Socialism: The Calculation Problem Is Not the Knowledge Problem
At the Mises Institute’s upcoming Austrian Economics Research Conference (AERC), there will be a panel commemorating the 30th anniversary of the second debate over socialist calculation. This second debate began with Israel Kirzner’s 1988 Review of Austrian Economics article that analyzed the original debate between Mises, Hayek, and the market socialists, in order to draw lessons for modern Austrians. Kirzner’s article prompted responses from Joe Salerno and other economists associated with the Mises Institute, some of whom will be at the AERC on a panel discussing their role in the second debate.
I will not be able to attend the AERC, but I thought I might share my perspective on the broad question: Is it useful to distinguish between the position staked out by Mises and then Hayek in the grand debate, or is it better to refer to a common “Mises-Hayek” stance? When I was in graduate school at NYU, I would see both Kirzner and Salerno at the weekly “Austrian Colloquium.,” so I was exposed to both of their perspectives. I can remember at the time, I had an attitude of, “Guys, we’re already outnumbered, let’s not fight among ourselves.” But after my last re-reading of Human Action (while writing my book Choice), I was struck by the importance Mises placed on economic calculation. And it seems clear to me that the Misesian “calculation problem” of socialism is not the Hayekian “knowledge problem.”
It should go without saying that nothing in this article is intended to disparage the tremendous contributions of Hayek to both pure economics as well as social science in general. After all, I dedicated my doctoral dissertation to this great capital theorist (along with John Hicks), and for his part Joe Salerno was very complimentary about Hayek during his recent appearance on the Tom Woods Show. Even so, there is a distinction between the “calculation problem” and the “knowledge problem.” It might be fine to use this type of language interchangeably when addressing a lay audience, but certainly academic economists should not be lumping the two together as if they are “saying the same thing.”
Mises Stipulates No Dispersed Knowledge
Let me reiterate: Hayek’s famous “knowledge papers” were masterpieces. I remember that in grad school one of my classmates asked what this “Austrian economics” was all about, and I gave him “The Use of Knowledge in Society” as a good summary. (As it turned out, my friend—who was from Japan—reported a week later that he had tried to read it but didn’t understand what Hayek was saying. I realized just how far the Austrian tradition was from the mathematical equilibrium analysis we were learning in our coursework.)
Even so, all of the problems of dispersed knowledge, tacit knowledge, and how prices are an efficient mechanism for communication of information—none of that is the fundamental flaw Mises attributed to socialism. From the beginning, when Mises would walk through his critique, he would stipulate at the outset that the central planner in a socialist regime had not only good intentions, but also all of the relevant technical knowledge at his disposal. Now to be sure, in the real world these problems do exist: A socialist dictator might be ruthless with his opponents, and (as Hayek stressed) he couldn’t possibly get all of the “facts on the ground” from experts around the country, jammed into his mind in order to make good decisions.
Yet even though these problems are enormous in the real world, nonetheless, for the sake of argument, Mises assumed away the problem of evil and the problem of dispersed knowledge. Yet it would still be the case, Mises claimed, that the socialist planner would be groping in the dark. Even after the fact, the planner would have no way of assessing whether the scarce resources—natural resources, capital goods, and labor—at his disposal were being deployed in the best manner. The socialist planner would have no way of measuring the economic efficiency of his plan for the of society’s resources.
I realize my argument may seem quite simple, but to me it’s obvious that what Mises thought the “calculation problem” was, could not be the “knowledge problem” that we associate with Hayek. To point this out isn’t to disparage the importance of the knowledge problem, it’s merely to note that these are different flaws with socialism.
Hayek’s Initial Response to the Market Socialists
We can gain further evidence that Hayek and Mises weren’t saying identical things when we recall Hayek’s famous reaction to the “mathematical solution” that some economists had proposed in response to Mises. (I summarize these exchanges in my 2006 QJAE article.) Specifically, H.D. Dickinson in 1933 had argued that Mises had overstepped when he claimed (originally in a 1920 article in German) that it would be impossible for socialist planners to rationally arrange economic affairs. Trained in the Walrasion general equilibrium tradition, Dickinson claimed that a socialist planner only needed to know the relevant production functions, resource supplies, and consumer preferences, in order to determine the efficient plan. After all, mathematical economists only had that information, and they were able to generate the “competitive equilibrium” in their models. So why couldn’t a socialist planner do the same thing, at least in principle, for the real world?
In response, Hayek in 1935 argued that such a mathematical solution “is not an impossibility in the sense that it is logically contradictory.” But he dismissed it as a serious answer to Mises because
what is practically relevant here is not the formal structure of the system, but the nature and amount of concrete information required if a numerical solution is to be attempted and the magnitude of the task which this numerical solution must involve in any modern community.
Now we can all agree with Hayek that the socialists pushing a Walrasian system of equations in order to “solve” the economic problem facing society, were fooling themselves if they honestly thought this would work. Nonetheless, Hayek’s reaction took back one of the conditions that Mises had stipulated. In his original salvo (and his formulation would remain the same even by the time he wrote Human Action), Mises didn’t argue that the socialist planners wouldn’t be able to process information in real-time. No, Mises kept stressing that there would be a categorical absence of a special type of information (if we want to use that word) that could only be produced amidst market institutions.
It is not merely pedantic Rothbardians in modern times who thought Hayek had adjusted the gauntlet that Mises threw down. In a famous (and smug) 1936 article, Oskar Lange first paid mock homage to Mises—saying the socialist planners in the future should erect a statue to him—and then argued that Hayek had watered down Mises’ bold claim:
Thus Professor Hayek and Professor Robbins [in their emphasis on the staggering number of equations necessary to actually implement the mathematical solution] have given up the essential point of Professor Mises’ position and retreated to a second line of defence. On principle, they admit, the problem is soluble, but it is to be doubted whether in a socialist community it can be solved by a simple method of trial and error, as it is solved in the capitalist economy.
I do not believe Lange is engaging in a cheap shot here. I think he is correctly pointing out that Hayek’s concession of the logical possibility of the “mathematical solution” is not something that Mises himself would have written. Indeed, in Notes and Recollections Mises refers to these economists pushing the mathematical solution and writes, “They failed to see the very first challenge: How can economic action that always consists of preferring and setting aside, that is, of making unequal valuations, be transformed into equal valuations, and the use of equations?”
“Something New Under the Sun”
When a standard academic economist—trained in the use of Cobb-Douglas production functions and von Neumann-Morgenstern utility functions—reads such a quotation from Mises, he understandably rolls his eyes at the antiquated Austrian thinker. “Of course we can use equations to model human action in the economy,” the modern economist thinks. “How else do people in our actual economy use numbers? If the average shopper can make such judgments, what’s to stop the Ivory Tower professor or even the central planner?”
Yet this is the flip side of the coin. Mises not only identifies the crucial flaw with socialism, but he also explains how a market economy solves the problem. Specifically, the institution of private property and the use of a common medium of exchange, allow for the generation of genuine market prices for all of the goods and services available. Entrepreneurs are then able to engage in monetary calculation, to embark on projects that they think will be profitable and avoid those that will suffer losses. This market process is what allows a capitalist system to efficiently allocate resources, whereas a socialist system cannot—not even “in principle.”
I like the way Joe Salerno explains it in a 1994 article:
…I conceive appraisement as neither knowledge nor arithmetic, but as something new under the sun, introduced into the world only when the institutional prerequisites of a market economy are fulfilled. The social process of appraising thus transcends the purely individual operations of knowing and computing at the same time that it complements them in creating the indispensable conditions for rational choosing by entrepreneurs and resource owners cooperating in the division of labor. [Emphasis added.]
Let me try to motivate the point this way: When we use a thermometer to measure the temperature inside an oven in a commercial bakery, the device transmits information to us. There really is an objective “fact of the matter” of the kinetic energy of the air molecules bouncing around inside the oven, and the thermometer is an imperfect way of translating that data to us, in a form our minds can comprehend and incorporate into our decisions. But there’s no doubt that the oven really has a temperature, regardless of our measuring it with a thermometer.
In contrast, when we ask, “How much economic value does the oven possess?” then that is a fundamentally different question. This isn’t an objective fact that is embedded in the arrangement of matter. The question takes into account all of the subjective preferences of everyone on the planet, as well as their expectations about the possibility of transforming matter into different forms. It is a mind-boggling question, in fact, that can only be answered by setting up a market economy and then making informed guesses as to what people would be willing to pay for the oven.
Mises and Hayek were both brilliant economists who made numerous contributions in the Austrian tradition. Yet is inaccurate to refer to “the Mises-Hayek position” in the famous socialist calculation debate, and to do so obscures the Misesian understanding of calculation, which is necessarily monetary calculation. Although scholars should always take care to exercise courtesy in their assessments, it is proper to disentangle distinct arguments that are sometimes lumped together.