Monday, August 5, 2019

Four Laws: Socialism Can't Compute Prices

There are, I think, Four Laws, scientific principles, if you like, that need to be understood in relation to all proposals for More Government.

The First Law was first enunciated in 1920 by the Austrian Jew Ludwig von Mises, the man that founded the Austrian School of economics in an article titled "Die Wirtschaftrechnung im sozialistischen Gemeinwesen" and translated into English by S. Adler as "Economic Calculation in the Socialist Commonwealth."

Mises expanded on his argument at book length in Socialism: An Economic and Sociological Analysis, first published in German in 1922. The short form of his argument is that socialism cannot work because it cannot compute prices.

In his 1978 Foreword to my copy of Socialism Nobel economist F.A. Hayek writes:
When Socialism appeared in 1922, its impact was profound. It gradually but fundamentally altered the outlook of many of the young idealists returning to their university studies after World War I. I know, for I was one of them... 
Socialism promised to fulfill our hopes for a more rational, more just world. And then came this book. Our hopes were dashed. Socialism told us that we had been looking for improvement in the wrong direction.
What exactly did Mises argue?

Let us assume, he writes, that the socialist state resolves the problem of consumption by handing out coupons for the various consumption goods to which the comrades are entitled. Immediately a market will arise. For instance, "beer tipplers" will want to exchange their non-alcoholic drink coupons with the alcoholic drink coupons of "teetotallers." And then an exchange problem arises.
If, for instance 1 cigar becomes equal to 5 cigarettes, it will be impossible for the administration to fix the arbitrary value of 1 cigar = 3 cigarettes as a basis for the equal distribution of cigars and cigarettes respectively. 
And, in fact, the socialist commonwealth will find itself using the informal prices in the consumer "market" as a guide to socialist production.

The problem is that there are no upstream prices, no way of rationalizing the production processes to deliver, in the end, consumer products in accordance with the demands of the comrades. It is one thing for Robinson Crusoe to make a complete inventory of costs and benefits in his solitary life as he evaluates economic options in his solitary attempt to survive. "In the case of more complicated and more lengthy processes of production it will, plainly, not answer."

In an exchange economy we get prices as the unit of economic calculation.
In the first place, it renders it possible to base the calculation upon the valuations of all participants in trade.
So prices reflect the net effect, today, of all the participants in the market. It also enables participants to determine whether they can participate profitably in the market, making their product or providing their service. Finally, prices provide a way of referring all exchange values back to a single unit: i.e., money.

Of course, money and prices do notd tell us directly about "extra-economic" values. Except, that obviously, they do. Because the "beer-tippler" unconsciously values his beer over other potential choices, such as food for his children. And his choices ripple through the economy.

It is tempting to think of a socialist commonwealth as rather like a big business, that has various divisions and relationships. But the economic calculations of big business are always related to market prices outside the boundaries of the corporation.
For each separate calculation of the particular branches of one and the same enterprise depends exclusively on the fact that is precisely in market dealings that market prices to be taken as the bases of calculation are formed for all kinds of goods and labor employed. Where there is no free market, there is no pricing mechanism; without a pricing mechanism, there is no economic calculation.
This is the vital point. In the market economy, people are buying and selling millions of items every day, setting prices that reflect their value preferences on that day, and those prices ripple up through the production system. And those prices reflect not just what people think and want today but what they think of the future. This is most notable in commodity and stock prices.

Of course there are substitute pricing mechanism in the socialist economy. First of all, there are the prices of commodities and labor outside the socialist commonwealth that the socialist planners can use in their plans.

Then there is Shortages. If a production unit runs out of a certain material then it shows that the socialist Plan has mistaken the demand for that factor of production. But then what? Does the production unit shut down until more product is delivered? Does it do a deal with another nearby production unit? Your pipe for my angle iron? Or do we wait for next year when the planners will have adjusted their plan to account for last year's error. In fact, though, socialist production enterprises tend to want to produce everything in-house, including manhole covers, because of the risk of running out and the uncertainty of getting stuff from other production units.

We moderns all complain about prices. But nobody does anything about it, and just as well.

Because the price system is another proof of God's existence. Who would have thought that individual buying decisions by individual consumers would transmit messages right through the economic "system" giving all participants daily nudges towards adjusting their activities towards satisfying the most urgent needs of the consumer? It's a miracle.

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