Economic Calculation in the Socialist Commonwealth

Ludwig von Mises’s seminal refutation of socialist economics, republished here, was written seventy years ago, but it is a description of the “real socialism” of today—or rather yesterday. Mises’s thesis is that in a socialist economy rational economic calculation is impossible; its attempts to allocate resources efficiently in the absence of private ownership of the means of production must fail. The East Bloc’s disastrous experience with socialism has shown the world that Mises was correct all along.

In this article, Mises writes of full-blown socialism, where the state is the sole owner of the means of production. Although made so long ago, his description reflects very well the economic realities of the Soviet Union since the late twenties, and of Central and Eastern Europe since the late forties until, practically, today.

In the socialist economy that Mises described, consumption goods are freely demanded and exchanged by individuals of different tastes. Money can exist, but only within the limited sphere of the market for consumer goods. In the sphere of production, however, there is no private ownership of the means of production. They are not exchanged, and as a consequence, it is impossible to establish prices that reflect actual conditions. If there are no prices, there is no method of finding the most effective combination of the factors of production.

Mises’s pathbreaking article led to a famous debate on socialist calculation. Polish economist Oskar Lange contested Mises’s position and tried to show that socialism can work by a “trial and error” method.1  In the Lange model, the economy has a free market for consumption goods. The production sphere is organized into enterprises and branches, and there is a Central Planning Board. The bosses of enterprises are required to establish production plans in exactly the same way the private entrepreneurs would do--in a way that minimizes costs and makes marginal cost equal to price. The Central Planning Board determines the rate of investment, the volume and structure of public goods, and the prices of all inputs. The rate of investment is established by equating the demand and supply of capital goods. The Board raises the prices when the demand is not satisfied and lowers them when supply is too large.

Presuming for a moment that this would work, the question arises: why is this method better than the real market? For Lange, there were two advantages. First, income can be more equally distributed. Since there is no capital income, people are paid according to their input labor. (Some talented people receive additional income which is a sort of “rent” on their particular skills.) Second, socialism allows for better planning of long-term investment. Investment will not be directed by short-term fluctuation of opinions about future opportunities, and thus it would be less wasteful and more rational. Similar to John Maynard Keynes and, later, Paul Samuelson, Lange thought that although the free market may give proper signals concerning short-term production decisions, it does not give long-term signals concerning investment.

Lange used neoclassical, not Marxist terminology. Although he was a socialist by conviction, he was fascinated by the intellectual side of marginalist economics and by the possibility of showing with this apparatus that Mises was wrong. Lange thought that, theoretically, the possibility of calculation without an actual market was shown by the Italian economist Enrico Barone in 1908. 2  Barone referred to a system of general equilibrium saying that if the sets of equations could be solved, the partial equilibria of producers and consumers could be established ex ante. Barone’s point was, however, that such a possibility is practically impossible, so (similar to Mises) he supported the view that socialism cannot work efficiently. Lange’s aim was to show that both Mises and Barone were wrong (but Mises to a larger degree) and that theoretically and practically, calculation was possible.

Lange thought he had finally solved the problems of socialist calculation that Mises had demonstrated in his essay “Economic Calculation in the Socialist Commonwealth.” And to this point Lange wrote in his article “On the Economic Theory of Socialism”:

Socialists have certainly good reason to be grateful to Professor Mises, the great advocatus diabol of their cause. For it was his powerful challenge that forced the socialists to recognize the importance of an adequate system of economic accounting to guide the allocation of resources in a socialist economy. Even more, it was chiefly due to Professor Mises’ challenge that many socialists became aware of the very existence of such a problem.... [T]he merit of having caused the socialists to approach this problem systematically belongs entirely to Professor Mises.

Thus Lange suggested the following:

Both as an expression of recognition for the great service rendered by him and as a memento of the prime importance of sound economic accounting, a statue of Professor Mises ought to occupy an honorable place in the great hall of the Ministry of Socialization or of the Central Planning Board of the socialist state.

Lange’s theoretical views, as well as his conviction of the practical applicability of a “shadow market” in the socialist economy, were, in turn, questioned by Friedrich A. Hayek. 3  Hayek thought that Lange had committed many errors. In Lange’s version of socialism, an army of controllers would be needed to verify the calculations of the heads of enterprises. But what would motivate the heads of enterprises and branches? Would they be prevented from cheating. Moreover, the results of these calculations would have to be compared with additional, counter-factual calculations in order to see whether the bosses of enterprises have chosen the best combination of factors of production possible. All this would call for an enormous bureaucratic state.

The practical side of socialism took its own course. A communist economy as we know it was constructed in the Soviet Union in the late twenties and early thirties and then transplanted to Central and Eastern Europe after World War II. For a time it seemed to have worked well, at least from the point of view of the ruling bureaucracies, who did not hesitate to use totalitarian measures and mass terror.

There was no place for private ownership, nor for the market. The only method of coordinating economic activity was government command and bureaucratic allocation. The result was a prolonged crisis, marked by a stagnation or decrease of production, by inflation, ecological disaster (because of wasteful use of all types of resources—energy, water, forests, etc.), by falling standards of living, and by widespread public frustration and social pathology. This crisis, coupled with political developments including the rise of an organized opposition, brought about the revolutionary changes we witnessed in 1989.

In Eastern European countries, and in Poland in particular, there is now a strong desire to reintroduce private property and the free market.

When it has been accomplished, perhaps Lange’s suggestion should be taken up: a statue of Mises should be erected in Poland—in tribute to his final intellectual triumph. For his vision of a free society provides firm intellectual grounding for the emergence of a free and prosperous Poland.

Jacek Kochanowicz

Professor of Economics

University of Warsaw, Poland

April 1990

• 1Oskar Lange, “On the Economic Theory of Socialism,” Review of Economic Studies (1936-37).
• 2Enrico Barone, “Ii zninisterio della produzione nello stato collettivista,” Giornale degli Economisti e Revista di Statistica, vol 37 (1908).
• 3Friedrich A. Hayek, “Socialist Calculation: the Competitive ‘Solution’,” Economica, ns., vol. vii, no. 26 (1940).