Feb
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Debates setting the two dominant economic systems of the 20th century viz. socialism and capitalism on opposite poles have always witnessed the acceptance of the superiority of capitalism on account of the better incentives available under it’s basic scheme of things which motivate the individual towards excellence. This induced the depressed to `order’ for the creation of a new `socialist man’ who works for nothing but the goodness of his comrades, and passion he holds for his work. Such moral proponents were the root cause of movements like the Stakhanovite movement in the erstwhile USSR. These things aside, the problems of a Centrally planned socialist economy[1] are immensely larger than mere motivational factors, it lies in the very structure and character of it’s economic institutions.
This was starkly exposed in the `socialist calculation debate’ of the early decades of the 20th century which involved waring minds (of economists) belonging to hostile camps. The capitalist camp was headed by economists from the Austrian School, most notably: Friedrich August von Hayek and Ludwig von Mises; the Socialist camp was represented by Oscar Ryszard Lange and Abba Ptachya Lerner. This article serves the purpose for purporting the essential ideas of Capitalism and the grave shortcomings of Central planning.
The fundamental feature of the Capitalism is the price system, with profit motive and economic competition as it’s inseparable soul. The price system is thus the most ingenious component of the market economy, so invincible that socialist economists of the 19th century trying to apply the labor theory of value to determine the prices of commodities (based on the amount of `socially necessary labor’ required to produce a commodity) accepted their defeat, and adopted the market pricing system, after all the price system is nothing but an expression of the subjective preferences of market players. In simple words, demand and supply forces determine the price of a commodity. Commodities do not have any magical value in themselves.
This was the essential outcome of the marginalist revolution.
However, a group of economists — namely the “market socialists” — persisting under the auspices of Polish economist Oscar Lange refused to bow down (except for their acceptance of the revelations of the marginal revolution), in fact they were immensely excited about prospects of their own system which could allow for central planning of the economy. These economists proposed a hybrid system - adopting the pricing system of the capitalist economy and also the `goodness’ of central planning. They seriously believed they did it.
The “market socialists” proposed the arbitrary fixing of prices of consumer goods and allow supply and demand to match at some given price. They were able to explain their system with temporary success:
if the prices were fixed too high, goods would stay unsold on the racks of stores; and if prices are fixed too low, shortages would result. The planning board would fix the prices on a `trial-and-error’ basis to determine the `clearing-price’ of the market, and the economy will be on it’s feet.
So far so good, or is it? It didn’t occur to them that they created the body of their economic system without a soul — the absence of private ownership of the means of production — until Austrian economist Ludwig Von Mises came up with his seminal work, “Economic Calculation in the Socialist Commonwealth” in 1920. Mises pointed out that without private ownership of the means of production, in other words, without competitive bidding from various private players for the ownership of capital and land, there was no way to rationally ascertain the prices of the various higher-order goods (capital and land).
This further means there is no scope for profit-loss calculation, and there ends any dream of rational allocation of resources under centrally planned socialism. The acquisition and usage of capital
resources in a centrally planned economy are merely `internal transfers’ within a single body since the State is the only owner of capital goods.
Oskar Lange who talked about such a system himself found convenient to copy the prices of a Capitalist system, than to follow his own suggestion, when he was made a member of Polish Central planning commission. As the famous joke goes, two socialist leaders are discussing their plans to bring Communist revolution all over the world. One of them suggests “well we can convert the whole world into Communism, but lets leave one capitalist country as Capitalism. Lets not convert Hong Kong into Socialism”, the other socialist replies, “Well Comrade what are you talking about? We must convert the whole world into Socialism, and get rid of all the Capitalist oppression, why leave Hong Kong”, the other socialist replies “Well we gotta copy the prices from somewhere.”
For those who did not get the above joke, without a Market system, its really impossible for anyone to rationally allocated the resources in a Society. For all you know you can start creating iPods made of gold covering, and use all that gold on the iPod, rather than making its circuit out of it(which makes much more sense, since gold is a better conductor of electricity). By having a price system you will realize that its not worth making an iPod out of pure gold because of high prices of gold, and less market price of iPods, people are not willing to pay for a gold iPod, also gold can be better used for something else.
Profits and losses play a very vital role in the market system. Profits in a sector indicate that the commodity (or service) in question is of use to the consumers (and hence demanded by them);
losses mean the reverse, that is, the commodity (or service) in question is not of much use to the consumers (and hence not demanded). Because of the absence of economic calculation socialism would lead to massive wastage of resources since the planners would be left groping in the dark to know which sector of the economy is in immediate need of a particular higher-order good.
Some mathematical economists have tried to ascertain arbitrary prices to capital goods by analyzing the price of consumer goods that are produced using the capital good. But such indirect measures have shown no scope of accurate determination of the prices of higher order goods.
Footnotes:- Socialism, Welfare, Braindrain, Reason for Liberty [↩]
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1 views13 Responses to “Socialism Can't Calculate”
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Don Emmerich Says:
February 14th, 2009 at 12:11 pmI’ve added a link to Reason for Liberty on my blogroll:
Thanks so much!
GP Says:
February 16th, 2009 at 7:12 pmok..Apart from message “Socialist are not accountant or finanacial planner” there is nothing new in this article.
renegade_division Says:
February 16th, 2009 at 8:38 pmI am sorry dude but that’s not the point of the article.
It has nothing to do with “Socialists” rather its talking about “Socialism cannot calculate”.
There is a huge difference which you clearly missed. And that is that in Socialism rational allocation of resources is not possible, because of the lack of Economic calculation.
In simple words it talks about the theoretically impossibility of Socialism.
Economic calculation problem explains why Lenin’s first attempt at pure Socialism failed so miserably and why he was forced to allow a market to exist in 1921.
prashanthguevara Says:
February 16th, 2009 at 9:00 pm@ GP
“ok..Apart from message “Socialist are not accountant or finanacial planner” there is nothing new in this article.”
Hi, I’m not sure about what your thoughts are; I simply can’t judge it from your one-liner. But the point is, the very basis to judge the efficiency of an economy is it’s allocative efficiency. While socialism doesn’t offer such a scope, there’s nothing further to talk about the system. Perhaps you didn’t get much out of this article because Mises has been so conclusive in his rebuttal of socialism.
Unpretentious Diva Says:
February 16th, 2009 at 9:13 pm@ Prashant
Don’t worry yourself about GP and his one-liners.
he thinks even if socialists cannot calculate, they are good and more useful than capitalists.
He just cannot understand that since socialist cannot calculate, hence they are dangerous and hazardous.
I am sure just like another 1 billion and more Indians, he knows nothing about Mises, nor it is important.
I don’t think it is necessary to advertise Mises, Rothbard, Rand, Hayek, John Locke, etc.
GP Says:
February 17th, 2009 at 6:10 pm@Unpretentious Diva
For the record, I never thought or said anywhever in my comments socialists are better than capitalists. Neither I am hard-core supporter of socialism.
But I do like the progress and positive changes being made by China ( which is again currently a mix of capitalist(due to eara of globalization) and socialist ideas)
I think thats possible due to socialist regime in China. However, I do accept there are inherent flaws in socialism, which needs to be addressed with proper planning.
Small suggestion - How about publishing the flaws of capitalism on your site? ..just to show both sides of coin to your readers ?
Unpretentious Diva Says:
February 17th, 2009 at 6:54 pm@ GP
About crony capitalism America, China and India following, we keep publishing the flaws of that.
You are free to mention any and every flaw of capitalism.
Remember Capitalism is different than crony capitalism. Crony capitalism is that which China, America and India are following.
In fact you are totally free to showcase any fault of capitalism and we can discuss it too properly.
yet you won’t find any fault.
What fault can there be in HONEST INDEPENDENT LIVING? that is what capitalism is.
GP Says:
February 17th, 2009 at 7:47 pm@Unpretentious Diva
Sorry, cant type much due to time constraint But i am sure you will now refute it as “comments on crony capitalism”
and I already commented on practical limitations in implementing idea of “free Market Capitalism” which you supported through your articles.
Unpretentious Diva Says:
February 17th, 2009 at 8:07 pm@
GP, sorry, i dont have time to go here and there, you are free to provide anything in support of your liking of slavery loot and robbery.
About practical limitations, there is NO LIMITATION, and every problem you can think of has proper practical free market solution.
Political Entrepreneurship « Confessions of a Sourashtrian Says:
February 18th, 2009 at 5:13 pm[…] is not. I have read mostly anti communist books and articles. Ranging from Animal Farm to a recent article (Socialism is mainly an economic system, while communism is both an economic and a political […]
RobotSocialist Says:
October 12th, 2009 at 1:56 amFlawed. Of course economic planners did not just try to determine the price. If they thought the market clearing price was too high to be fair they’d increase the supply in order to decrease the market clearing price to an acceptable level. Unlike in a capitalist economy where the government only regulates socialist systems are able to control the whole deal. They can control not only price but supply (by mandating production) and demand (by mandating consumption, though even in the most tyrannical states this was generally not done and is not supported by most socialists especially not any democratic socialists). Let’s say something is so important everyone who needs it needs to get it like healthcare. A socialist economy can calculate the likely need for healthcare services then increase production to match this level or go higher in case the estimation was too low. There are no needs for shortages and waiting lines. Countries with these problems are mismanaging their economies and should be working diligently to increase health care related production but this is complicated by lack of control of related industries that send resources into health care.
The problem with the argument is this. Efficiency is defined as:
-No one can be made better off without making someone else worse off.
-More output cannot be obtained without increasing the amount of inputs.
-Production proceeds at the lowest possible per-unit cost.
While the first might be true there may be many “efficiencies” depending on how much value is given to any particular want or need. If its at efficiency and you take from one person and give to another you’re still in a condition where if anybody gains somebody has to lose so the first condition allows for many possible outcomes.
For the second one that seems self evidently true for any economy. You wouldn’t be inputing it if you didn’t have to in order to make the output so naturally to have more output you always need more input. This is redundant and is true in any economy.
Third, I see no reason why planners can’t calculate per unit costs. In fact while private companies might only be concerned with the dollar value and don’t care what else went into it planners could record from the beginning, from the raw materials onward through the production process everything used in the process and make an exact calculation of resource use rather than just a dollar value. Direct measurement of the cost instead of representative(money only represents value).
Ultimately a centralized computer system would probably be the most efficient means of running an economy if we could program one to take into account everything that goes into the process and if all labor could be mechanized. When that time comes humanity will liberate itself from labor and each individual free to pursue life as they see fit. This by definition maximizes value for each individual, therefore society, and therefore digital socialism would be most efficient system of all.
Prashanth Perumal Says:
October 12th, 2009 at 2:28 am1) You’ve mentioned that the State in a socialist economy can regulate production based on demand for the commodity in question, and then all the talk of ‘efficiency’. But I just wonder why you believe the market won’t do the same(that is allocating resources towards the most important needs), in a much more efficient way through the profit-loss system.
I kind of like viewing the economy as a voting machine, where people with money vote for various goods. The market entrepreneurs allocate the available resources with these signals of profit-loss.
The problem socialists usually find with this system is that prices don’t always express the intensity of certain wants. Like for example, how a pauper without any money with him can’t vote with enough money to bid resources away from a rich guy who uses the same resources for other frivolous needs. This is a valid point. But usually, such a cherry-picked cases that ignore the advantages the proper pricing system makes available to us.
2) Next, planners cannot make a genuine calculation of costs since there is no real bidding actually happening. There have been many of these alternative proposals to have ‘competing’ government agencies which will bid for resources. So much for genuine ‘competitive’ pricing.
And any pricing system which doesn’t take into account the real subjective preference of consumers who bid with their money votes, simply doesn’t make a rational allocation of resources towards the most urgent demands.
And next, you would again be committing an error, what classical economists did, if you calculate costs from production stages rather than deriving it from consumer prices. That doesn’t mean you can ‘impute’ prices to capital goods based on the consumer market prices. It’s impractical for many reasons.
Try this for now: http://mises.org/Community/forums/p/10674/252308.aspx#252308
Isaac Says:
November 29th, 2009 at 1:12 pm“a pauper without any money with him can’t vote with enough money to bid resources away from a rich guy who uses the same resources for other frivolous needs”
This too misses the point. All but the truly homeless have at least some money to vote with, and plenty of businesses are vying for his patronage. Take Walmart for example: they very much cater to those of lesser means. Most Walmarts exist in low income rural areas; in fact that was the basis of Sam Walton’s business plan: to provide low prices to those who need it. Another example would be cheap food products like TV dinners and romen noodles, etc.