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Economic calculation problem

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The economic calculation problem is a criticism of socialist economics. It was first proposed by Ludwig von Mises in 1920.<ref>Ludwig von Mises, Economic Calculation in the Socialist Commonwealth, ISBN 0913966940</ref> Those who agree with this criticism claim it is a refutation of socialism and that it shows why a socialist planned economy could never work. The debate raged in the 1920's and 1930's, and that specific period of the debate has come to be known by Economic Historians as the The Socialist Calculation Debate.

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[edit] Liberal thinkers

Many Classical Liberal thinkers, especially those of the Austrian School believed that a full socialist economy to be unworkable because it denied private ownership of productive property. They state that without the free formation of prices due to private ownership of production—prices which represent vital market information—no cost accounting is possible by producers. Therefore, producers will have no basis to decide upon the right combination of factors of production.

This was first stated by Friedrich von Wieser and a good summation of this case was that of Ludwig von Mises in his article "Economic Calculation in the Socialist Commonwealth".

Friedrich Hayek further refined this by pointing out that by the time all the relevant information had been gathered the situation would have changed and so the government would be chasing a moving target. In their view, prices in a free market on the other hand instantly conveyed information on the demand and scarcity of products. In theory, the free market was effectively self organising in a way that a centrally planned one could never be. He also felt there were other dangers inherent in a planned economy, illustrated in his The Road to Serfdom.

[edit] Example

The first problem would be in land - although technical experts could say which fields were good (or even best) for growing strawberries, strawberries might not be the best thing to grow on that land. It might be near a town that, say, needs beetroot more than it needs strawberries: other crops could be grown on that land. Without knowing the market value of the land and its output, a farmer wouldn't know whether it was under or over performing or whether the choice of crop was appropriate.

Even if the community decided to just go ahead and grow strawberries, there are still problems. Strawberries, whilst they can be eaten as they are, can be an intermediate capital good - used an ingredient for making tarts, strawberry milkshakes and yogurts, etc. Even if demand for these goods could be measured, their producers would not be able to know how many strawberries to put in each item (whether to put more in, fewer, or to substitute with chemical flavourings).

Even if you knew how many strawberries were wanted, and how much yogurt, etc. you couldn't tell, without pricing, which was more desired and which should take priority. This is relevant for warehouses and shops. They have limited space and would need to know which product should take priority in filling that space.

All this could lead to strawberrries being grown in preference to other highly needed crops, or in the wrong place (causing increased fuel consumption). It could further lead to too many strawberries being used in pre-made goods meaning shortages of fresh strawberries on the shelves.

[edit] Extended explanation of argument

The basic economic problem is how to use the present economic resources most effectively. Inefficient and irrational usage means that effort that could be usefully applied is wasted.

Although, as Mises accepts, demand for consumer goods can be known without prices (or indeed, market prices could be set for consumer goods), without a market in capital goods and factors of production, there would be no way to co-ordinate meeting that demand in a rational economic manner. Specifically, there would be no way to assess the impact of choosing between different production methods.

In a free market, the market in capital would serve to indicate which methods of production were economically successful by increasing or decreasing the costs to profit ratio in a particular field of enterprise.

Under socialism, there is no market in capital goods, and so branches of activity may be carried out without any mechanism for measuring how successful they are at meeting needs.

Without such balancing factors of production may be under- and over-produced hampering the end production of consumer goods, the result of the calculation problem is that there will be acute shortages of one good or another.

Inherent in the calculation problem is the conclusion that it is impossible to predict which goods will experience shortage, since if that could be predicted, production could be adjusted to eliminate the shortage, and the calculation problem would in fact be solvable. The assertion of Mises is that the calculation problem is inherently unsolvable.

Thus the ostensible result is that socialism produces inefficient distributions of production. Historical examples include the Soviet Union's cyclical shortages of various goods.


This argument served as the starting point for F. A. Hayek's work on the use of knowledge in society. He contended that the only rational solution to the economic calculation problem is to utilize all the dispersed knowledge in the market place through the use of price signals.

Basically economic costs can't be known without prices. The problem is not one of having a unit of measure, though that is sometimes incorrectly identified as the economic calculation problem. So what is the cost of a space race? To answer the question in a socialist economy requires a knowledge of what people would have done with the time, labor, titanium, land, etc., if it were not instead used to produce a space race, but this is something that fundamentally can't be known.<ref>D.R. Steele, From Marx to Mises (Chicago: Open Court, 1992) ISBN 0-8126-9016-8</ref>

[edit] The economic calculation problem and Chinese economic reform

Efforts to resolve the economic calculation problem by introducing market pricing has remained of the main goals of Chinese economic reform with Chinese economists such as Wu Jianling referring explicitly to the work of Hayek and the economic calculation problem. The resolution which was implemented in the 1980's was dual track pricing in which an economy in which resources were allocated by prices exists along side with one in which resources were allocated by administrative order. By the early 1990's, the administrative system had been gradually removed, and resources were allocated by prices.

The system that has resulted in China is known as a socialist market economy in which large parts of the economic remains state owned, but in which market prices are used for resource allocation. One principle of the Chinese economy which has evolved during the 1990's is the principle that state-owned enterprises compete on an equal basis with privately owned ones.

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[edit] Criticism

This conclusion was attacked directly on two fronts. Firstly, by believers in the general equilibrium theory who maintained that all that matters is the knowledge of the most effective use of materials as long as the price system was in use; effective use of materials could then be calculated by any method, and in essence, other signals would take place of price for intermediate goods.[citation needed]

Secondly, by Marxists, who see prices, e.g. the ratio in which commodities (including money) are exchanged with one another, as determined by the amount of labor spend in the production. This critic is based on the Labor theory of value. If either of those alternative theories of price is accepted, in place of the marginalist theory presently most popular among economists, the calculation problem becomes harder to formulate.[citation needed]

Mises acknowledged that a stable economy could be organised rationally without money (although he argued that the vast changes required to achieve an economy in equilibrium still meant that socialism is impossible). The Trotskyist Hillel Ticktin has put forward such a model for socialist organisation, coupled with surveys to discover demand for new goods.<ref>Bertell Ollman, Market Socialism: The Debate Among Socialists (participants: David Schweickart ... [et al.]), New York; London: Routledge, 1997, ISBN 0-415-91967-3</ref>

This contradiction apparently contradicts what Trotsky himself wrote:

If there existed the universal mind, that projected itself into the scientific fancy of Laplace; a mind that would register simultaneously all the processes of nature and of society, that could measure the dynamics of their motion, that could forecast the results of their inter-reactions, such a mind, of course, could a priori draw up a faultless and an exhaustive economic plan, beginning with a number of hectares of wheat and down to the last button for a vest. In truth, the bureaucracy often conceives that just such a mind is at its disposal; that is why it so easily frees itself from the control of the market and of Soviet democracy.

The innumerable living participants of economy, State as well as private, collective as well as individual, must give notice of their needs and of their relative strength not only through the statistical determinations of plan commissions but by the direct pressure of supply and demand. The plan is checked and to a considerable measure, realized through the market. The regulation of the market itself must depend upon the tendencies that are brought out through its medium. The blueprints produced by the offices must demonstrate their economic expediency through commercial calculation.

...

Economic accounting is unthinkable without market relations.<ref>Leon Trotsky, Soviet Economy in Danger, New York, 1933. Quoted in Kevin McFarlane, Real Socialism Wouldn't Work Either, London: Libertarian Alliance, 1992, ISBN 1-85637-107-7.</ref>

(However, this quotation refers to the transition period between the New Economic Program, better known as the NEP, and the planned economy in the USSR.)

Also, it could be said that the fact that someone is willing to pay for something does not mean that it is able to do so, thus inequality (usually considered a consequence of private property) disrupts that mechanism. Critics point out that the fact that someone is willing (and able) to pay for something implies that the opportunity cost is (subjectively) considered as lower that its value (by this particular person).

Some socialists respond less directly, that this argument rests on the assumption that socialism would be a completely centralised economy based on society wide planning, but that in fact it need not necessarily be so. This counter-argument suggests a decentralized form of socialism with different levels of planning -- local, regional and global. This, they claim, would allow for a self-regulating mechanism of stock control to come into play (which cannot happen in the case of society-wide or central planning).[citation needed]

In this model, distribution points replenish stock as it is removed from the shelves by signaling to producers’ orders for new stock. Producers in turn contact their own suppliers of inputs as and when it is required and so on down the production.

According to the law of the minimum (after Justus Von Liebig) those factors that are most scarce in relation to demand, that constitute the "limiting factor" which proximately limits the production of any good, are precisely those that need most to be economised. The shortage of such factors as revealed via the self-regulating system of stock control will trigger the search for more abundant substitutes. This, some socialists claim, would overcome the economic calculation problem.[citation needed]

One response to this criticism is that fundamentally the calculation problem does not in fact rest on an assumption of centralization of decision making. Indeed, problems very similar can occur in decentralized systems, wherever the persons making choices are insulated from the inefficiencies of those choices.[citation needed]

Another response is to point out that the "stock control plus law of the minimum" proposal ignores the key difficulty identified by the economic calculation problem: the measurement of costs of production according to a common unit. For efficient allocation, it's necessary to have a common unit of cost for all the many thousands of productive inputs. Such a unit is given by market prices, but is not given by stock control or by the law of the minimum.[citation needed]

The classical economic critique of this theory is to point out that all real-world instances of socialism have involved central planning to a greater or lesser degree, and absent any example of actually functioning "Decentralized Socialism" it should be assumed to suffer from the economic calculation problem the way all other socialist economies have (a disputed claim, as some socialists, particularly anarcho-communists, consider that the social revolution in Spain was an experience of decentralized socialism).[citation needed]

[edit] References

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[edit] External links

nl:Economisch calculatieprobleem ja:経済計算論争

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