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May 13, 2013

Socialist Calculation III: The Value of Capital Goods

This is the third in a series of posts on the socialist calculation debate. Parts one and two appeared earlier.

Many early socialists denied that their utopia even needed economic calculation: The habits and morals of mankind would simply change, they declared, and each of us would come to feel in our very souls what we should do, in whatever economic circumstances might arise. That was heady stuff, but not at all practical. As a result, some of the more hard-nosed socialist theorists turned to calculation. But it should be remembered that the theory of economic calculation always far outstripped the practice.

Even in the Soviet Union, and even despite talented economists like Leonid Kantorovich, mathematical planning was rarely more than window dressing on what amounted to an elaborate, politically driven wish list.

Planners bickered, formed factions, falsified, cheated, stole, and – when all else failed – they allegedly lifted consumer prices directly from the Sears Catalog. But they didn’t calculate, whether in money prices, or shadow prices, or hours of labor, or anything else. In some ways this is a stronger indictment of the Soviet system than even the existence of the gulag: It shows the Soviets weren’t eating their own dog food.

One may wonder, then, how much of the socialist calculation debate amounts to the good guys being completely gulled by the other side. When real socialists do not calculate, how can we call it “socialist” calculation?[1]

As I’ve stressed before, though, we study socialist calculation because it is a kind of outline or a shadow to the market economy. Socialist calculation attempted to obtain consciously all of those things that markets tend toward through unplanned human action, through the so-called invisible hand. Examining socialist calculation makes the actions of the invisible hand more visible.

One such action is finding the value of capital goods. Ludwig von Mises was the first to stress the peculiar difficulty of this task under socialism.

Mises noted that consumption goods would be distributed in a planned society according to whatever criteria its leaders thought proper: presumably these criteria would be very egalitarian, perhaps with special consideration to individuals’ needs, although in practice a planned society could use whatever criteria its leaders wished.

Yet these distributions, whatever they were, would have great difficulty taking into account consumers’ varied and ever-changing preferences: We can’t give everyone a set of dentures and expect them all to be made equally happy.

Exchange would probably arise, regulated or not, with money or not, and it would likely be beneficial even in a planned society – but only for consumption goods. Capital goods, remember, would never be allowed to go to market. They’re owned collectively.

But how does one determine which capital goods go to what use? Whenever possible, we will want them to produce the consumer goods that have the highest consumption values, of course. But which kinds of capital goods should be preferred, and how are they to be used, and when? And how do we know when to stop using them here and start using them there? When a raw material goes through several stages of production, with choices of different later end products and/or intermediate processes, how do we know where to direct the intermediate goods – if not with price signals from the (sadly non-existent) capital goods markets?

Mises writes:

One may anticipate the nature of the future socialist society. There will be hundreds and thousands of factories in operation. Very few of these will be producing wares ready for use; in the majority of cases what will be manufactured will be unfinished goods and production goods. All these concerns will be interrelated. Every good will go through a whole series of stages before it is ready for use. In the ceaseless toil and moil of this process, however, the administration will be without any means of testing their bearings. It will never be able to determine whether a given good has not been kept for a superfluous length of time in the necessary processes of production, or whether work and material have not been wasted in its completion. How will it be able to decide whether this or that method of production is the more profitable? At best it will only be able to compare the quality and quantity of the consumable end product produced, but will in the rarest cases be in a position to compare the expenses entailed in production. It will know, or think it knows, the ends to be achieved by economic organization, and will have to regulate its activities accordingly, i.e. it will have to attain those ends with the least expense. It will have to make its computations with a view to finding the cheapest way. This computation will naturally have to be a value computation. It is eminently clear, and requires no further proof, that it cannot be of a technical character, and that it cannot be based upon the objective use value of goods and services.

Because capital is heterogenous—better at some things and worse at others—a mere reference to the exchange values of consumption goods is not enough to tell us where different capital goods should go.

The Soviets did make some theoretical efforts here. In particular, Leonid Kantorovich proposed mathematical techniques for optimizing the allocation of labor and capital goods to best fulfill a given set of production quotas. Inputs would be “priced” in terms of the gained or lost amount of product that would be had in pursuing one course of production rather than another, in a process known as shadow pricing.

His approach, though, is inapplicable to an economy for two reasons that have nothing to do with math. (Mathematicians, who understand such things better than I do, agree that his math is just fine as far as it goes, and it’s now an important part of many different optimization techniques in engineering.)

First, Kantorovich held that capital goods’ value was to be determined by the value of the labor that they saved, and by no other criteria. Like all good communists, Kantorovich was ultimately committed to the labor theory of value, at the very least for determining the efficiency of capital goods. (But you can’t please everyone: That he did not use the labor theory of value in directly formulating all of his shadow prices rendered Kantorovich a dangerous heretic to some Soviet commentators!)

Still, as Mises and many others have argued, the labor theory of value simply doesn’t work. One hour’s labor varies greatly in its productive value, not just as a function of the capital goods that back it up – a problem we could solve by looking recursively at the labor required to make the capital goods that amplify a laborer’s productivity – but also as a function of skill, serendipity, workers’ enjoyment or lack thereof in labor, and many other factors.

Nor does labor find anything like an egalitarian reward in the eyes of consumers. One may spend many hours in very difficult labor, all to no valuable end. Or one many stumble onto a million-dollar discovery in a moment of idle reflection over a beer. There just isn’t any correlation between labor and subjective value. In a slightly more just world, there might be. But not in ours. This is also why mainstream economics has rejected the labor theory of value.

Second, Kantorovich’s method was limited by the fact that it took the schedule of consumer goods to be produced as if it were a given. Which in Soviet society, it was. Given how? Given by the political and economic authorities. And not, in other words, by actual consumer demand.

And yet the search for what consumers really want is one of the biggest parts of the information discovery process performed by the market. One may very well optimize for labor under a given set of output constraints. But the discovery of the proper constraints themselves – that is, the discovery of consumers’ real demand schedules – is a process that, in a free market, unfolds in coordination with the allocation of labor and capital goods. At best, Kantorovich solved half the problem, but only by pretending that the other half didn’t exist.

As one reviewer put it:

First and most important, the planner takes as given by “the political and economic” authority and specified social needs the aims of society in the form of final demands. The shadow prices and standard effectiveness are not “regulators” of the economy but only means to the effective realization of goals… In general, the planners start and end with the final demands determined outside the planning system.[2]

Emphasis added. And yet it is the very function of an economy as we now understand it to discover such goals, not to presuppose them or to conjure them out of thin air. Further, as we will see in the next post, there are never really any “final” goals at all, only provisional ones.


  1. Sure, there was Project Cybersyn in socialist Chile – but if a socialist calculation system’s most notable success lies in crushing a labor movement, well, something’s definitely a little off here, if not in the calculation, then at least in the socialism.  ↩

  2. Benjamin Ward, “Kantorovich on Economic Calculation,” The Journal of Political Economy 68:6, December 1960, p 553.  ↩

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