Economic Theory

The Socialist Calculation Debate – then and now (Part 1)


On 20 September, the IEA’s Head of Political Economy, Dr Kristian Niemietz, gave a talk at King’s Maths School in London on the topic: “The Socialist Calculation Debate – then and now”. The article below is based on his talk.

 

I am going to talk about the so-called Socialist Calculation Debate, which was one of the major debates within economics of the 20th century: a debate about the feasibility of planned economies.

But first of all, I’d like to say few words about why this matters today, because some of you are probably thinking: “Why should I care what a bunch of dead white guys were arguing about 100 years ago?”

If so: ten years ago, you would have been right. After the fall of the Berlin Wall, and for about a quarter of a century, it was a widely held view that the capitalism-vs-socialism debate was largely settled. When Francis Fukuyama talked about “the end of history”, he did not mean that nothing interesting was going to happen anymore. He meant that the big ideological battles that had defined the 19th and 20th century were over.

For a while, that seemed true. In the 1990s and 2000s, there was a broad acceptance across most of the political spectrum – including the mainstream political Left – that planned economies had failed in practice, and that a successful economy would have to be predominantly market-based. The British Labour Party, for example, demoted its own socialist wing, and, under Tony Blair, rebranded itself as a party that was comfortable with the market economy.

There were, of course, always major disagreements about economic policy: about the appropriate size and scope of the state, about the limits of markets, about how markets should be regulated, about which model of capitalism was the best one. Nobody said that that was ever settled, or even that it could be. But these are debates within capitalism, not debates about whether we should have a capitalist economy at all.

Marxism never went away, but it receded from the frontline of economic policy debates, and became more of an academic subject. There were always prominent anti-capitalist movements, but in the 1990s, 2000s and early 2010s, they were really mostly that: anti-movements, not movements for a specific alternative.

This end-of-history feeling was still notable after the 2015 General Election, when lots of media commentators – including commentators sympathetic to Ed Miliband – argued that Miliband had lost, because he was, rightly or wrongly, seen as “too left-wing”. He had not managed to shed his “Red Ed” image.

Two years later, that idea was comprehensively refuted. If Miliband had lost because he was “too left-wing”, then logically, his successor Jeremy Corbyn, a self-described socialist who was way to the left of Miliband, should have lost by an even bigger margin.

But the exact opposite happened. Corbyn gained ten percentage points compared to Ed Miliband, and something like twenty percentage points among younger voters. He did not quite win, but he clearly did have the enthusiastic support of millions of people.

“Corbynmania” prompted polling companies to ask people more explicitly where they stood on the socialism-vs-capitalism debate, that debate which had supposedly been “settled” with the fall of the Berlin Wall. It turned out that it has not been “settled” at all. The idea that “we are all capitalists now” is completely wrong. Millions of people are very much not. Among young and middle-aged people, at least a relative – and perhaps even an absolute – majority prefer socialism to capitalism. If 1990 was “the end of history”, then history must have restarted itself at some point during the last decade.

This, in a nutshell, is why the Socialist Calculation Debate matters again. It is very much not just a 1920s issue; it is just as much a 2020s issue. That is why it makes sense to know a bit about this, and this is true irrespective of which side of the socialism-vs-capitalism debate you are on.

So what is the Socialist Calculation Debate?

Socialism has had its critics for as long as it existed, as a theory. However, before 1920, that criticism was more about human nature rather than, strictly speaking, about economics. Critics claimed that socialism would be unworkable, because it relies on people’s willingness to work for the common good rather than for themselves, and most people would be too selfish for that.

But the Socialist Calculation Debate is not about that at all.

In 1920, the Austrian economist Ludwig von Mises published a paper called Die Wirtschaftsrechnung im sozialistischen GemeinwesenEconomic Calculation in the Socialist Commonwealth – in which he critiqued socialism from a completely different angle. He went along with the socialists, and just assumed away the issue of human nature:

“[E]ven if we […] grant […] that each individual in a socialist society will exert himself with the same zeal as he does today […], there still remains the problem of measuring the result of economic activity in a socialist commonwealth which does not permit of any economic calculation.”

To see what he meant by that, we need to take a step back.

When we say that a unit of one good, X, is worth five times as much as one unit of a different good, Y – what do we mean by that? How do we know that? How do we know that it is five times as much, rather than 13 times, or 3000 times?

The answer is: because that is the ratio at which people are generally willing to trade X and Y for one another. If you give some people X, and other people Y, and you let them trade with each other, they will converge on that 5:1 exchange ratio.

But for that, you need exchange. If nobody ever trades X and Y, we have no idea what the “correct” ratio is.

Von Mises assumed that even in a socialist economy, there would still be something like “market prices” for consumer goods. That is because he assumed that there would be extensive informal secondary markets. Suppose the state assumes that X is worth three times as much as Y, and hands out rations of X and Y on that basis.

But that is the wrong ratio, because consumers value X five times as much as Y, not three times. People would then start trading with each other, and the 5:1 ratio would be observable in the secondary market. The state could then react to that, and correct the primary allocation.

That never happened, as far as I’m aware. There were extensive black markets under socialism, but I’m not aware of socialist planners observing market prices in those black markets and responding to them. But it was von Mises’s optimistic assumption that a socialist economy could, in this indirect way, still generate something resembling market prices for consumer goods.

But what there could not be is market prices for goods used in production: input factors and capital goods. There would be no market prices for different types of machinery, different types of factory buildings, different types of raw materials, different types of semi-finished goods, and so on.

If we don’t have market prices for those goods, we cannot have economic calculation, in the conventional sense. We cannot work out whether one production method is more efficient than another. We would be faced with myriads of different alternatives, but we would have no rational method for working out which of them are better, and which are worse.

“Socialist planning” would then not just be a bad idea. It would be literally impossible.

 

Continue to Part 2

 

Head of Political Economy

Dr Kristian Niemietz is the IEA's Head of Political Economy. Kristian studied Economics at the Humboldt Universität zu Berlin and the Universidad de Salamanca, graduating in 2007 as Diplom-Volkswirt (≈MSc in Economics). During his studies, he interned at the Central Bank of Bolivia (2004), the National Statistics Office of Paraguay (2005), and at the IEA (2006). He also studied Political Economy at King's College London, graduating in 2013 with a PhD. Kristian previously worked as a Research Fellow at the Berlin-based Institute for Free Enterprise (IUF), and taught Economics at King's College London. He is the author of the books "Socialism: The Failed Idea That Never Dies" (2019), "Universal Healthcare Without The NHS" (2016), "Redefining The Poverty Debate" (2012) and "A New Understanding of Poverty" (2011).


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