In this video, we look at the “Economic Calculation Problem of Socialism”, as put forward by Ludwig von Mises. Moreover, exploring the inability of central planners to find a basis other than prices to make economic calculations. This is the crux of why socialism always fails, and results in leaching of neighbouring capitalist economies.
Marxism is a sociological analysis of Class Struggle and its relationship to Capitalism, premised on the political theory of Karl Marx and associate Frederick Engles. According to Marxism, Capitalism is a system in which the working class own only their capacity to work, in that they lack control over their labor or their produce. Moreover, it is the Capitalist that dictates the distribution of labor, controls their produce and reaps the value created by their workers in a gross act of exploitation. Subsequently according to Marxists, through the misery and weariness of the working class, such exploitation warrants Socialism. Socialism being defined as the collective ownership of the means of production, and in the Marxist case, this means the abolition of private property, wage labour, currency, inheritance rights, social and economic class and subsequently the achievement of Communism. Now in the past, we have talked about the theory and ethics of Marxism, but even if we assume that it is correct when it speaks of exploitation and class theory. Does it work in practice? Can people effectively and efficiently allocate resources in a Marxist Communist society? Well according to economist Ludwig Von Mises and those that built upon his work such as Frederick Hayek, absolutely not.
Mises, in a pamphlet entitled Economic Calculation in the Socialist Commonwealth published in 1920, asks the question of how would a perfectly centrally planned economy absent of any of the facets of markets, distribute resources? As in a market, firms and producers seek to maximise profit, and supplying consumers with what they want is how they do it, thus there is a system of resource distribution. It may be exclusive, and you may even think it is highly flawed. But we can see through our day to day interactions in a semi-market based system, that it can distribute goods and services to people who are willing to pay for them. However, in a true socialist economy, without prices or profits, how will people distribute goods? Well Mises lays out various ways in which this could happen, and systematically explains how each one would result in demands for consumer goods not being met, and that central planners cannot replicate, let alone improve upon, how goods and services are distributed in a market system. Now if this sounds confusing, it will make more sense in the form of a thought experiment.
In Economic Calculation in the Socialist Commonwealth, Mises writes of a situation involving the construction of rail roads in a priceless, perfectly socialist economy. He asks the reader to imagine the construction of a new railroad, and imagine that you are a central planner in a soviet economy. And one of the other fellow planners reports to you with the most basic of questions regarding the building of a railway, that being how many rails should we build? What number of lines should be constructed? Should you build one, two, ten, a hundred? Because If you build too many, then the resources and building materials go to waste, as they could have been used on other things, while if you build too few, than resources are also going to waste, as they were spent on transporting goods and services which would have been avoided if there was a more efficient railway system. So how can we get the right number of railroads? Well In a market system, the answer is simple. Keep building railway lines as long as the returns of constructing one more railway is greater than the costs of doing so. And if the new reduced costs of transporting goods along the railroad is higher than the costs of constructing the railway, we can know building the railway is an efficient allocation of resources, and this can be repeated until the railroad is more costly than its returns are profitable.
This is all because we can calculate how many railways should be built by looking at the price, as under a market system, price is the basis for economic calculation. Because through using money, We can numerically express the value of iron, coal, building materials, hours of labour and all the resources involved in construction. We can give these things dollar values, that reflect the intersection of how many people are willing to supply them and how many people are willing to pay for them, in other words the costs can be numerically known through prices. Mises wrote in his 1920s pamphlet:
“Picture the building of a new railroad. Should it be built at all, and if so, which out of a number of conceivable roads should be built? In a competitive and monetary economy, this question would be answered by monetary calculation. The new road will render less expensive the transport of some goods, and it may be possible to calculate whether this reduction of expense transcends that involved in the building and upkeep of the next line. That can only be calculated in money. It is not possible to attain the desired end merely by counterbalancing the various physical expenses and physical savings. Where one cannot express hours of labor, iron, coal, all kinds of building material, machines and other things necessary for the construction and upkeep of the railroad in a common unit it is not possible to make calculations at all. The drawing up of bills on an economic basis is only possible where all the goods concerned can be referred back to money. Admittedly, monetary calculation has its inconveniences and serious defects, but we have certainly nothing better to put in its place, and for the practical purposes of life monetary calculation as it exists under a sound monetary system always suffices. Were we to dispense with it, any economic system of calculation would become absolutely impossible.”
However under socialism, there are no prices. How can one know how many railroads to build? If price is not the basis for economic calculation, what is? Many might posit that they could survey people and directly poll the population on what they want constructed, they could use surveys to see who needs railways or whatever needs to be produced. But think about the millions of people who would need to be polled, not only would millions of consumers need to be surveyed, but the thousands of people involved in constructing and producing these goods and services also. Just regarding the railroad, the producers would need to be surveyed on how many engineers they would need. Then the engineers would need to be surveyed on what supplies they would need for their construction blue prints, while the people who supply the building materials such as steel and concrete would need to be surveyed on how much they ingredients they need, while the truck drivers and people who deliver the resources would need to be asked how many trucks they would need to deliver them, even the people who supply trucks for the deliverers would have to be surveyed on how many trucks they need to create, and then same with the producers who supply the building materials for trucks. And this seemingly infinite list of surveying would need to occur in all facets of production, for every clothing producer, for every paint factory, for every restaurant. Whenever anything is needed to be produced. And obviously this would be difficult for a small commune, but how does anyone expect it to work in a densely populated urbanised society? Yet with prices, all of these decisions happen with ease every day through individuals buying and selling wanting to keep their marginal revenues higher than their marginal costs. And this inability to make economic calculations under socialism is true not just for railroads, but for all production. Whether it be agriculture, mining or other industries. And this has been observed in all efforts to achieve a communist society.
For instance, in Cuba during the late 1960s, their central planners made the stunning observation that they were using more factors of production, like mills, workers and the rest, then they were actually producing. Most notably, Che Guevera admitted this, claiming that the planners had no basis to make economic decisions, lacking the economic information that is given in a market system through prices. So moreover, Cuba made most of its economic decision through reflecting on the decisions of its neighbouring capitalist nations. In 2002, Cuba closed 71 sugar mills after realising all the resources they had wasted, only because they could rely on the world market prices to give them an idea of efficient resource allocation. In addition, the USSR displayed a very similar incompetency. Famous polish economist Oskar Lange during the 1950s in trying to plan the Polish Soviet, reported that Poland’s Central Planners had rejected traditional socialism in planning their economy, claiming that they leached off the price systems used in neighbouring capitalist economies. That is, they just referenced world prices to plan their economies. Now, The Soviet Union, as with any long running socialist regime, would have collapsed far earlier, if the black market hadn’t grown exponentially to meet the demands of firms and consumers. As quotas couldn’t be met as resources couldn’t be efficiently distributed. When economist Peter Wiles visited Poland to assist in the planning of the economy, he asked the Marxists in the administration, what will they do when all of the world is socialist and there are no neighbouring capitalistic price systems to replicate? And they responded “well cross that bridge when we come to it”.
And it for this reason, that shortages plague all socialist economies, as goods and services can’t be allocated to where they are needed most. This is why Nazi Germany had shoe shortages, Soviet Russia built their houses without roofs and millions of people went starving. And so it would seem Capitalism does play a role in production that can’t be played by the workers alone. But it doesn’t matter, because Marxism is an ideology built on idealism rather than engineering principles, it assumes resources are infinite and that historical surpluses have nothing to do with the economic principles underlying them. And so, I would like to conclude with a quote from Ludwig von Mises.
“Economics, as such, figures all too sparsely in the glamorous pictures painted by the Utopians. They invariably explain how, in the cloud-cuckoo lands of their fancy, roast pigeons will in some way fly into the mouths of the comrades, but they omit to show how this miracle is to take place. Where they do in fact commence to be more explicit in the domain of economics, they soon find themselves at a loss…” -Ludwig von Mises
Thanks for watching.