Mar 1, 1981

Socialist Economic Calculation

“Hayek analyses is of central importance to the growing literature of the “economic of information.”

Karen I. Vaughn
George Mason University

“Economic Calculation under Socialism: the Austrian Contribution.” Economic Inquiry 18(October 1980):535–554.

The publication in 1920 of Austrian free-market economist Ludwig von Mises’s (1881–1973) article, “Economic Calculation in the Socialist Commonwealth,” launched a scholarly controversy between free-market and socialist economists during the period of 1920 to 1940. Known as the debate over “economic calculation under socialism,” its ostensible subject was whether it was possible for a real economy to operate efficiently without free markets and without private ownership of capital and land. The core issues for economic theory, however, ran deeper and are still unresolved some 40 years later. Professor Vaughn gives a clear overview of the debates, issues, personalities, and scholarship.

Economic theories of socialism during the 1930s were based on Walrasian general equilibrium models in which the government central planning board was to function as the price determiner or auctioneer. Socialists assumed that “market socialism” would achieve all the efficiencies characterizing the abstract model of perfect competition, and at the same time, avoid the serious market imperfections alleged against real capitalist economies (monopolies, externalities, business cycles, and unjust income and wealth distributions).

The Austrians, chiefly Ludwig von Mises and Friedrich Hayek (cf. Hayek’s 1935 Collectivist Economic Planning), argued that socialism (even socialism with some market mechanisms allowed to price consumer goods) would fail to achieve the efficiency of real market capitalism. Mises and Hayek reasoned that the Walrasian models of perfect competition, which socialists employed to construct their economic theory, left out of consideration those vital features of real markets that were required to generate efficient outcomes. Specifically, the socialists’ Walrasian model ignored three crucial features: (1) the entrepreneurial nature of the market adjustment process, (2) the importance of decentralized information in setting market- clearing signals for efficient supply and demand, and (3) the role of incentives and disincentives under varying market and non-market institutional settings.

A crude synopsis of the economic calculation debate runs as follows: Mises wrote an article arguing that rational or efficient economic calculation was impossible under socialism. Mises’s article prompted those who favored socialism to try to refute him. (These included Fred Taylor, H.D. Dickinson, Oskar Lange, Abba Lerner, E.M.F. Dubin, and Maurice Dobb). Those arguing for “market socialism” were forced by Mises’s analysis to construct an economic model that would show how a centrally directed socialist economy could be rationally administered. Mises chief allies in his theoretical defense of capitalism were the Austrian Friedrich Hayek and Lionnel Robbins (who was influenced by the Austrian school of economics). Hayek wrote two sophisticated and penetrating critiques of socialist planning but they were, in the main ignored. Mises seemed easy to refute, and so for twenty years, socialists continued to refute their version of his arguments, therefore avoiding consideration of the far more difficult issues raised by Hayek.

Professor Vaughn’s discussion falls into four parts: (1) the first part examines Mises’s 1920 article to identify the sources of the controversy: (2) the second part outlines the major developments in the economic theory of socialism during the 1930s; (3) the third part presents Hayek’s criticisms of socialist economic programs; and (4) the fourth part summarizes the theoretical problems raised during the debate. This last section allows us to appreciate the relevance of the Austrian analysis as a contribution to current problems in economic theory.

Hayek’s critique of neoclassical socialist economics was its inappropriate application of static Walrasian equilibrium models to the formation of a new economic order. The static equilibrium model omits considerations of the process by which equilibrium is approached, the effects of uncertainty on the conclusions of the model, and consideration of what constitutes economic information and to whom it is available. Each one of these omissions are sufficient to guarantee that an economic order resulting from conscious centralized planning according to the equilibrium model will differ substantially from the one envisoned by the socialist planners.

Hayek’s major source of criticism against applying the general equilibrium model to socialist economics was his perception of the role of information in making economic decisions. Hayek pointed out that the real problem of any economic model is to show how the information and knowledge necessary for rational decision making which exists in millions of separate individuals (consumers with their preferences) can be transmitted to appropriate decision makers to permit an orderly economy to emerge. The free market’s mechanism handles the problem of transmitting market knowledge because it takes advantage of decentralization of knowledge (“division of knowledge”) and decentralized decision making. Hayek argued that the burden of proof was on the socialists to show that centralized planning could improve upon the free market’s production and use of information. Hayek analyses is of central importance to the growing literature of the “economic of information,” which asks “how individuals should and do behave when imperfectly informed.”