The ECP (Economic Calculation Problem) is a critique of central planning and why they are inherently doomed to fail. The ECP was put forth by Ludwig von Mises. In it he argues that economic calculation cannot occur in centrally-planned systems due to the lack of a market prices in producer goods. Understanding the ECP is crucial for knowing why planned economies fail while unobstructed market economies succeed.
In a free market system, prices form organically as a result of the supply and demand of any particular good or service. The prices charged for these goods reflect certain key conditions that are important for a functioning economy. The minimum amount that goods sell for in a free market is, however, as much the seller is willing to trade it for. In most cases, this will not be below the cost of producing the good, as no business wishes to deliberately lose money. Meanwhile, the maximum amount that a good could be sold for on the free market is how much a customer is willing to pay for it. Firms cannot charge as they please for their products as they must provide enough value for the customer’s money for the customer to make a purchase.
In centrally-planned economies, prices do not form organically as a result of supply and demand but are dictated by the state. As a result, prices do not reflect the willingness of firms to produce or the willingness of consumers to purchase. The state may attempt it’s best to emulate how prices form in free markets, but it will lack the ability to actually do so since it does not allow actual markets. Centrally-planned economies are also usually politically-motivated and may attempt to make certain goods and services more affordable or accessible at the cost of extreme distortions elsewhere. Inevitably, they destabilize as a result of not having price signals direct the structure of the economy.
Due to the obfuscation of prices in a planned economy, individuals and firms do not have access to information they would have gained from prices otherwise. When a product has high prices, firms will produce more of the same product as they receive information that current supply does not adequately fulfill demand. Conversely, firms will produce less if they see that the price of their product is going down as it reflects a greater amount of supply than demand on the market. The same cannot occur in planned economies, or at least not instantaneously. A planning board may always revise production plans and decreed prices but they will not be exempt from the inherent inefficiencies of not having true prices in the economy.
A private company has a significantly easier pathway toward determining the viability of a venture than a central planning board, despite not having state monopoly power. A private company planning a project needs only to estimate the costs of the project and judge if the value they provide consumers will result in revenue great enough to make the project profitable. A central planning board—that does not have access to prices and cannot estimate costs—starts off in a significantly worse position. The board has no method of seeing if the resources they must commit to the project could be better used elsewhere. By contrast, a private company could realize the unviability of the project if they saw that the costs were greater than the potential revenues.
Ascribing arbitrary production and price values could never replace the actual market process yet has been tried many times throughout human history. Even worse, many still wish to try out central planning now despite even more empirical evidence to the contrary than when Mises initially proposed the ECP. “Socialism works in theory but not in practice” is an often said phrase but one with not much truth behind it. Central planning does not work in theory either, and it should be no surprise that it fails when implemented.
