Economic Calculation Under Socialism

[George H. Smith]

The following is excerpted from a lecture I gave around 15 years ago. I am posting it in connection with an exchange that is currently underway on the "Kinsella and Thin Air" thread. It is too long to include in that thread, so I am posting it separately. It has been years since I have looked at this piece, and I have made no effort to correct typos and other incidental errors.

The Problem of Economic Calculation Under Socialism

George H. Smith

Ludwig von Mises is best known for his early critique of socialism, which convinced many economists, including a young socialist named Friedrich Hayek, that rational economic calculation is impossible in a socialist system, and that economic coordination can best be achieved in an unregulated market, where prices transmit crucial information about the supply and demand of capital goods.

Mises drew on the economic theory of value to argue that socialism could not solve what he called the problem of “economic calculation.” Thus, before presenting the Misesian argument, I will first present some background information on the theory of value.

Central to all economic analysis is the concept of value. In classical economics – whose major exponents were Adam Smith, David Ricardo, and John Stuart Mill – two kinds of value were often distinguished: namely, value in use and value in exchange. Use-value refers to the usefulness, or utility, of a given commodity, such as water -- which, because it is essential to human life, was said to have a high use-value. Exchange-value, in contrast, refers to what a given commodity can fetch in the market, when it is exchanged for something else. For example, diamonds were said to have a high exchange-value, because they will command a good deal in return.

This dichotomy of use-value and exchange-value generated a serious problem for the classical economists, who were perplexed by the relationship between the two kinds of value. This problem is illustrated in what economists call the “water-diamond paradox,” which was expressed by Adam Smith as follows:

The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water; but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.

Smith understood that the resolution of this paradox lies in the notion of relative scarcity. He points out, for example, that someone stranded in the desert, where water is scarce, will value water more highly than he would in normal circumstances, where water is plentiful. Thus it is the scarcity of water relative to its demand in a particular situation that will determine the exchange value of water. Despite this insight, however, the classical economists were unable to formulate a unified theory of value that would adequately explain the water-diamond paradox and similar problems.

A satisfactory theory of value did not emerge until the 1870s, when there occurred what is known as the “marginal-utility revolution” in economic thought. This important innovation was arrived at independently by three men: William Stanley Jevons in England, Leon Walras in Switzerland, and Carl Menger in Austria. Although these men differed somewhat in their treatments of marginal utility, their central insights were essentially the same.

As these economists pointed out, when we choose one commodity over another, we do not consider the general usefulness of that commodity. We do not, for example, consider the general utility of water -– its role in supporting human life -– when deciding how much we are willing to exchange for a specific amount of water. True, if we had to choose between all the water in the world and all the diamonds, then we would clearly choose water over diamonds, but rarely are we faced with this all-or-nothing situation. Instead, we confront commodities as they exist in specific quantities, or units, and the value we place on a commodity depends on what we plan to use it for.

Suppose we are deciding whether or not to purchase a gallon of water. Our decision will be based, not on the general usefulness of water, but on the contribution that the additional gallon of water will make in satisfying our wants. And this, of course, depends on how much water we already have. The man in a desert, who is dying of thirst, will value a gallon of water more highly than he would in normal circumstances, because he will use that gallon to sustain his life -– rather than using it, say, to wash his car, which is what he might do if water were more plentiful. .

That we normally value diamonds more than water is not because of some paradox or conflict between use-value and exchange-value. Economic value ultimately depends, not on the general usefulness of a commodity, but on the specific usefulness -– or marginal utility -– of a given unit of that commodity in satisfying our most pressing desires. If water is abundant -– that is, if most of our important wants are easily satisfied by the available water -– then we will place a relatively low value on each additional unit of water, because that unit will be used to satisfy a want that we consider relatively unimportant. And if diamonds, while greatly prized, are normally scarce, then we will place a relatively high value on each additional diamond, because that unit will be used to satisfy a want that ranks high on our scale of preferences.

As I said before, the classical economists were able to explain the “water-diamond paradox” fairly well in terms of relative scarcity, but their dualistic theory of value, which distinguished between use-value and exchange-value, created more problems than it solved. The theory of marginal utility represented a significant theoretical advance, because it was able to dispense with this dichotomy in favor of a unified theory of value. It was now recognized that exchange-value can ultimately be explained in terms of use-value -– provided, of course, that we correctly understand the meaning of “use-value.”

This is where the discussion of marginal utility by Carl Menger is especially important if we are to appreciate what Ludwig von Mises had to say about economic calculation. Menger, who is generally acknowledged as the founder of the Austrian School of economics, stressed the subjective nature of use-value. The economic value of a commodity, argued Menger, depends ultimately on the our subjective valuations – specifically, on how we assess the usefulness of a good in furthering our subjective goals. Economic science does not pass judgment on the true worth, or objective value, of an economic good. It does not, for example, evaluate the true worth of water in relation to diamonds. Rather, economics takes as its starting point what people do in fact value, and then analyzes the economic phenomena that emerge from this pursuit of subjective goals.

Menger’s distinctive contribution to marginal utility was his extension of this theory to what he called “goods of a higher order” – or what are sometimes called “capital goods” or “the means of production,” in contrast to “consumer goods.” Many economists, both before and after Menger, have contrasted supply (or the factors of production) with consumer demand, as if these elements operated according to different principles of value. But this is not true, said Menger; ultimately the value of all higher-order goods depends on their role in producing consumer goods, or those things that people use directly to satisfy their desires. “Goods of a higher order” – so-called because they fall higher than consumer goods on the scale of production – are indirect, rather than direct, means of satisfying human wants. A steel factory, for example, may not produce anything that is directly used by the consumer, but it does satisfy consumer demand indirectly by providing the material for the building of cars, which are directly used by the consumer.

Menger’s discussion of higher-order goods was extremely important, because it allowed him to apply the notion of marginal utility, not only to consumer goods, but to the factors of production as well. This insight proved essential to the argument later developed by Ludwig von Mises, that the planners in a socialist economy will be unable to engage in rational economic calculation. Mises first advanced this argument in a 1920 essay, “Economic Calculation in the Socialist Commonwealth,” and he expanded upon it two years later in his seminal book, Socialism: An Economic and Sociological Analysis.

Pure socialism is a system in which there is no private ownership of the means of production; all production decisions are made by a central planning authority. Unlike a market system, where capitalists and entrepreneurs can base their production decisions on the objective prices of higher-order goods, the planners in a socialist economy have no such prices to guide them. What, then, can these planners substitute for market prices? What rational criteria can they use in determining what higher order goods are needed, and in what amount, in order to produce the desired consumer goods?

Without market prices to guide production, says Mises, no rational calculation is possible. Thus, the so-called economic planning of socialism leads, in fact, to economic chaos -– to inefficiency and waste on a massive scale.

The idea of centralized planning is plausible only if we assume that economic value is an objective feature of commodities, one that can be rationally ascertained apart from the give and take of market competition. Karl Marx, of course, made precisely this assumption. Like David Ricardo and other economists in the classical school, Marx defended a labor theory of value. It is interesting to note that Marx finished only one volume of Capital during his lifetime, and this appeared just as the theory of marginal utility was revolutionizing economic thought. But this was one revolution that Marx failed to understand; consequently, his labor theory of value was widely condemned by economists as outdated as soon as the first volume of his masterpiece had fallen from the press.

Economic value, according to Menger and others in the Austrian school, is not an objective property of commodities. Rather, value is imputed to commodities according to their perceived utility in serving human wants. To quote from Mises:

Every man who, in the course of economic activity, chooses between the satisfaction of two needs, only one of which can be satisfied, makes judgments of value. Such judgments concern firstly and directly the satisfaction themselves; it is only from these that they are reflected back upon goods. (Soc., 98)

We evaluate our preferences by ranking them, not by measuring them. It makes sense, for example, to say that I like apples more than oranges, and oranges more than pears, and therefore that I like apples more than pears. But it makes no sense to say that I like apples twice as much as I like oranges, and oranges three times more than pears, and therefore that I like applies six times more than I like pears.

In other words, since economic value derives from an estimate of personal satisfaction, and since there is no invariable unit of satisfaction that can serve as a standard of measurement, is impossible to measure, compute, or add up the marginal utility of various commodities. We can, as is sometimes said, rank values ordinally, but we cannot measure them cardinally. As Mises points out, this creates a problem when we need to make economic calculations:

Computation demands units. And there can be no unit of the subjective use-value of commodities. Marginal utility provides no unit of value. …Judgments of value do not measure: they arrange, they grade.

Mises goes on to say that our subjective estimates of value may prove sufficient when dealing with simple situations, as when Crusoe, alone his island, is calculating how to provide for his wants in the immediate future. But the problem of calculation quickly becomes insurmountable in more complex conditions, especially where a sophisticated division of labor is at work. Here, where long and complicated processes of production are involved, our estimate of subjective use-value will fail to give us the accurate information we need for long-range economic planning.

In an exchange economy, what subjective use-value cannot accomplish is in fact achieved by objective exchange-value. By “objective exchange value,” Mises means the money-price of a commodity, which serves as the required unit of economic calculation. Money, he stresses, does not measure value, nor are prices somehow measured by money. Rather, prices are simply amounts of money. Mises calls the price of a commodity its “objective exchange value,” because that price -- which arises from the interplay of the subjective valuations of those who engage in buying and selling – can serve as a practical means of economic calculation.

Calculations of this sort provide a control upon the appropriate use of the means of production. They enable those who desire to calculate the cost of complicated processes of production to see at once whether they are working as economically as others. If, under prevailing market prices, they cannot carry through the process at a profit, it is a clear proof that others are better able to turn to good account the instrumental goods in question. Finally, calculations based upon exchange values enable us to reduce values to a common unit. And since the higgling of the market establishes substitution relations between commodities, any commodity desired can be chosen for this purpose. In a money economy, money is the commodity chosen. (99)

Money prices are necessary if we are to engage in long-range and complex calculations. They allow us to compare different production methods and determine which will produce the desired good at the lowest cost. Mises offers a concrete example of a problem that socialism is unable to solve, precisely because socialism, by prohibiting the private ownership of capital goods, also abolishes the market transactions that are required to generate prices.

Suppose…that the socialist commonwealth was contemplating a new railway line. Would a new railway line be a good thing? If so, which of many possible routes should it cover? Under a system of private ownership we could use money calculations to decide these questions. The new line would cheapen the transportation of certain articles, and, on this basis, we could estimate whether the reduction in transport charges would be great enough to counterweigh the expenditure which the building and running of the line would involve. Such a calculation could be made only in money. …We can make systematic economic plans only when all the commodities which we have to take into account can be assimilated to money. True, money calculations are incomplete. True, they have profound deficiencies. But we have nothing better to put in their place. And under sound monetary conditions they suffice for practical purposes. If we abandon them, economic calculation becomes absolutely impossible. (104-5)

This is why Mises predicted the inevitable failure of central planning. His portrayal of socialism, made in 1920, proved to be remarkably accurate:

All transactions . . . will be subject to the control of a supreme authority. Recourse will be had to the senseless output of an absurd apparatus. The wheels will turn, but will run to no effect.

Socialism, far from being more scientific and rational than the free market, actually represents the abolition of rational planning.

In the socialist commonwealth every economic change becomes an undertaking whose success can be neither appraised in advance nor later retrospectively determined. There is only groping in the dark. Socialism is the abolition of rational economy.

The arguments of Mises compelled socialists to re-examine the plausibility of their own theories, and even caused some to embrace the free market principles of classical liberalism. Among these former socialists was a young Friedrich Hayek, who would go on to become one of the century’s greatest champions of the free market and limited government. As Hayek noted of his generation in Vienna after the first world war,

We felt that the civilization in which we had grown up had collapsed. We were determined to build a better world, and it was this desire to reconstruct society that led many of us to the study of economics. Socialism promised to fulfill our hopes for a more rational, more just world.

When Socialism first appeared in 1922, its impact was profound. It gradually, but fundamentally, altered the outlook of many of the young idealists returning to their studies after the First World War. I know, for I was one of them.

Hayek later expanded on the ideas of Mises, applying them in ways that greatly expanded our understanding, not only of why socialism fails, but of why capitalism succeeds. The free-market system is able to use the dispersed knowledge from millions of different people in a way that maximizes economic efficiency. As Hayek put it in his 1945 essay, “The Use of Knowledge in Society”:

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate ‘given’ resources--if ‘given’ is taken to mean given to a single mind which deliberately solves the problem set by these ‘data.’ It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.

The price system not only enables us to make economic calculations, as Mises had said; it is also a highly sophisticated system for communicating knowledge. Again quoting Hayek:

We must look at the price system as such a mechanism for communicating information if we want to understand its real function....

When governments forcibly intervene in market transactions, they inevitably reduce or distort the information that would otherwise flow through market channels. And this can cause serious problems which, in turn, often create a misguided demand for even more intervention. Thus, despite the best intentions of planners, their interventions will tend to generate additional interventions, thereby creating a downward spiral into a highly regimented economy. This is the “Road to Serfdom” that Hayek described so well in his best-selling book. Or, in the words of Mises, this is the way to “planned chaos.”

Ghs

[Peter]

Socialists like Obama are narcissists. They truly think they have the answers, that they better know what to do with our money than we do, and that they can “plan” to cover any contingency. They feel in their bones that they should be in charge.

When their thinking fails as it inevitably will, they resort to the initiation of force to get their way.

The Austrian School’s arguments are compelling. I especially appreciate the idea that Capitalism requires millions and billions of decisions based on reason. What will work? What action is cost affective? And billions of free people are constantly wondering, what is in my rational self-interest? Now that is the original micro-management, that requires no compulsion or coercion.

I have recently heard Progressive apologists mention Mussolini had the trains running on time, and golly, look at Sweden which is socialist, because they aren’t having a debt problem.

You mentioned that this lecture was never proofread.

HERE ARE A COUPLE OF THINGS I FOUND, GEORGE. LOOK FOR THE ( )

Mises goes on to say that our subjective estimates of value may prove sufficient when dealing with simple situations, as when Crusoe, alone (add the word ON here???) his island, is calculating how to provide for his wants in the immediate future.

And since the higgling (HAGGLING???) of the market establishes substitution relations between commodities, any commodity desired can be chosen for this purpose. In a money economy, money is the commodity chosen. (99)

THAT’S IT. I WASN’T PROOFREADING BUT JUST SAW THESE TWO.

Peter

[Starbuckle]

A very fine summation. Good job.

[GALTGULCH8]

I find it to be curious that it is mentioned above that Obama is a narcissist as I just came across an article in which apparently the psychiatrists working on their Diagnostic and Statistical Manual are considering the removal of the condition of Narcissistic Personality Disorder from their list of diseases.

Just in time to spare our leader from the embarrassment of being officially mentally ill to add to his constitutional ineligibility to be president. The Framers intended by their stipulation that to be eligible for the presidency one must be a "natural born citizen" as opposed to being merely an American citizen, that both of one's parents had to be American citizens. In this way they hoped to ensure that as a future president one would be raised without divided loyalty because of the influence of a parent who was a citizen of another country. Needless to say Obama makes no secret of the fact that his father was a Kenyan citizen hence a British subject.

Regarding the ignorance of those in the current administration of the principles and concepts of the Austrian school of Economics, I wonder whether anyone has attempted to make them aware by sending copies of Human Action, or perhaps better still, Hayek's The Fatal Conceit.

You may recall that during Ron Paul's attempt to become the Republican nominee in 2008, a dirigible appeared with Who Is Ron Paul displayed on its side which took to the airwaves for a time funded by Ron Paul supporters who were impassioned by the fact that Ron Paul took his oath of office seriously and over 300 times was the sole No vote on bills in which the Congress sought a power not among the enumerated powers in Article 1 Section 8.

I would contribute to the cause if we could find that dirigible and fly it over Washington from which copies of Austrian economics books could be parachuted down.

A stack of G. Edward Griffin's The Creature From Jekyll Island could be left on the steps to the Federal Reserve System headquarters in the hope that Chairman Bernanke would read it and come to his senses as well.

Edited December 6, 2010 by gulch8

[Kimmler]

http://www.worldsocialism.org/articles/why_we_dont_need.php

It's just not British not to give the udder point of view.

[AristotlesAdvance]

The following is excerpted from a lecture I gave around 15 years ago. I am posting it in connection with an exchange that is currently underway on the "Kinsella and Thin Air" thread. It is too long to include in that thread, so I am posting it separately. It has been years since I have looked at this piece, and I have made no effort to correct typos and other incidental errors.

The Problem of Economic Calculation Under Socialism

George H. Smith

Ludwig von Mises is best known for his early critique of socialism, which convinced many economists, including a young socialist named Friedrich Hayek, that rational economic calculation is impossible in a socialist system, and that economic coordination can best be achieved in an unregulated market, where prices transmit crucial information about the supply and demand of capital goods.

Mises drew on the economic theory of value to argue that socialism could not solve what he called the problem of “economic calculation.” Thus, before presenting the Misesian argument, I will first present some background information on the theory of value.

Central to all economic analysis is the concept of value. In classical economics – whose major exponents were Adam Smith, David Ricardo, and John Stuart Mill – two kinds of value were often distinguished: namely, value in use and value in exchange. Use-value refers to the usefulness, or utility, of a given commodity, such as water -- which, because it is essential to human life, was said to have a high use-value. Exchange-value, in contrast, refers to what a given commodity can fetch in the market, when it is exchanged for something else. For example, diamonds were said to have a high exchange-value, because they will command a good deal in return.

This dichotomy of use-value and exchange-value generated a serious problem for the classical economists, who were perplexed by the relationship between the two kinds of value. This problem is illustrated in what economists call the “water-diamond paradox,” which was expressed by Adam Smith as follows:

The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water; but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.

Smith understood that the resolution of this paradox lies in the notion of relative scarcity. He points out, for example, that someone stranded in the desert, where water is scarce, will value water more highly than he would in normal circumstances, where water is plentiful. Thus it is the scarcity of water relative to its demand in a particular situation that will determine the exchange value of water. Despite this insight, however, the classical economists were unable to formulate a unified theory of value that would adequately explain the water-diamond paradox and similar problems.

A satisfactory theory of value did not emerge until the 1870s, when there occurred what is known as the “marginal-utility revolution” in economic thought. This important innovation was arrived at independently by three men: William Stanley Jevons in England, Leon Walras in Switzerland, and Carl Menger in Austria. Although these men differed somewhat in their treatments of marginal utility, their central insights were essentially the same.

As these economists pointed out, when we choose one commodity over another, we do not consider the general usefulness of that commodity. We do not, for example, consider the general utility of water -– its role in supporting human life -– when deciding how much we are willing to exchange for a specific amount of water. True, if we had to choose between all the water in the world and all the diamonds, then we would clearly choose water over diamonds, but rarely are we faced with this all-or-nothing situation. Instead, we confront commodities as they exist in specific quantities, or units, and the value we place on a commodity depends on what we plan to use it for.

Suppose we are deciding whether or not to purchase a gallon of water. Our decision will be based, not on the general usefulness of water, but on the contribution that the additional gallon of water will make in satisfying our wants. And this, of course, depends on how much water we already have. The man in a desert, who is dying of thirst, will value a gallon of water more highly than he would in normal circumstances, because he will use that gallon to sustain his life -– rather than using it, say, to wash his car, which is what he might do if water were more plentiful. .

That we normally value diamonds more than water is not because of some paradox or conflict between use-value and exchange-value. Economic value ultimately depends, not on the general usefulness of a commodity, but on the specific usefulness -– or marginal utility -– of a given unit of that commodity in satisfying our most pressing desires. If water is abundant -– that is, if most of our important wants are easily satisfied by the available water -– then we will place a relatively low value on each additional unit of water, because that unit will be used to satisfy a want that we consider relatively unimportant. And if diamonds, while greatly prized, are normally scarce, then we will place a relatively high value on each additional diamond, because that unit will be used to satisfy a want that ranks high on our scale of preferences.

As I said before, the classical economists were able to explain the “water-diamond paradox” fairly well in terms of relative scarcity, but their dualistic theory of value, which distinguished between use-value and exchange-value, created more problems than it solved. The theory of marginal utility represented a significant theoretical advance, because it was able to dispense with this dichotomy in favor of a unified theory of value. It was now recognized that exchange-value can ultimately be explained in terms of use-value -– provided, of course, that we correctly understand the meaning of “use-value.”

This is where the discussion of marginal utility by Carl Menger is especially important if we are to appreciate what Ludwig von Mises had to say about economic calculation. Menger, who is generally acknowledged as the founder of the Austrian School of economics, stressed the subjective nature of use-value. The economic value of a commodity, argued Menger, depends ultimately on the our subjective valuations – specifically, on how we assess the usefulness of a good in furthering our subjective goals. Economic science does not pass judgment on the true worth, or objective value, of an economic good. It does not, for example, evaluate the true worth of water in relation to diamonds. Rather, economics takes as its starting point what people do in fact value, and then analyzes the economic phenomena that emerge from this pursuit of subjective goals.

Menger’s distinctive contribution to marginal utility was his extension of this theory to what he called “goods of a higher order” – or what are sometimes called “capital goods” or “the means of production,” in contrast to “consumer goods.” Many economists, both before and after Menger, have contrasted supply (or the factors of production) with consumer demand, as if these elements operated according to different principles of value. But this is not true, said Menger; ultimately the value of all higher-order goods depends on their role in producing consumer goods, or those things that people use directly to satisfy their desires. “Goods of a higher order” – so-called because they fall higher than consumer goods on the scale of production – are indirect, rather than direct, means of satisfying human wants. A steel factory, for example, may not produce anything that is directly used by the consumer, but it does satisfy consumer demand indirectly by providing the material for the building of cars, which are directly used by the consumer.

Menger’s discussion of higher-order goods was extremely important, because it allowed him to apply the notion of marginal utility, not only to consumer goods, but to the factors of production as well. This insight proved essential to the argument later developed by Ludwig von Mises, that the planners in a socialist economy will be unable to engage in rational economic calculation. Mises first advanced this argument in a 1920 essay, “Economic Calculation in the Socialist Commonwealth,” and he expanded upon it two years later in his seminal book, Socialism: An Economic and Sociological Analysis.

Pure socialism is a system in which there is no private ownership of the means of production; all production decisions are made by a central planning authority. Unlike a market system, where capitalists and entrepreneurs can base their production decisions on the objective prices of higher-order goods, the planners in a socialist economy have no such prices to guide them. What, then, can these planners substitute for market prices? What rational criteria can they use in determining what higher order goods are needed, and in what amount, in order to produce the desired consumer goods?

Without market prices to guide production, says Mises, no rational calculation is possible. Thus, the so-called economic planning of socialism leads, in fact, to economic chaos -– to inefficiency and waste on a massive scale.

The idea of centralized planning is plausible only if we assume that economic value is an objective feature of commodities, one that can be rationally ascertained apart from the give and take of market competition. Karl Marx, of course, made precisely this assumption. Like David Ricardo and other economists in the classical school, Marx defended a labor theory of value. It is interesting to note that Marx finished only one volume of Capital during his lifetime, and this appeared just as the theory of marginal utility was revolutionizing economic thought. But this was one revolution that Marx failed to understand; consequently, his labor theory of value was widely condemned by economists as outdated as soon as the first volume of his masterpiece had fallen from the press.

Economic value, according to Menger and others in the Austrian school, is not an objective property of commodities. Rather, value is imputed to commodities according to their perceived utility in serving human wants. To quote from Mises:

Every man who, in the course of economic activity, chooses between the satisfaction of two needs, only one of which can be satisfied, makes judgments of value. Such judgments concern firstly and directly the satisfaction themselves; it is only from these that they are reflected back upon goods. (Soc., 98)

We evaluate our preferences by ranking them, not by measuring them. It makes sense, for example, to say that I like apples more than oranges, and oranges more than pears, and therefore that I like apples more than pears. But it makes no sense to say that I like apples twice as much as I like oranges, and oranges three times more than pears, and therefore that I like applies six times more than I like pears.

In other words, since economic value derives from an estimate of personal satisfaction, and since there is no invariable unit of satisfaction that can serve as a standard of measurement, is impossible to measure, compute, or add up the marginal utility of various commodities. We can, as is sometimes said, rank values ordinally, but we cannot measure them cardinally. As Mises points out, this creates a problem when we need to make economic calculations:

Computation demands units. And there can be no unit of the subjective use-value of commodities. Marginal utility provides no unit of value. …Judgments of value do not measure: they arrange, they grade.

Mises goes on to say that our subjective estimates of value may prove sufficient when dealing with simple situations, as when Crusoe, alone his island, is calculating how to provide for his wants in the immediate future. But the problem of calculation quickly becomes insurmountable in more complex conditions, especially where a sophisticated division of labor is at work. Here, where long and complicated processes of production are involved, our estimate of subjective use-value will fail to give us the accurate information we need for long-range economic planning.

In an exchange economy, what subjective use-value cannot accomplish is in fact achieved by objective exchange-value. By “objective exchange value,” Mises means the money-price of a commodity, which serves as the required unit of economic calculation. Money, he stresses, does not measure value, nor are prices somehow measured by money. Rather, prices are simply amounts of money. Mises calls the price of a commodity its “objective exchange value,” because that price -- which arises from the interplay of the subjective valuations of those who engage in buying and selling – can serve as a practical means of economic calculation.

Calculations of this sort provide a control upon the appropriate use of the means of production. They enable those who desire to calculate the cost of complicated processes of production to see at once whether they are working as economically as others. If, under prevailing market prices, they cannot carry through the process at a profit, it is a clear proof that others are better able to turn to good account the instrumental goods in question. Finally, calculations based upon exchange values enable us to reduce values to a common unit. And since the higgling of the market establishes substitution relations between commodities, any commodity desired can be chosen for this purpose. In a money economy, money is the commodity chosen. (99)

Money prices are necessary if we are to engage in long-range and complex calculations. They allow us to compare different production methods and determine which will produce the desired good at the lowest cost. Mises offers a concrete example of a problem that socialism is unable to solve, precisely because socialism, by prohibiting the private ownership of capital goods, also abolishes the market transactions that are required to generate prices.

Suppose…that the socialist commonwealth was contemplating a new railway line. Would a new railway line be a good thing? If so, which of many possible routes should it cover? Under a system of private ownership we could use money calculations to decide these questions. The new line would cheapen the transportation of certain articles, and, on this basis, we could estimate whether the reduction in transport charges would be great enough to counterweigh the expenditure which the building and running of the line would involve. Such a calculation could be made only in money. …We can make systematic economic plans only when all the commodities which we have to take into account can be assimilated to money. True, money calculations are incomplete. True, they have profound deficiencies. But we have nothing better to put in their place. And under sound monetary conditions they suffice for practical purposes. If we abandon them, economic calculation becomes absolutely impossible. (104-5)

This is why Mises predicted the inevitable failure of central planning. His portrayal of socialism, made in 1920, proved to be remarkably accurate:

All transactions . . . will be subject to the control of a supreme authority. Recourse will be had to the senseless output of an absurd apparatus. The wheels will turn, but will run to no effect.

Socialism, far from being more scientific and rational than the free market, actually represents the abolition of rational planning.

In the socialist commonwealth every economic change becomes an undertaking whose success can be neither appraised in advance nor later retrospectively determined. There is only groping in the dark. Socialism is the abolition of rational economy.

The arguments of Mises compelled socialists to re-examine the plausibility of their own theories, and even caused some to embrace the free market principles of classical liberalism. Among these former socialists was a young Friedrich Hayek, who would go on to become one of the century’s greatest champions of the free market and limited government. As Hayek noted of his generation in Vienna after the first world war,

We felt that the civilization in which we had grown up had collapsed. We were determined to build a better world, and it was this desire to reconstruct society that led many of us to the study of economics. Socialism promised to fulfill our hopes for a more rational, more just world.

When Socialism first appeared in 1922, its impact was profound. It gradually, but fundamentally, altered the outlook of many of the young idealists returning to their studies after the First World War. I know, for I was one of them.

Hayek later expanded on the ideas of Mises, applying them in ways that greatly expanded our understanding, not only of why socialism fails, but of why capitalism succeeds. The free-market system is able to use the dispersed knowledge from millions of different people in a way that maximizes economic efficiency. As Hayek put it in his 1945 essay, “The Use of Knowledge in Society”:

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate ‘given’ resources--if ‘given’ is taken to mean given to a single mind which deliberately solves the problem set by these ‘data.’ It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.

The price system not only enables us to make economic calculations, as Mises had said; it is also a highly sophisticated system for communicating knowledge. Again quoting Hayek:

We must look at the price system as such a mechanism for communicating information if we want to understand its real function....

When governments forcibly intervene in market transactions, they inevitably reduce or distort the information that would otherwise flow through market channels. And this can cause serious problems which, in turn, often create a misguided demand for even more intervention. Thus, despite the best intentions of planners, their interventions will tend to generate additional interventions, thereby creating a downward spiral into a highly regimented economy. This is the “Road to Serfdom” that Hayek described so well in his best-selling book. Or, in the words of Mises, this is the way to “planned chaos.”

Ghs

Economist Joseph Salerno lectures to the Mises Institute on the topic of economic calculation.

Salerno is professor of economics at Pace University, Lubin School of Business.

http://www.youtube.com/results?search_query=Joseph+Salerno&aq=f

Other lectures by Joseph Salerno on YouTube

[Selene]

http://www.worldsoci...e_dont_need.php

It's just not British not to give the udder point of view.

Steven:

After I stopped laughing, the following paragraph from your source's diatribe illustrates exactly why socialism will always lead to gas chambers, gulags or bloody rice paddies.

"The Priorities in Socialism In socialism the situation will be quite different: these factors will be automatically taken into account in the decision-making process and will not have to be imposed from outside as a sort of after-thought, since among the highest priorities of production will be the health and welfare of the producers. We can imagine the decisions as to choice of productive methods being made by a council elected by the work force, or by a technical subcommittee of such a democratically-elected council. In making their choice they will first take into account, not minimizing average total production time as the economic laws of capitalism enforce today, but the health, comfort and enjoyment of the work force, the protection of the environment and the conservation of materials and energy."

Essentially, the sacred fallacy which socialist avoid, evade and suppress, the "dirty little secret" is that humans with power cannot make "philosopher king" decisions because 1) they are not Gods and 2) they are humans with the same strengths and weaknesses that all humans possess.

You actually believe that by merely wishing humans to be different, shazaam!, they will be!

No, reality, the invisible hand of millions of decisions cannot be "automatically taken into account."

Adam

[merjet]

AristolesAdvance,

You should learn how to use and not use the quote facility.

For post #6 it was not necessary to quote George's post #1. You could have clicked the "Add Reply" button or the "Fast Reply" thingy at the bottom of the page rather than the "Reply" button at the bottom of George's post.

Elsewhere you have quoted somebody else's entire post, then excerpted pieces of it, repeated such piece after the quote in italics, then add you own comments. This is not necessary. It is easy to break up the other person's post and place your comments next after that part about which you want to comment. In the posting workspace insert {/QUOTE}{QUOTE} -- but use square brackets rather then curly braces -- at the end of such part. Then put your comment between the two sets of brackets.

There is also no need to quote an entire post. You can delete parts you have nothing to comment about. Just be careful when there are embedded quotes. Each {QUOTE} should have a paired {/QUOTE} and each pair should be suitably nested.

I used curly braces rather than square brackets above so they wouldn't be used as if I were quoting somebody.

Edited December 6, 2010 by Merlin Jetton

[Peter]

gulch8 wrote:

You may recall that during Ron Paul's attempt to become the Republican nominee in 2008, a dirigible appeared with Who Is Ron Paul displayed on its side which took to the airwaves for a time funded by Ron Paul supporters who were impassioned by the fact that Ron Paul took his oath of office seriously and over 300 times was the sole No vote on bills in which the Congress sought a power not among the enumerated powers in Article 1 Section 8.

end quote

Now if the dirigible had “Rand Paul” on its side . . .

Is “megalomaniac” still a verifiable psychiatric condition? If so, it fits Obama.

Fox is talking about which states will default first, California or New York. What will the domino affect be? One commentator is saying Obama will guarantee their bonds. What this will do is give the welfare states the ability to print money. Our money.

By guaranteeing their bonds, they can then raise the payout rates to artificially entice buyers, avoiding the inevitable bankruptcy.

Bankruptcy is necessary for all the welfare states. The state, county and city unions in exchange for their Democrat vote have given retiring government employees HUGE pensions. Unsustainable pensions. The only way to renegotiate these contracts is for California and New York to declare bankruptcy and then look at sustainable pension amounts.

I can’t believe the following appeared in Nooseweak.

Peter

"The Triumphant Return of Hayek," Ruchir Sharma, Newsweek, November 28

Last year the consensus opinion was that we are all Keynesians now. Virtually everyone in the commentariat believed that John Maynard Keynes's solution for the Great Depression—heavy government spending to resuscitate the economy—was also the answer to today's global downturn. The first cracks in the consensus appeared with the outbreak of the fiscal crisis in Greece earlier this year. Across the developed world, critics began to argue that government spending had reached the point of diminishing returns, and was producing an anemic recovery that mainly benefited special-interest groups. And the electorate listened. From Europe to the United States, as voters started to reward candidates focused on fiscal discipline and less government intervention, Keynesianism quickly fell out of favor.

One key exception was U.S. Federal Reserve chairman Ben Bernanke.... Bernanke says he is doing everything Milton Friedman would have had the Fed do. Friedman, the father of monetarism, argued that the Great Depression was largely the result of a major contraction in money supply, and that such a severe economic outcome could have been avoided had the Fed held the money supply stable.

The public doesn't buy it....

In a sign of the times, some of the most popular videos on YouTube this year are satires on economic policy; the latest lampoons the Fed amid a growing feeling that policymakers are committing what economist Friedrich Hayek called the "fatal conceit" in micromanaging the economic cycle. Hayek hated policy intervention of any kind. Keynes, Friedman, and Hayek were leading lights of the three most influential schools of economic thought of the last century. Hayek was associated with the Austrian school, ascendant in the 19th and early 20th centuries, which argued that the private sector should be left free to carry out the task of any readjustment in a downturn.

[Reidy]

As for Paul's No votes, TAS published an investigative piece during the 2008 campaign season finding that there's less to this than meets the eye. His technique is to insert as many special-interest favors ("pork" is such an ugly word) as he can into appropriations bills and then ostentationsly to vote No, knowing fully well that the bills will pass anyway.

The standard comeback is that this is merely constituent service and that as long as the system is in place he might as well get some of his consituents' tax money back. This might have merit if he were candid about it and explained himself this way, rather than ignore it and let others do the explaining, and if he merely abstained, but as it works out in practice it's simple hypocrisy.

[Starbuckle]

"The standard comeback is that this is merely constituent service and that as long as the system is in place he might as well get some of his consituents' tax money back. This might have merit if he were candid about it and explained himself this way, rather than ignore it and let others do the explaining, and if he merely abstained, but as it works out in practice it's simple hypocrisy."

Such a rationalization would not have merit from a libertarian and constitutional perspective. Earmarks and porkbarrel spending are corrupt in themselves and the gateway drug to even larger corruptions. Paul should all along have refused such requests from his constituents. The way to let taxpayers keep more of their money is by tax cuts, not by enabling, however "reluctantly" or disingenuously, the very system of pelf-grabbing and pelf-dispensing that Paul claims to oppose.

Edited December 7, 2010 by Starbuckle

[George H. Smith]

As for Paul's No votes, TAS published an investigative piece during the 2008 campaign season finding that there's less to this than meets the eye. His technique is to insert as many special-interest favors ("pork" is such an ugly word) as he can into appropriations bills and then ostentationsly to vote No, knowing fully well that the bills will pass anyway.

The standard comeback is that this is merely constituent service and that as long as the system is in place he might as well get some of his consituents' tax money back. This might have merit if he were candid about it and explained himself this way, rather than ignore it and let others do the explaining, and if he merely abstained, but as it works out in practice it's simple hypocrisy.

Paul's explanation, such as it is:

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Ghs

[studiodekadent]

George,

A wonderful essay and a fantastic summary of the Economic Calculation Argument.

Also, I'm glad you didn't fall into the "Dehomogenization" trap that some of the Rothbardians have fallen into. Your inclusion of Hayek's contributions and elaboration of their underpinnings in Mises is something I am very happy to see.

[DavidMcK]

It is also interesting that because of an inability to calculate every decision by a central authority is regarded as right because who can prove otherwise? In other words (to use the example from above) since building a railway from point a to b benefits at least someone, and since everyone knows that we need more railways, food etc. then every railway is justified without economic calculation. Of course in reality the railways are built often from motives that aren't exactly economic but that never bothers the advocates of central authorities.