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 and further expounded by his student Friedrich Hayek.^[1] According to this criticism, without information provided by market prices it is impossible to rationally allocate resources. Those who agree with this criticism claim it is a refutation of socialism and that it shows that a socialist planned economy could never work. The debate raged in the 1920s and 1930s, and that specific period of the debate has come to be known by Economic Historians as the The Socialist Calculation Debate.^[2]

Contents 1 Mises' formulation 1.1 Example 2 Computational complexity 3 Dispersed knowledge 4 Implementation of central planning decisions 5 Capitalism not efficient 6 References 7 See also 8 External links

[edit] Mises' formulation

Ludwig von Mises argued in a famous 1920 article "Economic Calculation in the Socialist Commonwealth" that the pricing systems in socialist economies were necessarily deficient because if government owned the means of production, then no prices could be obtained for capital goods as they were merely internal transfers of goods in a Socialist system and not "objects of exchange" (unlike final goods) - thus they were unpriced and hence the system would be necessarily inefficient since the central planners would not know how allocate the available resources efficiently.^[3] This lead him to declare "...that rational economic activity is impossible in a socialist commonwealth."^[1]

[edit] Example

Mises gave the example of chosing between producing wine or oil:

It will be evident, even in the socialist society, that 1,000 hectolitres of wine are better than 800, and it is not difficult to decide whether it desires 1,000 hectolitres of wine rather than 500 of oil. There is no need for any system of calculation to establish this fact: the deciding element is the will of the economic subjects involved. But once this decision has been taken, the real task of rational economic direction only commences, i.e. economically, to place the means at the service of the end. That can only be done with some kind of economic calculation. The human mind cannot orientate itself properly among the bewildering mass of intermediate products and potentialities of production without such aid. It would simply stand perplexed before the problems of management and location.^[1]

Such intermediate products would include land, warehouse storage, bottles, barrels, oil, transport, etc. Not only would these things have to be assembled, but they would have to compete with the attainment of other economic goals. Without pricing for capital goods, essentially, Mises is arguing, it is impossible to know what the rational/most efficient use of those goods is.

[edit] Computational complexity

Opponents argued that in principle an economy can be seen as a set of equations. Thus, there should be no need for prices. Using information about available resources and the preferences of people, it should be possible to calculate an optimal solution for resource allocation. Friedrich von Hayek responded that the system of equations required too much information that would not be easily available and the ensuing calculations would be too difficult.^[3] He contended that the only rational solution is to utilize all the dispersed knowledge in the market place through the use of price signals. ^[4]

The early debates were made before the much greater calculating powers of modern computers become availabe but also before research on chaos theory. It may be impossible to make long-term predictions for a highly complex system such an economy.^[5]

Advocates of Market socialism, such as Oskar Lange, argue that prices can been seen merely an accounting practice. In principle, also socialist managers of state enterprises can use a price system, as an accounting system, in order to minimize costs and convey information to other managers.^[6]

One criticism has been that proponents of the problem overstate the strength of their case, in describing socialism as impossible, rather than inefficient.^[7] Some have gone on to suggest that with detailed use of real unit accounting and demand surveys a planned economy could operate without a capital market, in a situation of abundance.^[8]

[edit] Dispersed knowledge

However, Hayek's argumentation is not only regarding computational complexity for the central planners. He further argues that much of the information individuals have cannot be collected or used by others. First, individuals may have no or little incentive to share their information with central or even local planners. Second, the individual may not be aware that he has valuable information, and when he becomes aware, it is only useful for a limited time, too short for it to be communicated to the central or local planners. Third, the information may be useless to other individuals who do not have the necessary knowledge to interpret it. Therefore, Hayek argues, individuals must be allowed to act themselves using their own information.^[9]

[edit] Implementation of central planning decisions

Hayek also, in his book The Road to Serfdom, argues that the central administrative resource allocation, which often must take away resources and power from subordinate leader and groups, necessarily requires and therefore selects ruthless leaders and the continued strong threat of coercion and punishment in order for the plans to be somewhat effectively implemented. This, in combination of the failures of the central planning, necessarily leads socialism down the road to an oppressive dictatorship.

[edit] Capitalism not efficient

Another counter-argument is that arguing that a free market is not efficent at resource allocation. Alec Nove argues that von Mises "tends to spoil his case by the implicit assumption that capitalism and optimum resource allocation go together", and Joan Robinson further avers that "private property in the means of production, combined with rights of inheritance produces a totally irrational distribution of purchasing power within society which completely undermines the whole conception" that markets rationally allocate resources. She further claims many prices in modern capitalism are effectively "administered prices" created by "quasi monopolies", thus challenging the connection between capital markets and rational resource allocation.^[10]

[edit] References

[edit] See also

• Enrico Barone
• Ludwig von Mises
• Friedrich Hayek
• Otto Neurath
• Austrian School
• Socialism
• Post scarcity

[edit] External links

• The Socialist Calculation Debate and the Austrian Critique of Central Economic Planning
• The Impossibility of Economic Calculation Under Socialism by Ludwig von Mises
• The Use of Knowledge in Society by Friedrich Hayek
• Oskar Lange and the Impossibility of Economic Calculation by D.W. MacKenzie
• Socialism: Still Impossible After All These Years by Peter J. Boettke and Peter T. Leeson
• The “Economic Calculation” controversy: unravelling of a myth by Robin Cox
• Must Economies Be Rational? by David Gordon
• The economics of information, market socialism and Hayek's legacy
• Information and Economics: A Critique of Hayek by Allin F. Cottrell and W. Paul Cockshott
• Review Essay to Towards a New Socialism? by Allin F. Cottrell and W. Paul Cockshott by Len Brewster
• Real Socialism Wouldn't Work Either
• Calculation, Complexity and Planning: The Socialist Calculation Debate Once Again
• The End of Socialism and the Calculation Debate Revisited by Murray Rothbard
• Socialism: A Property or Knowledge Problem? by Hans-Hermann Hoppe