Economic calculation problem

From Academic Kids

The economic calculation problem is a criticism of socialist economics. It was first proposed by Ludwig von Mises in 1920. Those who agree with this criticism claim it is a refutation of socialism and that it shows why a socialist command economy could never work.


Liberal thinkers

Many liberal thinkers, especially those of the Austrian School believed Marxist economics to be impractical because it denied private ownership of productive property. They state that prices represent information about market conditions, and are necessary for economic activity. In this view a socialist economy, therefore, would require a price system in order to operate. The socialist economy is said not to set prices as efficiently as private owners, as private property owners seek the best profits for factors of production they owned, even in constantly changing circumstances. It would be this process that would ensure the best use of resources for the capitalists.

This was first stated by Friedrich von Wieser and a good summation of this case was that of Ludwig von Mises in his article "Economic Calculation in the Socialist Commonwealth".


Hayek further refined this by pointing out that by the time all the relevant information had been gathered the situation would have changed and so the government would be chasing a moving target. In their view, prices in a free market on the other hand instantly conveyed information on the demand and scarcity of products. In theory, the free market was effectively "self organising" in a way that a centrally planned one could never be. He also felt there were other dangers inherent in a planned economy, illustrated in his "The road to serfdom".

Extended explanation of argument

The argument goes roughly as follows:

  1. The variation and selection, in the market, of prices for goods and services (including capital goods) are the means by which consumers and producers become aware of needs and the availability of supplies.
  2. Without private property in the means of production of goods and services, there will be no market system and hence no pricing mechanism.
  3. Without the information the pricing mechanism provides, participants in the economy will be unable to calculate efficient use of capital to produce the goods and services proportionally with demand, or to efficiently choose among goods.

The ostensible result is that socialisms produce inefficient distributions of production. Historical examples include the Soviet Union's cyclical shortages of various goods, and efforts to resolve the economic calculation problem was one of the main goals of Chinese economic reform in the 1980s.

This argument served as the starting point for F. A. Hayek's work on the use of knowledge in society. He contended that the only rational solution to the economic calculation problem is to utilize all the dispersed knowledge in the market place through the use of price signals.


A road needs to be built from Place A to Place B. In between, there is a mountain.

Several methods could be used:

  • The road could go around the mountain.
  • The road could tunnel through the mountain.
  • The road could go over the mountain.

Each method has costs and benefits.

How does one calculate the comparative costs of different options, without prices? Vital information about the relative cost of labor, materials, delays, impact on travel time, etc. is automatically aggregated from thousands of factors into prices, in a market economy. It would be impractical for a central planning authority to gather and compare all this information, changing it in real time.


This was attacked on two fronts. Firstly by the believers in the general equilibrium theory who maintained that all that mattered was the knowledge of the most effective use of materials (who denied the marginalist theories which are now more widely boosted) as long as the price system was in use. It was also attacked by Marxists, who see prices, e.g. the ratio in which commodities (including money) are exchanged with one another, as just one small part of a process of production which has the primary purpose of profit according to the Labor theory of value.

Some socialists respond that this argument rests on the assumption that socialism would be a completely centralised economy based on society wide planning, but that in fact it need not necessarily be so. This counter-argument suggests a decentralized form of socialism with different levels of planning -- local, regional and global. This, they claim, would allow for a self-regulating mechanism of stock control to come into play (which cannot happen in the case of society-wide or central planning).

In this model, distribution points replenish stock as it is removed from the shelves by signaling to producers’ orders for new stock. Producers in turn contact their own suppliers of inputs as and when it is required and so on down the production.

According to the law of the minimum (after Justus von Liebig) those factors that are most scarce in relation to demand, that constitute the "limiting factor" which proximately limits the production of any good, are precisely those that need most to be economised. The shortage of such factors as revealed via the self-regulating system of stock control will trigger the search for more abundant substitutes. This, some socialists claim, would overcome the economic calculation problem.


One response to this criticism is that fundamentally the calculation problem does not in fact rest on an assumption of centralization of decision making. Indeed, problems very similar can occur in decentralized systems, wherever the persons making choices are insulated from the inefficiencies of those choices.

Another response is to point out that the "stock control plus law of the minimum" proposal ignores the key difficulty identified by the economic calculation problem: the measurement of costs of production according to a common unit. For efficient allocation, it's necessary to have a common unit of cost for all the many thousands of productive inputs. Such a unit is given by market prices, but is not given by stock control or by the law of the minimum.


Decentralist socialists argue that while the calculation problem may not in itself rest on the assumption of society-wide or central planning, the resolution of that "problem" in a non-market society will remain obfuscated or hidden from view if one assumes such a society to be a central planned one in this sense. This is because the notion of central planning necessarily precludes the operation of a self regulating system of stock control which is a key component of an effective counter-argument to the economic calculation argument along with calculation in kind (Otto Neurath) and the law of the minimum.

It could also be argued that the philosophical basis of the calculation problem has a fatal flaw. Proponents argue that optimum economic settings are unknowable but also purport to know that the market can provide them.

Chinese socialism

The method used by China to resolve the economic calculation problem is that of a socialist market economy, in which the goals and the ownership are largely public, but this exists within a market pricing system. Of course, one might question whether China is still a socialist economy as it claims, when the means of production are increasingly privately owned and the Gini coefficient is higher than many capitalist countries.


One of the more surprising entries in the debate was this from Trotsky:

"If there existed the universal mind, that projected itself into the scientific fancy of Laplace; a mind that would register simultaneously all the processes of nature and of society, that could measure the dynamics of their motion, that could forecast the results of their inter-reactions, such a mind, of course, could a priori draw up a faultless and an exhaustive economic plan, beginning with a number of hectares of wheat and down to the last button for a vest. In truth, the bureaucracy often conceives that just such a mind is at its disposal; that is why it so easily frees itself from the control of the market and of Soviet democracy."

"The innumerable living participants of economy, State as well as private, collective as well as individual, must give notice of their needs and of their relative strength not only through the statistical determinations of plan commissions but by the direct pressure of supply and demand. The plan is checked and to a considerable measure, realized through the market. The regulation of the market itself must depend upon the tendencies that are brought out through its medium. The blueprints produced by the offices must demonstrate their economic expediency through commercial calculation."

Economic accounting is unthinkable without market relations."

Leon Trotsky, "Soviet Economy in Danger", New York, 1933. Quoted in "Real Socialism Wouldn't Work Either".

See also

For elucidation of the economic calculation problem, see:


D.R. Steele, From Marx to Mises (Chicago: Open Court, 1992) ISBN 0812690168

External links


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