Economic Calculation Revisited

Now that outright socialism has failed, the quest for a third way has gained prominence. Political leaders insist that a free society is inherently unjust and the privileged prosper at the expense of the unfortunate many. Thus the state must correct the failures of the market.

The critics of the modern version of Western “capitalist” (properly called “mercantilist”) societies are right on the issue of privilege, but they are wrong when they identify it with the free society, for in a truly free society privileges would be absent. It is precisely the injustice of state-granted privileges, such as corporate welfare, that gives the “capitalist” system its bad name. That deserves to be cleared up. But it is just as important to understand why the seemingly plausible intervention of governments in the quest for a third way is not the solution for the wrongs perceived. The case against that intervention is the same as the one that was brought to bear against socialism at the peak of its popularity.

In the 1920s a debate on “the problem of economic calculation” took place in Europe. The essence of the controversy was the thesis that without private property in the means of production, and its concomitant exercise of free exchange, no meaningful price structure could evolve to permit the economic allocation of resources. “Economic allocation” means that the products are of more value than the effort and the resources spent in production; it also means that these products are the best of the possible alternatives. Thus human cooperation and use of resources would enrich society. If the allocation was not “economic,” for lack of a way (relative prices) to determine what continual adjustments must be made in the use of resources as conditions changed, society would impoverish itself and eventually collapse.

Socialist countries could indeed manage to survive by using the price structure of capitalist countries and copying (and sometimes improving) the scientific inventions and methods of production of the West. With a little bit of economic assistance, they could postpone the day of reckoning. Indeed, the United States provided aid to the Soviets in the 1920s, ’30s, ’40s, and so on until the ’80s, in addition to large amounts of resources to prop up their satellites and semi-socialist countries in Africa and Latin America.

Debunkers Shunned

Since the argument regarding economic calculation was a logical and systematically articulated prediction of the failure of the socialist experiment in vogue at the time, its proponents became unpopular in academic circles. Initially, the problem of socialism was expounded by Austrian economist Ludwig von Mises. He sparked a lively debate, which F. A. Hayek (who won a Nobel prize in 1974) later joined to refute the outstanding socialist theoreticians Oskar Lange and Fred Taylor. Independently, T. J. B. Hoff in Norway argued the same point. Others, including the distinguished mathematician Leonid Kantorovich, also addressed the problem, to no avail. The debate was interrupted by World War II and many consider it now only a theoretical relic.

That the “the problem of economic calculation” critique is not exclusive to socialism is a point that has been largely missed. It is perhaps the most rigorous analysis of why an economy becomes inefficient and ultimately cannot function to the degree society departs from the legal system of private property and contracts; that is, to the degree government attempts to plan the economy. The discussion is pertinent not only to full socialism, but also to the mixed economies of today.

In the meantime it is sad to see the media full of news regarding economic crises all over the world. The economic woes of Russia, Asia, and Latin America are ever present. Most amazing was that almost everyone was surprised by the sudden demise of the Soviet socialist empire a decade ago. Immediately, the Eastern bloc countries swarmed with university professors and economic advisers from the World Bank, IMF, and agencies, all competing for opportunities to dispense wisdom, along with bundles of money from the U.S. taxpayers. Unfortunately only a handful of those advisers sought market solutions based on the sanctity of property and contracts, and the rule of law. True, most of them suggested privatization but with the same stifling economic regulations that pervade the “capitalist” countries, supposedly to correct the market’s failures.

The analysis of the calculation problem is still pertinent, for it helps us to understand why crises recur all over the world, why the transition from socialism to capitalism without the rule of law has not been and cannot be successful, why Japan fails in its never-ending attempts to manage its economy, and why government economic intervention (planning) is bound to produce unintended and undesirable consequences.