Economic calculation is not possible in a socialist world

In the 1920’s the Austrian School economist Ludwig von Mises first pointed out that in a socialist system economic calculation is not possible. Mises was later to be proved correct when the economies of the Soviet Union collapsed and socialist countries were compelled to abandon their policies and transform their economies to give consumers and entrepreneurs a greater say, through prices, in the production of goods and services.

As Mises explained, ‘the ultimate source of the determination of prices is the value judgements of the consumers’, which means that in a totally socialist world there would be no prices to guide socialist production planners. In government-monopoly spheres of activity, politicians and government officials dictate to consumers, imposing on them their own preferences guided by the severely limited knowledge available to them under such circumstances. The vital role of entrepreneurs in serving and informing consumers, and discovering, interpreting and influencing their value judgements, is entirely absent.

In his book The Russians, Hedrick Smith, 1970’s Moscow representative of the New York Times reported that: ‘In spite of the various tinkering reforms, the Soviet economy still operates by Plan from above rather than in response to consumer demand from below and this produces a lop-sided assortment of goods. Sometimes the anomalies are baffling. Leningrad can be overstocked with cross-country skis and yet go several months without soap for washing dishes’.

In 1971 Leonid Breshnev announced that ‘Our plan is to make the life of the Soviet people still better, still more beautiful, and still more happy’. Despite the promises, according to Smith, ‘… the Soviet woman spends two hours in line, seven days a week, daily going through double the gauntlet that the American housewife undergoes at her supermarket, once maybe twice a week’.

In 1940, Professor von Mises once again criticised the refusal of socialist planners to recognise that their methods were doomed to failure because they refused to allow consumers to determine prices. In his book Human Action he said: ‘For more than a hundred years the substitution of socialist planning for private enterprise has been the main political issue. Thousands and thousands of books have been published for and against the communist plans. No other subject has been more eagerly discussed in private circles, in the press, in public gatherings, in the meetings of learned societies, in election campaigns, and in parliaments. Wars have been fought and rivers of blood have been shed for the cause of socialism. Yet in all these years the essential question has not been raised.’

The essential question that was not raised was the impossibility of economic planning in circumstances where consumers do not freely determine prices. The consequence of this economic truth has further repercussions in that planning to meet consumer demand can be carried out efficiently only by entrepreneurs competing in an unhampered economic environment. Such planning, conducted by millions of competing entrepreneurs seeking to improve their own condition by supplying the wants of others, has a much greater probability of efficiently fulfilling those wants than have the central planning attempts of a single authority such as a government or its agency.

The difference between non-socialist and socialist economic environments lies in the nature and validity of the information upon which they base their economic calculations. Entrepreneurs operating in a free economic environment have the benefit of prices that reflect the wishes of consumers. Such prices guide suppliers towards meeting the consumers’ wishes. Government planners in an unfree economic environment, on the other hand, receive no meaningful information from consumers and have no option but to make autocratic decisions based on their own subjective judgements as to what they believe consumers should want.

While there is a remarkable regularity in price information, which allows entrepreneurs to make long-term plans to profit from meeting consumer demands, there is never certainty. Reducing this to our own everyday activities we will recognise that while our purchasing habits have a certain regularity, we are constantly making changes, most often when we find what we consider to be cheaper or better alternatives. Lurking somewhere behind the scenes there are entrepreneurs who spend their lives trying to bring about changes in our purchasing habits, trying to persuade us to buy their products in preference to our old favourites.

Entrepreneurs, in turn, live in a turbulent world of ‘fickle consumers’ whose hierarchies of values and preferences are relatively stable but constantly changing. However, this state of affairs exists only in fully functioning markets in which the value judgements of consumers are the determinants of prices. In such circumstances profit-seeking entrepreneurs find possibilities to enrich themselves but also face losses if they misinterpret the market signals that prices are sending out. It is in price anomalies, in finding new uses for existing resources, and finding new and more efficient methods to satisfy the wants of consumers that the greatest potential for entrepreneurial profit lies.

Whatever difficulties entrepreneurs and consumers may face in non-socialist economies they are as nothing compared to the utter chaos and misery faced by people living in socialist economies in which consumer preferences have little or no influence on prices and consequently on the production of goods and services. Governments of countries that disregard the fundamental wishes of their consumers, simultaneously condemn their citizens-as-consumers to a poor quality of life.

Author: Eustace Davie is a Director of the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Free Market Foundation.

FMF Feature Article\ 15 March 2005 - Policy Bulletin / 30 June 2009