Socialist Failures: Explained by Mises

While socialist failures can be observed everywhere, they also have to be theoretically explained. This was done by Ludwig von Mises...

One hundred and one years ago a lecture was given at the Austrian Economic Society which turned out to be one of the seminal events in European intellectual history. It was given in the second week of January 1920 by Austrian economist Ludwig von Mises in Vienna, and what he did was to analyse the socialist economic programme: the abolition of private property rights to the means of production. The topic was highly relevant. Led by Vladimir Lenin, socialists, or communists, had seized power in Russia two years earlier, in November 1917, and it seemed to many that a world revolution was imminent. Communists had briefly taken power in Hungary and Bavaria, and communist parties had much support both in Germany and Austria, in the midst of the rubble after the First World War.

Mises did not employ the usual arguments against communism (although he certainly agreed with them): that under a regime of common property there would not be sufficient incentives for people to make an effort, and that centralisation of economic power could threaten individual freedom. His analysis was different. He asked how the planners who under communism would replace the capitalists and make decisions about production could rationally do so. How could they, if the means of production were not privately owned and transferable between individuals and their companies, compare different alternatives? It is not a problem to choose between 100 and 500 litres of petroleum. The latter is obviously preferable. But what about the choice between 100 litres of petroleum and 100 litres of water, or wine, or some other valuable liquid? In what kind of units can the alternatives be compared?

This, in a nutshell, is what Mises called the calculation problem. It is that the planners cannot make calculations about the estimated costs of different alternatives. This is a problem which is solved spontaneously in a free market where the means of production are priced in a process of exchanges, according to what economists call their marginal utility, or their capacity to satisfy human needs. If you have to choose between transporting timber by road or ship, you can compare the prices of the capital goods required for each alternative and make decisions based on your calculations. But you have no such prices to guide you under a system where all the means of production, all the capital goods, are owned by the state and not priced in a process of exchange. Under capitalism, if wheat becomes much more valuable than milk over the long term, then a landowner will turn a pasture into a cornfield. When an industrial manager has to decide between oil, coal or hydroelectric power as sources of energy, he can compare costs in a common unit, the price.

Mises pointed out that a modern economy is complex and dynamic: there are always some changes taking place, not only normal wear and tear of capital goods such as buildings and machinery, but also unforeseen events such as new technology or a change in demand, or good or bad harvests, not to forget the biblical droughts and plagues. How were the planners to cope with such changes? The father of communism, Karl Marx, had notoriously refused to describe how to implement his ideas. He was not going to write any recipes of the kitchens of the future, as he contemptously put it. Lenin had only vaguely addressed the issue, saying that after the proletarian revolution the whole economy would be organised on the line of the post office. He did not offer any real guidance after the Bolshevik coup in November 1917, only exhorting his subjects to work harder, and keep accurate accounts, and execute all speculators. In a newspaper article in 1918, he had pointed out that Russia possessed enormous resources, ore in the Urals, coal in Western Siberia, oil in the Caucasus, peat in Central Russia, plenty of timber and ample waterpower. But how much of each resource should be developed, and when and how?

Mises’ conclusion was that socialism was impossible to implement in the sense in which its proponents wanted. It could of course be imposed by terror. But the planners could never rationally allocate effort between different alternatives, because they could never calculate or estimate their real costs. When Mises gave his lecture, another well-known economist, Joseph Schumpeter, was in the audience. He suggested, as a thought experiment, that the socialist government would issue an equal amount of money to each citizen and allow them to choose between goods. In this process goods could be priced and allocated. Mises responded that this did not solve the fundamental problem about economic calculation under socialism, which was how to price production goods, not consumption goods. If the means of production were not privately owned, then they could not be exchanged, and if they were not exchanged, production goods could not be properly priced.

By his forceful analysis of the impossible economic task faced by would-be planners, Mises influenced a generation of highly gifted economists: Friedrich von Hayek in Austria, Wilhelm Röpke in Germany, Bertil Ohlin in Sweden, Trygve Hoff in Norway and Lionel Robbins in England. Some socialists later recognised the problem of calculation that Mises had demonstrated. In response, they presented what was called ‘market socialism’, where managers of government-owned enterprises were instructed to exchange capital goods in a competitive process. But Mises was not convinced. He stressed that the process of pricing capital goods in a process of exchanges could not be simulated: Under socialism, even the market socialism envisaged by some, there was no role for entrepreneurs and venture capitalists who make decisions at their own risk.

When communism collapsed under its own weight in the late 1980s, Mises stood vindicated. Certainly enforced accumulation of capital was possible under communism. Resources could be forcibly transferred from agriculture to industry in an effort to modernise the economy, as Stalin did in the 1930s. But what was not possible was to make decisions in such a way that resources were allocated into their most efficient or productive uses, for the consumers. Thus, in the long run communism was bound to lag behind capitalism. This is precisely what happened, not only in the Soviet Union but everywhere else. Compare China, even after she partially reintroduced capitalism, to the other three Chinese economies, of Taiwan, Hong Kong and Singapore. Recall the disastrous socialist experiments in Allende’s Chile, in Ne Win’s Burma, in Mengistu’s Ethiopia and now in Venezuela and compare them to the great strides out of poverty in most of the world in the last forty years. In his critique of socialism and communism, Mises was, and is, right.