Economic Cycles

All the economics and cycling you could want.

Archive for March 2012

Mises vs. the Socialists: The Economic Calculation Argument

leave a comment »

I gave this talk last night for the Evergreen Tea Party. Below are my notes.



Why I wanted to talk about this.

Soviet Union – the beginnings:

Lenin comes to power in October 1917. Soviet Union is born and the socialist economy begins.

Lenin an interesting character. What he thought reveals a lot about why central planning fails.

Lenin smarter than managers, businessmen he knew. Running an economy is like running a business! It’s going to easy!

From Oct 1917 to Dec 1991, many people pointed out the many problems with the socialist economy.

Mises writes “Economic Calculation in the Socialist Commonwealth” in 1920.

Problems with socialism:

Several problems with the socialist economy arise. Socialists respond:

  1. Incentive problem – who will take out the trash? Why work hard? Answer: we’ll create a new socialist man.
  2. Knowledge problem – what do people want/need? How many loaves of bread in St. Petersberg? Answer: Our leaders know better what our people want than they do. Theoretically, if our leaders had complete information, socialism could work. (Hayek agreed).
  3. Perverse incentive problem – the political leader is king, not the consumer. Make one gigantic nail or millions of small nails. Answer: Our new man will overcome these miscommunications.
  4. Entrepreneurship problem – Why innovate? Where will new, undiscovered products come from? We’ll look at the rest of the world. We’ll study innovations and new procedures. Plus, we know better what our people want anyway.
  5. Economic calculation problem – the only problem that is not overcome even after granting ALL assumptions.

The economic calculation problem – when government owns the means of productions (factors of production), there is no market for capital goods. Or as Mises says, goods of a higher order. Without a market for capital goods, there are no market prices for capital goods. Without prices for capital goods, there cannot be any profit and loss accounting – in other words, no economic calculation. Thus, there is no way to rationally allocate scare factors of production. Even if the central planners knew exactly what to produce, they would have no idea HOW to produce it. The economy is stuck in a state of shock. Socialism is literally impossible.

Mises called this the paradox of planned economies. “The paradox of planning is that it cannot plan because of the absence of economic calculation. What is called a planned economy is no economy at all. It is just a system of groping about in the dark.”

Seems simple enough. Implications are HUGE.

“Impossible” is a hyperbole?

Granting the assumptions above, we have the fundamental calculation problem: with no prices to guide the production process, planners have no idea which productions plans/materials to choose out of the infinite combinations. If they “grope in the dark” and choose one, they have no idea if it was the right one after the fact!

Even if the socialists have been able to create a mighty army of citizens all eager to do the bidding of their masters, what exactly would the socialist planners tell this army to do?

How would they know what products to order their eager slaves to produce, at what stage of production, how much of the product at each stage, what techniques or raw materials to use in that production and how much of each, and where specifically to locate all this production? How would they know their costs, or what process of production is or is not efficient?

The result? Shortages and surpluses found everywhere. Field ready to be farmed but without the gas to drive the tractors or people to drive them. IOW, millions of people starve to death and millions more on the brink of death.

Had REAL consequences for REAL people!

War Communism – Soviet experience. The economy produced a fraction of what it produced before WC. Workers fled the cities for the farms in order to be closer to food production. Estimated 3 to 10 million people died.

“The collapse of the productive forces surpassed anything of the kind that history had ever seen. The country, and the government with it, were at the very edge of the abyss.” -Leon Trotsky on war communism

WC replaced by the NEP after a destructive 4 years.


When government owns the factors of production, there is no market for production goods. No market means no trade in the realm of higher order goods.

Why is this important? When trade exists, what is the result? Prices! AKA exchange ratios. Prices are “social phenomena.”

Why are prices important? Embedded information! Example: You don’t need to know there was a big storm in Florida to know that you should economize (ration) oranges. You see the price went up and therefore, buy less.

In addition to providing the basis of profit and loss, prices convey information to entrepreneurs about the resources available in the economy. It tells them what resources are in abundance and what resources are scarce.

Prices guide what is to be used, how much of it to use, when to use it, and when to stop using it.

Example: We own a pizza shop. Pepperoni is scarce. The price for getting our pepperoni went up and we don’t know why. First scenario, you increase the price of your pepperoni pie and consumers gladly pay it. Second, you increase the price of your pepperoni pie and consumers do not want to pay it. What is the result? At that particular time, at that particular place, pepperoni was better used somewhere else. It was “needed” more elsewhere. Prices told us that if we were to continue to use as much pepperoni as before, we would not be maximizing total consumer satisfaction. IOW, our pizza shop was wasting valuable resources.

Important Austrian insight concerning capital:

Prices and calculation would be a lot less important if capital were homogenous or if all capital were 100% specific.

Capital is heterogeneous! Capital goods are not 100% specific or identical. They have different uses and differing values. They can be employed for various means. There are an infinite amount of ways you can produce electricity or make hamburgers. How on earth do you decide what procedure to use? Where to locate?


Calculation requires a common medium of exchange, aka money.

Example: I ran 5, he ran 10. Who ran longer?

Money is what allows the profit and loss test. Why is the profit and loss test so important?

Without money as the common denominator, there exists no way to compare differing factors of production and structures of production. “Money is the vehicle of economic calculation.”

Money is the means of putting all competing interests on the same level playing field. The baker must compete with the cobbler. The cobbler must compete with the pizza guy. The pizza guy must compete with the Wall St executive. And so on.

All these differing interests compete with one another for the scarce higher order goods and labor. Only with money can they determine whether their actions are satisfying consumer desires.

Real world example:

Granting all assumptions to socialists, here is an example: We “know” we must produce 1,000 purses. With no money prices at a level beyond final consumer goods, how do we figure out HOW to produce 1,000 purses? How much labor should we employ? Should we have just a couple of workers and lots of machinery or lots of workers making them by hand? What material should the purses be made of? Cotton, suede, leather, canvas, wool, etc? If we choose suede, how should we obtain the suede? And on and on and on…

Being advanced technologically can tell you exactly HOW to produce 1,000 purses efficiently, but it cannot tell you:

1. Whether you SHOULD produce 1,000 purses

2. What materials to use

3. Where and how to get the materials

4. WHEN to make them

5. WHERE to put your factories.

Mises on technology’s limit: “[Technology] ignores the economic problem:  to employ the available means in such a way that no want more urgently felt should remain unsatisfied because the means suitable for its attainment were employed – wasted – for the attainment of a want less urgently felt.”

Objections to economic calculation:

  1. Play market: We’ll have our factory managers pretend to pursue profit. (not reality. Managers are beholden to the central planners, not the market. They cannot rationally pursue profit. Instead they pursue not getting murdered).
  2. We’ll have our managers trade with each other! (Trade without ownership is meaningless. Again, succumbs to political interests)
  3. We’ll watch the world market and take their prices (ignores circumstances of time, place, resources, labor, subjective valuation etc)
  4. We’ll copy production practices elsewhere (see above).

Implications for today?

I-70 traffic problems?

Single payer health care?

Written by jlongo12

March 13, 2012 at 10:09 am

Posted in economics