It was the most important debate of its time, maybe of all time. It single-handedly changed the world and led to a “war” of monumental importance. So, what was this debate of ideas? The Lincoln-Douglas Debate? The Scopes Monkey Trial? No…it was the Socialist Economic Calculation Debate led by the esteemed Ludwig von Mises.
Ludwig von Mises & Economic Calculation?
By 1920, even ardent admirers of socialism (defined as a society in which the government owns the means of production) knew they had “an incentive problem.” A society where man was supposed to produce “according to his ability” yet only consume “according to his needs,” left that man little reason to work hard or perform unpleasant tasks. Socialists attempted to sidestep that problem by declaring that a socialist society would somehow cause people to become less selfish and more willing to work for the “greater good.”
Then in 1920, Austrian economist Ludwig von Mises published Economic Calculation in the Socialist Commonwealth. In the process he dropped a bomb on the heretofore unchallenged socialists and thus, launched the Socialist Economic Calculation Debate. As Murray Rothbard put it in The End of Socialism and the Calculation Debate Revisited:
“Mises in effect said: All right, suppose that the socialists have been able to create a mighty army of citizens all eager to do the bidding of their masters, the socialist planners. What exactly would those planners tell this army to do?” ~ Murray Rothbard
Ludwig von Mises didn’t bother with socialism’s problematic incentive issues. Instead, he argued that “rational economic calculation” couldn’t exist in a socialist economy. Since the government owned all productive resources, there were no market-generated prices. And without prices, it was impossible to know the best use for a piece of land or machinery. That made it impossible for central planners to make rational economic decisions.
The Socialists Strike Back
The socialists knew they had a problem. In fact, the problem was so serious that it vexed them for almost two decades. However, 16 years later, the so-called definitive response was published by the neoclassical economist Oskar Lange. Although he, along with Abba Lerner, acknowledged that prices were essential, Lange argued that they didn’t have to come from free markets. A Central Planning Board could tell “managers” of socialist companies to fix prices. These prices could then be adjusted by the managers via complicated equations and trial and error. Lange’s reply was widely applauded by his fellow Neoclassical economists and considered a damning refutation of Ludwig von Mises.
Around this time, Friedrich Hayek, a pupil of Ludwig von Mises, joined the debate. Hayek essentially conceded that Lange was correct in theory. However, he argued that the scheme was impossibly complicated and based on a “perfect world” that looked nothing like the real one. There was just too much information and too many equations that would need to be solved on a continuous basis. But Hayek’s arguments were largely dismissed by mainstream neoclassical economists as mere practical problems. And with that, the Austrian economists were considered defeated…at least for the moment.
“…there can hardly be any room for debate: of course, socialism can work. On this, Lange certainly is convincing. If this is the sole issue, however, one wonders whether at this stage such an elaborate theoretic demonstration is in order. After all, the Soviet planned economy has been operating for thirty years. Whatever else may be said of it, it has not broken down.” ~ Professor Abram Bergson, Socialist Economics
The Soviet Union Problem?
In 1991, the Soviet Union collapsed. And afterward, the grim reality of the situation in that country became apparent to the world. The Soviet Union had falsified its GNP and production numbers for decades. Its citizens lived in abject poverty. Black markets and bribery were rampant and indeed, these markets were often the only reason that basic needs were met.
So, who won the debate between the socialists and the Austrians? Well, Hayek’s criticisms of Lange’s theories were valid. But if these problems could be overcome, perhaps through computers, then it stands to reason that “market socialism” could work. However, if that’s the case, then why did the Soviet Union collapse?
Guerrilla Explorer’s Analysis
I would argue that neither Lange nor Hayek really won the debate. Instead, I’d give the honor to the economist who started it…Ludwig von Mises. Lange and his supporters were focused on proving that they could duplicate prices for consumer goods. Hayek agreed this was possible, at least on a theoretical level. But that was never Mises’s key problem with socialism.
The real problem with socialism isn’t finding prices for consumer goods. The real problem is finding prices for land, machinery, and other means of production. In a socialist economy there will be endless transactions of capital goods in which the government is both the buyer and the seller. Without real markets, there’s no way to determine the value of these things. This is, as Murray Rothbard put it, “where calculational chaos…reigns.”
Ironically, the only reason the Soviet Union lasted as long as it did was because of free markets. The Soviet Union wasn’t a pure socialist economy. Instead, it “borrowed” prices for its capital goods from nations with free economies. Without those prices, it would’ve never lasted as long as it did.
In the end, Ludwig von Mises won the debate. In fact, no one ever successfully challenged his original position. Instead, the Socialists seized on Hayek’s contention that market socialism was feasible, focused their attacks on him, and ignored the arguments posed by Ludwig von Mises. Today, the ideological battle between the Austrians and the socialists continues. While neither side has conceded, its difficult to imagine the socialists ever being able to counter the problems posed by the brilliant Ludwig von Mises.