conclusions, and all in a manner that goes virtually unnoticed, except by the sharpest and most profound theorists.”[4] Lange could never understand why Mises considers socialism “theoretically impossible” because he considers theory to simply mean the neo-classical theory under which it is always “theoretically possible” to perform economic calculation.

Even if the technological information of production functions, the curves which represent the physical output possibilities of various inputs could be communicated to the central planner this would be far from helping him produce “economically”. He would need to know the relative scarcities of the factors of production, not the curves that represent physical output but which production method to pick out of a myriad of ways to produce a commodity.

Suppose a product worth 50 dollars can be produced by 5 units of A, 6 units of B and 3 units of C, or by 2 units of A, 8 units of B and 4 units of C. In a market economy, we can see that if the price of A is higher relative to the price of B and C the second method of production will be less costly. The central planner lacks this information because there is no market for the goods A, B and C. Even this would not be enough, once it is known which one of the methods of production is “cheaper” there still remains the problem of how much to produce of each good with any given method. Given that the prices of goods diminish as their supply increase, entrepreneurs are able to estimate if the increase in the amount of goods produced with more factors of production will yield a higher profit. These types of estimations and calculations are only possible with real market prices.

Lange’s “solution” is not much different than the one Taylor initially proposed. These parametric prices would be adjusted using the trial and error method, if the demand for some production goods exceed the supply, parametric prices are increased and if the supply exceeds demand, prices are lowered to clear the market. We need not repeat the points we have already mentioned, they continue to remain relevant. One last comment we can make on the trial and error method is that the concepts of surplus and shortages is dependent on the subjective judgement of the entrepreneur. The fact that there are shirts on the shelves of a store does not mean that there is a “surplus of shirts”, the seller will hold back from lowering prices and selling the shirts if he believes he will be able to find customers that are willing to pay the existing price. It is crucial to repeat yet again that prices are not formed by the intersection of supply and demand curves, these curves do not exist in reality but are merely useful tools to comprehend the bidding process that occurs on the market. Prices spring from the interactions of flesh and blood actors who are always trying to forecast future conditions.

The only original contribution of Lange, despite his fame, is to link the previous proposed solutions more logically with the neoclassical-Walrasian model. Once it is conceded that costs are a subjective phenomenon and are not given, that “cost curves” do not exist, every solution proposed by the socialists collapses.

After Hayek’s response entitled “Socialist Calculation: The Competitive Solution”, in 1940 Oskar Lange in a letter to Hayek writes:

“There is no question that you have succeeded in raising essential problems and in showing gaps in the pure static solution given by me. I intend to work on this subject and give an answer to your paper ... sometimes in the fall”

In the same letter:

“Practically, I should, of course, recommend the determination of prices by a thorough market process whenever this is feasible, i.e., whenever the number of selling and purchasing units is sufficiently large. Only where the number of these units is so small that a situation of oligopoly, oligopsony, or bilateral monopoly would obtain, would I advocate price fixing by public agency.”[5]

And in 1944:

“The essay is so far removed from what I ought to write on the subject today that I am afraid that any revision would produce a very poor compromise, unrepresentative of my thoughts. Thus, I am becoming inclined to let the essay go out of print and express my present views in entirely new form. I am writing a book on economic theory in which a chapter will be devoted to this subject. This may be better than trying to rehash old stuff.”[6]

It seems like Lange had finally realized that the calculation problem only exists under dynamic conditions and acknowledged the need for the market process, but the awaited answer was never given. Until his death Lange was unable to respond to the Austrian criticism. Had Lange abandoned all socialist models?

Not quite, Hayek’s influence did not last long. Beginning with the Second World War and Lange’s entrance to the Polish Communist Party, Lange slowly started to abandon the market socialist model to the point of praising Stalin’s economic system which he had been providing an alternative for. He extolled Stalin’s work as “a momentous event in the history of science with far-reaching practical consequences.”[7] In 1956, Lange refused permission for the publication of a Polish translation of his classic 1936 work because “he did not want to lend his support to the ‘socialist free marketers.’”[8]

The last paper by Lange that deals with the economic calculation problem is entitled “The Computer and the Market” which was published after his death (1967). In the aforementioned paper he makes a reference to his original paper “On the Economic Theory of Socialism” claiming he had refuted all the arguments by suggesting the utilization of a trial and error method. The following comment is wholly tragic:

“Today my answer to Hayek and Robbins so what’s the trouble? Let us put the simultaneous equations in an electronic computer and we shall obtain the solution in less than a second. The market process may be considered as a computing device of the pre-electronic age”

After all those years, Lange reverts back to the static equilibrium model which he recognized as fallacious in his correspondence to Hayek and denies the need for a market with the development of computer systems. The ultimate defeat of Lange’s proposals are apparent in his pupils confessions who were also once in the market socialist camp:

“...as the article ‘The Computer and the Market’ written shortly before his death seems to witness, he [Oskar Lange] never succeeded in confronting the Austrian challenge ... Other contributions to the theory of market socialism made by Polish economists – and by economists of other socialist countries as well – failed to do this either: those of non-Marxist provenance followed mainly the Walrasian approach, while Marxist pro-marketeers – including the present authors – formed the ranks of Kornai’s ‘naïve reformers,’ viewing the prospect of the market-plan combination with excessive optimism.”[9]

The curious case of Maurice Dobb:

Some socialists did not even bother solving the economic calculation problem, to them the economic inefficiency of a socialist economy is irrelevant. Socialism must be pursued for political or ethical reasons. It does not matter how inefficient and wasteful socialism will be or how much the living standards of the populous will be lowered. One of the proponents of this idea was Maurice Dobb. Dobb accepts the totalitarian nature of socialism, outlines the need for suppressing individual freedoms and scoffs at the market socialists for attempting to integrate a market to this system:

“Competition necessarily implies not only diffusion but also autonomy of separate decisions; and it is the separate autonomy of individual decisions which produces these results… Either planning means overriding the autonomy of separate decisions or it apparently means nothing at all. Those who dream of marrying collectivism to economic anarchy must, at any rate, not pretend that the progeny of this strange match will inherit only the virtues of its ill-mated parents”[10]

In his article Dobb considers Lange’s collaborator, Abbe Lerner “an invisible opponent” as Lerner was one of the main proponents of the market socialist model yet was ambiguous and evasive in his proposals.[11] Dobb advocates for the allocation of workers by force and the abolition of any type of consumer sovereignty, to call this planner a king would be an understatement.

Ignoring the economic calculation problem however, does not make it disappear. Even this omnipotent dictator who imposes his will on the whole of society would not know if in achieving certain ends with factors of production, he is neglecting the achievement of his more desired ends with the given resources. We may admit that Dobb’s proposal is at least honest and does not attempt to hide the brutal destructionism of a socialist system.

Conclusion:

Here we conclude the complete intellectual demolition of socialist economics. Not only has the challenge put forth by Ludwig von Mises not been answered, but it cannot be answered as every form of socialism must restrict the free entrepreneurial decisions individuals make by pursuing their own interests. Mises was correct in calling a socialist economy strictly impossible. Not because the central planners cannot physically produce goods but there would be no way of knowing at what expense goods were produced, preventing any type of rational economic activity.

We need not even mention the ethical problems of confiscating generations of wealth or the insurmountable amount of technical problems that will arise during the implementation of such a system like bureaucratization, corruption, mass propaganda, silencing of dissidents, restriction of civil liberties, formation of black markets, environmental pollution etc. We also have not investigated the historical precedent of socialism in Cambodia, Vietnam, China, Ethiopia, USSR, Venezuela and Cuba. Regardless of the fact that some proponents of socialism do not consider these countries to be truly socialist, we leave to the reader to investigate the historical record and see for themselves the life under these regimes.

[1] Ludwig von Mises, “Human Action” p. 702

[2] Martin L. Weitzman, “The New Soviet Incentive Model”

[3] F. A. Hayek, “ Two pages of fiction: The Impossibility of Socialist Calculation”

[4] Jesús Huerta de Soto, “Socialism, economic calculation and entrepreneurship” p. 192

[5] Tadeusz Kowalik, “Lange, Oskar Ryzard (1904-1965)”

[6] Tadeusz Kowalik, “Lange, Oskar Ryzard (1904-1965)”

[7] Oskar Lange, “ Economic Policy Problems in Light of J. Stalin’s Work “

[8] Tadeusz Kowalik, “Lange, Oskar Ryzard (1904-1965)”

[9] Wlodzimierz Brus and Kazimierz Laski, “From Marx to the Market: Socialism in Search of an Economic System” p. 60

[10] Maurice H. Dobb, “Political Economy and Capitalism: Some Essays in Economic Tradition” p. 276

[11] Maurice H. Dobb, “Economic Theory and Socialist Economy: A Reply”