Economic Calculation

Saturday, Jun 26, 2010

In summary, "The theory of economic calculation shows that in the socialistic community, economic calculation would be impossible. The problem of economic calculation is the fundamental problem of socialism. The problem of economic calculation is a problem which arises in an economy which is perpetually subject to change, an economy which every day is confronted with new problems which have to be solved. Far more important than the transformation of existing raw materials into consumers' goods, the renewal of capital and the investment of newly formed capital is the central problem of economic calculation."

In general, humans act only because they are not completely satisfied. Were they always to enjoy complete happiness, they would be without will, without desire, without action. In the land of the lotus-eaters there is no action. Action arises only from need, from dissatisfaction. It is purposeful striving towards something.

Materials are limited so that they have to be used in such a way that the most urgent needs are satisfied first, with the least possible expenditure of materials for each satisfaction.

All rational action is economic. All economic activity is rational action. All rational action is in the first place individual action. Only the individual thinks. Only the individual reasons. Only the individual acts. Society arises from the actions of individuals.

All human action, so far as it is rational, appears as the exchange of one condition for another. Humans apply economic goods and personal time and labor in the direction which, under the given circumstances, promises the highest degree of satisfaction, and they forgo the satisfaction of lesser needs so as to satisfy the more urgent needs. This is the essence of economic activity-- the carrying out of acts of exchange.

Every human 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.

Under very simple conditions, a human should have little difficulty in forming a judgment upon the relative significance of the factors of production. When, however, conditions are at all complicated, and the connection between things is harder to detect, we have to make more delicate computations if we are to evaluate such instruments. An isolated human can easily decide whether to extend hunting or cultivation. The processes of production one has to take into account are relatively short. The expenditure they demand and the product they afford can easily be perceived as a whole. But to choose whether we shall use a waterfall to produce electricity or extend coal mining is quite another matter. Here the processes of production are so many and so long, the conditions necessary to the success of the undertaking so multitudinous, that we can never be content with vague ideas. To decide whether an undertaking is sound we must calculate carefully.

But computation demands units. And there can be no unit of the subjective use-value of commodities. Marginal utility provides no unit of value. The worth of two units of a given commodity is not twice as great as one-- although it is necessarily greater or smaller than one. Judgments of value do not measure: they arrange, they grade. If a human relies only on subjective valuation, even an isolated human cannot arrive at a decision based on more or less exact computations in cases where the solution is not immediately evident. As a rule the human will not be able to reduce all to a common unit. But he or she may succeed in reducing all elements in the computation to such commodities as can be evaluated immediately, that is to say, to goods ready for consumption and the disutility of labor and then he or she is able to base a decision upon this evidence. It is obvious that even this is possible only in very simple cases. For complicated and long processes of production it would be quite out of the question.

In an exchange economy, the objective exchange value of commodities becomes the unit of calculation. In the first place we are able to take as the basis of calculation the valuation of all individuals participating in trade. The subjective valuation of one individual is not directly comparable with the subjective valuation of others. It only becomes so as an exchange value arising from the interplay of the subjective valuations of all who take part in buying and selling. Secondly, 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 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. Any commodity desired can be chosen for this purpose. In a money economy, money is the commodity chosen.

Money calculations have their limits. Money is neither a yardstick of value nor of prices. Money does not measure value. Nor are prices measured in money: they are amounts of money. The relation between money and goods perpetually fluctuates not only on the goods side but on the money side also.

The deficiencies of money calculations arise for the most part, not because they are made in terms of a general medium of exchange, money, but because they are based on exchange values rather than on subjective use-values. For this reason all elements of value which are not the subject of exchange elude such computations. The beauty of a place or of a building, even if it does not enter into exchange relations, is just as much a motive of rational action, provided people think it significant. If we know precisely how much we have to pay for beauty, health, honor, pride, and the like, nothing need hinder us from giving them due consideration. Sensitive people may be pained to have to choose between the ideal and the material. But that is not the fault of a money economy. It is in the nature of things. For even when we can make judgments of value without money computations we cannot avoid this choice. Called upon to choose between bread and honor, if honor cannot be eaten, eating can at least be forgone for honor.

Two things are necessary if computations of value in terms of money are to take place. First, not only goods ready for consumption but also goods of higher order must be exchangeable. If this were not so, a system of exchange relationships could not emerge. No single human, be he or she the greatest genius ever born, has an intellect capable of deciding the relative importance of each one of an infinite number of goods of higher orders. No individual could so discriminate between the infinite number of alternative methods of production that he or she could make direct judgments of their relative value without auxiliary calculations. In societies based on the division of labor, the distribution of property rights effects a kind of mental division of labor, without which neither economy nor systematic production would be possible. In the second place, there must be a general medium of exchange, a money, in use.

In the simple conditions of a closed household, it is possible to survey the whole process of production from beginning to end. It is possible to judge whether one particular process gives more consumption goods than another. But, in the incomparably more complicated conditions of our own day, this is no longer possible. True, a socialist society could say that 1000 litres of wine were better than 900 litres. It could decide whether or not 1000 litres of wine were to be preferred to 500 litres of oil. Such a decision would involve no calculation. The will of some human would decide. But the real business of economic administration, the adaptation of means to ends only begins when such a decision is taken. And only economic calculation makes this adaptation possible. Without such assistance, in the bewildering chaos of alternative materials and processes the human mind would be at a complete loss.

To suppose that a socialist community could substitute calculations in kind for calculations in terms of money is an illusion. In a community that does not practice exchange, calculations in kind can never cover more than consumption goods. They break down completely where goods of higher order are concerned. Once society abandons free pricing of production goods rational production becomes impossible. Every step that leads away from private ownership of the means of production and the use of money is a step away from rational economic activity.

The existence of a surrounding system of free pricing supports State and municipal undertakings to carry out technical improvements, because it is possible to observe the effects of similar improvements in similar private undertakings at home and abroad.

Without calculation, economic activity is impossible. Since under Socialism economic calculation is impossible, under Socialism there can be no economic activity in our sense of the word. In the absence of criteria of rationality, production could not be consciously economical. For some time possibly the accumulated tradition of thousands of years would preserve the art of economic administration from complete disintegration, however, changing conditions would make them irrational. They would become uneconomical as the result of changes brought about by the general decline of economic thought. The command of a supreme authority would govern the business of supply. The wheels would go round, but to no effect.

Under a system based upon private ownership in the means of production, the scale of values is the outcome of the actions of every independent member of society. Everyone plays a two-fold part in its establishment, first as a consumer, secondly as a producer. As consumer, he or she establishes the valuation of goods ready for consumption. As producer, he or she guides production-goods into those uses in which they yield the highest product.

Under Socialism, the economic administration may indeed know exactly what commodities are needed most urgently. But this is only half the problem. The other half, the valuation of the means of production, it cannot solve. It is possible to conceive arrangements permitting the use of money for the exchange of consumer goods. But since the prices of the various factors of production (including labor) could not be expressed in money, money could play no part in economic calculations.

Suppose, for instance, 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. True, money calculations are incomplete. True, they have profound deficiencies. But we have nothing better to put in their place. Under sound monetary conditions they suffice for practical purposes. If we abandon them, economic calculation becomes absolutely impossible.

This is not to say that the socialist community would be entirely at a loss. It would decide for or against the proposed undertaking and issue an edict. But, at best, such a decision would be based on vague valuations. It could not be based on exact calculations of value.

A stationary society could, indeed, dispense with these calculations. If we assume that the socialist system of production were based upon the last state of the system of economic freedom which it superseded, and that no changes were to take place in the future, we could indeed conceive a rational and economic Socialism. But only in theory. A stationary economic system can never exist. Capital goods employed in production are sooner or later used up. This is true, not only of those goods which constitute circulating capital, but also of those which constitute fixed capital. Those, too, sooner or later are consumed in production. In order that capital may be maintained in the same proportions, or that it may be increased, constant effort is necessary. Care must be taken that the capital goods used up in the process of production are replaced; and, beyond that, that new capital is created. Capital does not reproduce itself (177).

Under Socialism all the means of production are the property of the community. The community alone disposes of them and decides how to use them in production. The community produces, the products accrue to the community, and the community decides how those products are to be used.

Modern socialists lay great emphases on designating the socialist community as Society, and therefore on describing the transfer of the means of production to the control of the community as the "Socialization of the means of production." The word "society," with its corresponding adjective "social," has three separate meanings. It implies, first, the abstract idea of social interrelationships, and secondly, the concrete conception of a union of the individuals themselves. Between these two sharply different meanings, a third has been interposed in ordinary speech: the abstract society is conceived as personified in such expressions as "human society, " "civil society."

The reason for all this is in order to avoid using the term State or its equivalent, since this word has an unpleasant sound to all those lovers of freedom and democracy. The Marxian social democracy could at one and the same time contemplate the destruction of the existing State machine, fiercely combat all anarchistic movements, and pursue a policy which led directly to an all powerful state.

Now it does not matter in the least what particular name is given to the coercive apparatus of the socialistic community. What is important is the problem of the organization of this socialistic State or community. For the Marxists talk glibly about expressing the will of society, without giving the slightest hint how "society" can proceed to will and act. Yet of course the community can only act through organs which it has created.

Now it follows from the very conception of the socialistic community that the organ of control must be unitary. Of course this organ can be subdivided and there can be subordinate offices to which definite instructions are transmitted. But the unitary expression of the common will, which is the essential object of the socialization of the means of production and of production, necessarily implies that all offices entrusted with the supervision of different affairs shall subordinate to one office. This office must have supreme authority to resolve all variations from the common purpose and unify the executive aim. It does not matter whether this organ is an absolute prince or an assembly of all citizens organized as a direct or indirect democracy. It does not matter how this organ conceives its will and expresses it. That under the unitary direction of the central authority the administration of individual branches of production is entrusted to seemingly independent departments does not alter the fact that only the central authority directs. The relations between the individual departments are settled, not on the market by the competition of buyers and sellers, but the command of authority. The problem is this: that there is no standard by which one may account and calculate the effects of these authoritarian interventions, because the central authority cannot be guided by exchange-relationships formed on a market. The authority may indeed base its calculations on substitution-relationships, which it determines itself. But this decision is arbitrary; it is not based, as are market prices, on the subjective valuations of individuals and imputed to the producers' goods by the economic operation of all those active in production and trade. Rational economic calculation cannot therefore be based upon it (476).

Some socialists believe that the socialist community could solve the problem of economic calculation by the creation of an artificial market for the means of production. They admit that it was an error on the part of the older socialists to have sought to realize Socialism through the suspension of the market and the abolition of pricing for goods of higher orders. And they contend that Socialism must create a market in which all goods and services may be priced. Unfortunately, the motive force of the whole process which gives rise to market prices for the factors of production is the ceaseless search on the part of the capitalists and the entrepreneurs to maximize their profits by serving the consumers' wishes. Without the striving of the entrepreneurs for profit, of the landlords for rent, of the capitalists for interest and the laborers for wages, the successful functioning of the whole mechanism is not to be thought of. The prospect of profit is the market's mainspring by setting it in motion and maintaining it.

The advocates of the artificial market, however, are of the opinion that an artificial market can be created by instructing the controllers of the different industrial units to act as if they were entrepreneurs in a capitalistic state. They argue that even under Capitalism the managers of joint stock companies work not for themselves but for the companies, that is to say, for the shareholders. The only difference would be that under socialism the product of the manager's labors would go to the community rather than to the shareholders.

However, these controllers of individual industrial units would have to be appointed. Under Capitalism the managers of the joint stock companies are appointed either directly or indirectly by the shareholders. In so far as the shareholders give to the managers power to produce by the means of production of the company's stock they are risking their own property or a part of their own property. The speculation may succeed and bring profit; it may, however, misfire and bring about the loss of the whole or part of the capital concerned. This committing of one's own capital to a business whose outcome is uncertain and to men or women whose future ability is still a matter of conjecture whatever one may know of their past, is the essence of joint stock company enterprise.

Capitalist production is that which adopts wise roundabout methods in contrast with a non-capitalistic production which goes directly to its end in a hand to mouth manner. The characteristic feature of the capitalistic method of production is that the producer works to obtain a profit. Capitalistic production is production for profit, socialist production will be, as the socialists say, production for the satisfaction of needs. But to achieve a profit, that is a result greater in value than the costs, must also be the aim of the socialistic community. If economic activity is rationally directed, that is if it satisfies more urgent before less urgent needs, it has already achieved profits, since the cost, i.e. the value of the most important of the unsatisfied needs, is less than the result attained.

An economic action is said to be profitable if in the capitalist system it yields an excess of receipts over costs. An economic action is said to be productive when, seen from the point of view of a hypothetical socialist community, the yield exceeds the cost involved. Some economic acts which are profitable are not productive and, vice versa, some are productive but not profitable. This fact is sufficient to condemn the capitalistic order of society. Whatever a socialist community would do seems to socialists indisputably good and reasonable; that anything different can happen in a capitalistic society is, in their opinion, an abuse which cannot be tolerated. But an examination of the cases in which profitability and productivity are alleged not to coincide will show that this judgment is purely subjective.

For example, speculation in the capitalist system performs a function which must be performed in any economic system however organized: it provides for the adjustment of supply and demand over time and space. If it is eliminated, then some other organization must take over its function: the community itself must become a speculator. Without speculation there can be no economic activity reaching beyond the immediate present.

Far more important than the transformation of existing raw materials into consumers' goods, the renewal of capital and the investment of newly formed capital is the central problem of economic calculation, not the problem of disposing of the circulating capital already in existence. One cannot base decisions of this sort, which are binding for years and decades ahead, on the momentary demand for consumers' goods. One must look to the future, that is, one must be "speculative" (477).

Socialism, An Economic and Sociological Analysis, Ludwig von Mises, 1947, Pages 96-130 (473), http://files.libertyfund.org/files/1060/Mises0069EBk_v5.pdf.

In an article on "Economic Calculation in a Socialist Community," which appeared in the spring of 1920, he demonstrated that the possibility of rational calculation in our present economic system was based on the fact that prices expressed in money provided the essential condition that made such reckoning possible. The essential point on which Professor Mises went far beyond anything done by his predecessors was the detailed demonstration that an economic use of the available resources was only possible if this pricing was applied not only to the final product but also to all the intermediate products and factors of production, and that no other process was conceivable that would in the same way take account of all the relevant facts as did the pricing process of the competitive market.

http://mises.org/daily/4590