Socialist Calculation Debate

Israel Kirzner. The Encyclopedia of Libertarianism. Editor: Ronald Hamowy. Sage Publications. 2008.

The socialist calculation debate revolves around the question of whether central planners can, at least in principle, make the economic calculations necessary to achieve the rational, efficient allocation of society’s economic resources. In 1920, Ludwig von Mises argued powerfully that such economic calculation cannot be made; economic theory demonstrates that rational central planning is simply impossible. This situation set off a vigorous interwar debate, in which a number of German, British, and other economists attempted to refute Mises’s argument and in which Mises and others, particularly F. A. Hayek, sought to rebut these attempts. After World War II, mainstream economic literature uncritically assumed that Mises’s thesis had been definitively refuted. However, in the 1980s, Don Lavoie challenged this orthodoxy and, on the basis of insights central to the newly resurgent tradition of Austrian economics, demonstrated how mainstream literature, operating without appreciation of these insights, had failed to grasp the subtlety of the Misesian argument. The following text examines the central elements of the history of this debate in 20th-century economic discussion and briefly explores its relevance for libertarian thought.

In 1920, Mises published an article challenging the possibility of rational central planning. Two years later, he published an influential book-length critical analysis of socialism. In this book, Mises reproduced, in substantially unchanged form, his earlier paper. We can summarize Mises’s argument as follows.

For economic efficiency in any decision to be achieved, it is necessary for the decision maker to calculate the benefits and costs of alternative courses of action. In a market economy, the entrepreneurs are able to make such calculative decisions (and thus to seek efficiency in their operations) by using present and prospective market prices to represent the values of inputs and outputs. But the central planning authority under socialism is, by the very definition of socialism, unable to make calculations based on market prices of inputs—because no market (and therefore no market prices) exists for resource services. Without a market for resource services, no indicators of relative resource values exist. Decision making by would-be central planners, therefore, cannot be made in a manner that systematically aims at efficiency.

Mises’s challenge to the possibility of rational central planning was not the first critique of socialism as an economic system. In 1935, F. A. Hayek edited a volume (including an English translation of Mises’s 1920 paper) in which he republished several earlier pioneering analyses of socialism and, in particular, an important 1902 critique by the Dutch economist N. G. Pierson. But these earlier treatments had hardly been noticed by the economics profession. It was Mises’s paper, published at a time when socialism was seriously contemplated in Austria and elsewhere, that placed the issue—and his provocative challenge—squarely at the center of the professional attention. It set off a series of counterarguments seeking to refute the Misesian thesis. During the 1920s and 1930s, a large literature emerged in which these arguments and counterarguments were debated. This literature was at the outset mainly in German, with an astonishing variety of defenses of the possibility of socialist planning being offered by, among others, Eduard Heimann, Otto Leichter, Klare Tisch, Herbert Zassenhaus, and Carl Landauer. By the 1930s, defenses of socialist economic efficiency were advanced in the main in British economic literature by a number of authors, among them Henry Dickinson, Evan Durbin, Maurice Dobb, Oskar Lange, and Abba Lerner. Among the statements reaffirming the validity of Mises’ thesis and criticizing the various attempted refutations of it were those of Lionel Robbins, Friedrich Hayek, and Mises himself. The literature up until shortly before the outbreak of World War II was extensively surveyed in a 1938 Norwegian-language book by Trygve J. B. Hoff (published in English translation in 1949). With the benefit of hindsight, it is clear that the most influential among the defenses of socialist efficiency was that advanced by the Polish economist Oskar Lange in two articles published in the United Kingdom in 1936 and 1937. Lange’s position is generally bracketed with that of Abba P. Lerner, who published an attack on Mises at about the same time. It was apparently the Lange-Lerner line of argumentation that convinced post-World War II economists that the Mises’s thesis had been definitively refuted.

Lange credited Mises with having clearly formulated the economic problem facing socialism, an important contribution in itself. But his understanding of Mises’s critique of socialism was such as to convince him that Mises was quite wrong in declaring economic calculation to be impossible under socialism. Lange understood Mises as claiming that the achievements of a market economy cannot be duplicated under attempted central planning. But Lange quite incorrectly interpreted Mises as seeing the achievements of a market economy as consisting strictly in attaining an approximation to the pattern of resource allocation that would emerge in a perfectly competitive market economy in Walrasian general equilibrium. A perfectly competitive market economy is one in which many industries each consisting of a large number of relatively small firms find themselves confronting an “equilibrium” market price for their product; these firms are unable to change this price and must therefore treat it as a given. Such an equilibrium price enables each firm to successfully produce and sell the amount it wishes to sell at the equilibrium price. Thus, although these firms have no control over the price at which their good or service sells, they do have complete control over the amount they produce and put forward for sale. The array of such equilibrium prices across the entire market economy constitutes the set of market prices making up “Walrasian general equilibrium.”

Lange understood Mises to argue that, because no money market prices for resource services could exist under socialism, it followed that a “general equilibrium” (for which resource prices would be an important ingredient) in a socialist economy is a logical impossibility. Lange then proceeded to show that, although market prices for resources would indeed not exist under socialism, the more general sense of prices (referring to the “terms on which alternatives are available”) does, of course, still hold for a centrally planned economy. So the logical possibility of a socialist system being in a state of general equilibrium certainly does exist. Moreover, Lange proceeded to devise a system of trial and error through which an actual socialist economy might, in fact, seek to approach a pattern of (non-market) prices that would constitute the state of general equilibrium, and thus be consistent with the same pattern of efficient resource allocation generally associated with Walrasian equilibrium under capitalism.

As we have noted, Lange’s critique of Mises was, during the mid-20th century, uncritically accepted in the mainstream literature. The economic calculation debate appeared to have ended with the successful refutation of the Mises-Hayek position. It is true that not all economists believed Mises to have been refuted. In 1969, James Buchanan offered an interpretation that rendered the Lange-Lerner critique harmless. But this interpretation did not challenge the mainstream perception (from which Lange had proceeded) that Mises had shared the Walrasian understanding of what a market economy consists in. It was the late 20th-century resurgence of Austrian economics that finally revealed the error in Lange’s interpretation of Mises (and thus the error in his practical proposals for socialist central planning). Only then was the social calculation debate resumed in earnest.

In 1985, Don Lavoie published his Rivalry and Central Planning. This book carefully reexamined the entire socialist calculation debate, sharply disagreeing with the mainstream account of this debate (and particularly with its conclusion that the Lange-Lerner position constituted a definitive refutation of Mises’s critique of the possibility of socialist planning). The mainstream literature (including Lange and Lerner) had not grasped the Austrian understanding of how the dynamic rivalry of competing entrepreneurs (totally absent in perfectly competitive equilibrium) drives the beneficial coordinating market process of capitalism.

From the perspective of the Austrian competitive market process, the logical possibility of an array of nonmarket but equilibrium prices, under socialism, is almost completely irrelevant to the central issue. The central issue is how, under socialism, resource values can be revealed for the planners to engage in economic calculation. Under capitalism it is the rivalrous, entrepreneurial activity of market participants that generates such values (in the form of [non-equilibrium] market prices). Such rivalrous entrepreneurial activity is, by definition in a socialist system, ruled out in a centrally planned economy. The consequent impossibility of centralized economic calculation means that central planners necessarily lack the knowledge needed for the efficient allocation of resources.

There occurred a gradual erosion of the earlier mainstream unanimity in regard to the possibility of socialist calculation in the economic literature of the closing decades of the 20th century. With the award of the Nobel Prize in economics to Hayek in 1974, interest renewed in the earlier Austrian critique regarding rational calculation under socialism. Economists had, by the end of the century, again become aware of the problems and complications introduced by human ignorance. The downfall of socialist regimes in eastern Europe generated new doubts (even among socialists) concerning the possibility of efficient socialist planning. The debates concerning socialist economics became more unorthodox, more intellectually open. Some of the literature of the debate within socialism is discussed in the 1993 book Market Socialism: The Current Debate, edited by P. K. Bardhan and J. E. Roemer. A late 20th-century survey of the calculation debate from an Austrian perspective appears in a 1998 paper by Peter Boettke. The socialist calculation debate lives on. Let us turn to the relevance of this debate for libertarian thought. Two strands of relevance can be identified.

The first area of relevance is straightforward. Clearly the case for classically liberal political arrangements rests, at least in part, on the circumstance that economics demonstrates, as libertarians claim, that such political arrangements tend to generate relative prosperity. Were it shown that a centrally planned economy could be relied on to produce a similar or better economic outcome, the case for a libertarian society would be correspondingly weakened. Indeed Mises’s critics in fact claimed that a socialist economy can be more efficient than a capitalist system. Precisely because it is centrally planned, the socialist economy can, the critics held, aim at an efficiency that the “anarchy of production” under capitalism cannot, in its haphazardness, be expected to achieve. Rational socialist planning, they argued, is not only possible, but can accomplish targeted social objectives (deliberately planned rates of growth, economic equality, full employment stability, etc.) absent under capitalism, thus providing its critics with rhetorical ammunition. The provocative aspect of Mises’s challenge consisted largely in that he had not merely questioned the supposed superiority of socialist planning; he had gone further and asserted that no rational planning, no systematic pursuit of efficiency, was possible under socialism at all.

Where libertarianism confronts not the central planning of complete socialism, but (as so often is the case in our modern experience) the interventionist policies of proactive governments of “mixed” economies, the socialist calculation debate has quite similar relevance for libertarian concerns. The truth is, as I have argued in “The Perils of Regulation: A Market-Process Approach,” the same Misesian insights that demonstrate the overwhelming calculational problems challenging complete socialism also demonstrate the hazards of piecemeal planning or interventionism. Once we understand the discovery procedure of which the market process consists, it becomes clear that interventionist policies, so far from being precise measures aimed at specific social problems, are likely to stifle or inhibit the desirable discovery process that the free market would, in the absence of these measures, have tended to generate. Imposed price ceilings, price floors, impeded industrial mergers, and imposed safety measures that are not justified by consumer demand tend not merely to constrain market activity away from perceived opportunities, but, more important, to obscure possibly profitable entrepreneurial opportunities that may now remain forever undiscovered. The libertarian case against such interventions is substantially strengthened by the Austrian understanding of the capitalist entrepreneurial discovery process that underlies the Mises-Hayek side of the calculation debate. We are now ready for the second, less direct strand of relevance for libertarian thought.

This aspect draws attention to the essential nature of individual freedom in the free-market system advocated by libertarians. A narrow conception of individual freedom sees each individual, in a free market, as at liberty to choose between perceived alternatives. The economic analysis of a market system defined in terms of this narrow conception of freedom allows no place to the entrepreneurial role. To find a place for this role, it is necessary to broaden one’s concept of individual freedom. In its broader conception, individual freedom includes not only the capacity to choose between already perceived alternatives but also the creative freedom of identifying, in the face of the initial absolute ignorance of what alternatives are in fact available, the arrays of alternatives from among which one may choose. Once one has broadened one’s conception of freedom to include this creative, entrepreneurial dimension, one has attained a perspective from which one can recognize the free-market process as one of active, dynamic, entrepreneurial competition. The active rivalry of entrepreneurs is then seen as the source for the basic ability of the market to generate market prices for consumer goods and for resource services on the basis of which economic calculation by market participants may proceed.

The socialist calculation debate is highly relevant to these insights concerning the entrepreneurial dimension of individual freedom in the operation of the free-market economy. As previously noted, what permitted Oskar Lange to believe that he had solved the problem posed for socialism by Mises was his narrow (neoclassical) understanding of the scope of the economic analysis of the market economy. That analysis had, in effect, no room whatsoever for the dynamic, innovative activity of market entrepreneurs.

It was the socialist calculation debate that forced the economics profession to recognize the active, entrepreneurial element in individual liberty and the crucial role that this element must play in our understanding of how a society structured on libertarian principles will operate.