Debunking Austrian Economics’ Socialist Calculation Problem

The ‘Calculation Problem‘ is what market economists commonly argue against socialism but there is no reason to be smug about economic calculation under capitalism. Communist workers could hardly do a worse job of allocating investment funds than do highly fluctuating interest rates and exchange rates produced by capitalist finance. And there are good reasons for thinking that economic decision-making would be far superior to that under capitalism. To begin with, the absence of ownership barriers would increase the scope for coordination, and lessen the scope for secrecy and deception.

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Reprinting this from David McMullen’s site, Simply Marxism. Originally published in May 2017. 

The so-called Austrian school of economics makes much of what they call the socialist calculation problem. They argue that a society based on social ownership could not have an effective price system and therefore could not have the decentralized decision-making we see in a market economy.

The claim was first made by Ludwig Von Mises in the 1920s. Really all he is saying is that transfers between enterprises using a decentralized price system must be market exchanges. Without explaining why, he rules out the possibility of such transfers occurring between socially owned enterprises where there is no exchange of ownership but simply a transfer of socially owned property from one custodian to another. I am thinking here of a transfer between a supplier and user of some component in production. Without predicting what will actually happen in the communist future we could easily imagine production units using decentralized pricing to determine least costs methods of production and assigning output to the highest bidder. We could also easily imagine such a system being ultimately driven by consumer demand.

Then we had the intervention of Frederick Hayek in the 1930s and 40s. He demolished the rather lame decentralized socialist model devised by the economist Oskar Lange. That model confines decentralized price adjustments to consumer goods while price adjustments for intermediate goods are carried out by a central agency that is keeping an eye on inventory levels. Hayek correctly points out the inadequacy of such an arrangement and how it does not represent a fully functioning price system. Discrediting the Lange model is all very well, but Hayek did not then go on to show that an economy based on social ownership would in fact be limited to the Lange model. In other words he did not show that there is something about social ownership that would prevent the use of decentralized price adjustment in the allocation of intermediate goods. So I think I can justly say that all that Hayek has done is refute a straw man.

OK now we come to the final version of the argument and this was developed in the 1980s by Don Lavoie of George Mason University. He conceded that a socially owned economy could have a price system but that it would not be a very good one. In his book Rivalry and Economic Planning, he contends that any price system under social ownership would be inferior to a market based one because it would be unable to reflect the discovery process that emerges from competition between market participants. According to Lavoie, it is important, in the presence of uncertainty, to have numerous participants trying out different approaches to problems, based on their own opinions, guesses and hunches. Those who come up with the best and most highly valued products using the cheapest methods win out in this competitive contest. I fully agree with what he is saying. However, if, as I contend, decentralized custodianship is an important part of social ownership, diversity of approach should not be a problem.

Under social ownership, it would still be very common for an individual enterprise or facility to be just one of many producing the same good or close substitutes and each of them would be free to try out different production methods and product designs. Some would be new entrants who were either existing enterprises moving into a new field with synergies or starts ups established by enthusiasts with ideas that the incumbents were not open to or capable of developing. This diversity would be greatly assisted by having numerous independent agencies being responsible for disbursing funds in each industry and making their own assessment of what were good investments. At the same time, enterprises would be free to choose their suppliers based on cost and quality, and would have to outbid other users of a resource or intermediate good. Discovering and adopting the best methods and products would of course mean that it would be common to see activities abandoned and enterprises closed or reorganized. So, the only real obstacle to a decentralized price system would be the absence of daring and conscientious custodians and this gets us back to the question of whether we can do without the profit motive. Can we do our best just because we enjoy the work and want to contribute? As I argue elsewhere this does not strike me as being all that fanciful if we are sharing high and increasing affluence and all the unpleasant work is performed by robots and computers.

So the calculation argument is not a separate argument from the standard one about whether we need the profit motive.

I think it is appropriate to point out that there is no reason to be smug about economic calculation under capitalism. Communist workers could hardly do a worse job of allocating investment funds than do highly fluctuating interest rates and exchange rates produced by capitalist finance. And there are good reasons for thinking that economic decision-making would be far superior to that under capitalism. To begin with, the absence of ownership barriers would increase the scope for coordination, and lessen the scope for secrecy and deception.

So to sum up. My basic point is that when it comes to economic calculation, communism will be able to do anything capitalism can and do a better job of it.

I have links below to a number of articles that go into more detail on this topic.

https://economsoc.files.wordpress.com/2014/04/re-opening-the-debates.pdf

https://economsoc.files.wordpress.com/2014/04/the-economic-case-for-social-ownership.pdf

4 thoughts on “Debunking Austrian Economics’ Socialist Calculation Problem

  1. Bill I thought that you might like to see this. Stephanie Kelton is the most pre eminent advocate of Modern Monetary Theory. Two points from me those against are arguing against reality in that MMT is here Stephanie is just pointing out reality and saying that we would be better off acknowledging it. The other point is that yes France under Louis went bankrupt but it was because he was bankrolling the US war of independence after France had just lost the 7 years war. Im unaware that any MMT theorist is arguing to blow out the deficit to fight wars but that is exactly what is done in time of war.
    https://www.bloomberg.com/news/videos/2020-12-04/that-s-debatable-stop-worrying-about-national-deficits-video?sref=12NyCRzn

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  2. A lot of what will underpin MMT is the future development of Capitalism. I think that Catherine Wood has the best grasp of what is coming and believe me she is excited about the future.

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  3. “Without explaining why”… It would seem awfully peculiar for Mises to have missed out on explaining his theory, having devoted a book to it, and having cited it in many other works. Of course, he did explain it! Market prices are needed to coordinate production because those prices contain information about the preferences of people in that society. They efficiently capture opportunity costs and trade-offs that people make and translate them into a common unit so that calculations are much easier to perform. And as you rightly note, the price systems within centrally-planned economies are very shaky and arbitrary, so they are no substitute for genuine market prices.

    Whereas central planners have to “try out different production methods and product designs”, the capitalist economy would eliminate a lot of this reliance on trial and error (and any trial and error that does occur in a freer market receives very quick feedback), and would thereby reduce a lot of wastage. It is always possible that some of those socialistic trials would bear much fruit, but the question is how well such a hap-hazard system, controlled by distant bureaucrats, and which has failed dismally during past trials, is likely to perform against a market approach that has worked for a long time.

    And lastly, we should not be calling it ‘social ownership’. It’s a nice hypocorism, but we should call it what it is: government control.

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    • Hi Paul. Thanks for comments.

      I only know of one place in Mises’s writing where he contends that exchanges between firms using decentralized prices would have to be market exchanges (and therefore could not be transfers of custody) and that is in his 1920 article. He simply asserts it without giving a reason. His argument against a socialism using decentralized prices in Socialism and Human Action is that you cannot do without capitalists to make investment decisions. That is a different argument.

      See my more recent article for the quote from the 1920s piece and for a rebuttal of the claim that we cannot do without capitalists. https://osf.io/preprints/socarxiv/e6g3h/

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