In the war between capitalism and socialism millions shed their blood, in the streets of Budapest and Santiago de Chile, in the jungles of Angola and Vietnam. And yet, bullets weren’t the only ammunition used in this, the conflict that defined the 20th century, and that in a way remains unsolved. Academics and intellectuals throughout the world also clashed in a fierce battle for the ideological supremacy of both economic systems. In 1920, Ludwig von Mises, then a professor at the University of Vienna, escalated the conflict to stratospheric levels when he posited in his essay, “Economic Calculation in the Socialist Commonwealth”, that there was an insuperable impossibility at the heart of the socialist plan. 

What followed was a decades-long battle between some of the finest economists of the past century, known as the “Socialist Calculation Debate”. The Debate is a fascinating episode, from which one can learn many lessons about how markets work or how socialist economies should work in principle. But after the fall of the Berlin Wall, the issues related to the Debate faded away, the world entered an age where capitalism appeared to emerge as the great winner and such ideas were irrelevant. Of course, that is incorrect.

Socialism has lived over the past three decades, not only as a theoretical construct but also as a new political reality for millions of people. For example, in Latin America, the “Socialismo del Siglo 21” (the “XXI Century Socialism”) promoted by Hugo Chavez in Venezuela became the frame of reference for the government plans of the left and right, which positioned themselves as followers or opponents of that plan. The intention of the Socialismo del Siglo 21 to become a pan-regional phenomenon has evaporated. Still, at a local level, the question of whether the next president will be a socialist or not remains of utmost importance to Latin Americans.

Since the Great Financial Crisis of 2008, many in the United States and Europe have raised the point that perhaps we should all give socialism another chance, a concern that I am sure will exacerbate the aftermath of the Covid pandemic during the next decade. The conversation on socialism is thus far from over, and we would do well not to forget the lessons left by the Socialist Calculation Debate 

Reading Mises

“Economic Calculation in the Socialist Commonwealth” is an essay of about thirty pages that doesn’t need many prerequisites, though perhaps some patience to be read. The language is somewhat ambiguous, and the ideas are not elaborated with clarity. However, most frustrating is to realize that Mises makes a series of critical observations but falls into the trap of vanity when he believes that they are much more lethal than they genuinely are.

Let’s be clear then: Mises makes a relevant characterization of capitalist markets, but at no point does he succeed in achieving that seductive promise that he has found the impossibility of socialism. 

First, let’s focus on the positive message. Mises makes an appropriate observation about a phenomenon of capitalism, which, if I had to summarize it to send it in a tweet, would be something like “A capitalist economy allows the generation of prices of goods, which are then used to plan production.” This somewhat dry sentence is less trivial than it sounds and needs to be explained in more detail.

Let’s start with “capitalist economy”, a system that for me (and in my words) has the following six elements:

• Capitalism: When we produce something, we do it because we can make a profit that we can keep.
• Private property: The things we need to produce belong to me or someone else, but not to the state. In particular, the state does not own absolutely all producer goods.
• Free market: any pair of people have the right to exchange any good.
• Money: There is a universal exchange unit.
• Competition: anyone has the right to try to produce any good.
• Entrepreneur: a person who seeks new ways to produce goods or seeks to create new ones.

Two remarks. The first: These six elements may or may not overlap and may or may not be dependent on each other. One could try to think if there can be Capitalism without Free Market or Entrepreneurs without Competition. Those are interesting questions, but I will not deal with them in this post.

The second: It should be clear that one cannot say whether an economy is capitalist or not, but rather what level of development these different six elements have. There isn’t and never has been such a thing as a “100% capitalist” economy.

In my description of these six elements of the capitalist economy, I use the word “people” loosely. I suppose that if I were writing something a little more formal and not a blog post, I would write “economic agent” (oh, but how boring!), that is, any individual or group of individuals that produces or consumes goods in an economy. Here are ten examples of those agents:

1. Me
2. You
3. The other 7.8 billion people in the world
4. The 1.5 billion households in the world
5. The more than 300 million companies that exist in the world
6. The government of Japan
7. The Regional Government of Cundinamarca in Colombia
8. The Southwark Council in London
9. The “Friends for the Reconstruction of Notre Dame” organization
10. The “International Club of Tall People” foundation

Any of these individuals or groups of individuals are consumer agents when they acquire some product that they want or need from the market (a tomato, a computer, a nuclear reactor). Many of these consumer agents also play a dual role, as producer agents, supplying the market with all kinds of goods (an X-ray, a semiconductor, a bag of coffee).

Although the taxonomy of the goods that an economy produces can be quite complex, it is beneficial to distinguish them based on their usage: some goods are meant to be consumed, and therefore their usefulness is terminal, and some others are used within the supply chain of other goods or services. The former are known as consumer goods and the latter capital or producer goods (though Mises calls them low-order goods and high-order goods, respectively, a terminology that I find quite appropriate).   

A consumer good is the coffee I had this morning at Starbucks, as well as a rug that the Maltese government bought to adorn the Prime Minister’s office and the tires that NASA bought to put on the rover vehicle it sent to Mars last year. Producer goods are the computer program used by a visual effects specialist, the scissors of a hairdresser, and the refrigerator that my local store has to keep the beer

Where do the prices come from?

We have now all the terminology to understand the following observation that Mises made about capitalist economies. Consumers are well aware of their preferences regarding the products they want or need, and to some extent can organize them, say, from highest to lowest. For example, a couple of weeks ago, when I was looking for a cell phone protector, I had a greater preference for the transparent one than for the golden one, and I preferred this one over another with a sticker of Sailor Moon. With its ability to freely exchange products, the market transforms (and this is the crucial part) those ordered preferences of all consumers into numbers called prices. For example, the prices of the three cell phone protectors were £5.99, £4.50 and £7.15 respectively. In a completely decentralized way, the market took the preferences of all people that have looked for cell phone protectors and determined that the price of the transparent one is higher than the awful golden protector but lower than the one stamped with a children’s comic figure.

In slightly more technical words, for each good in the economy the market takes a collection of ordinal number (that is, the preferences of consumers and given with numbers like “first”, “third”, or “seventh”) in a single cardinal number that we call price (5.99, 4.50, or 7.15). This transformation is extraordinary and is one of the aspects that makes the market a piece of truly exceptional machinery.

Having described this transformation of preferences into prices (which he had already presented in his 1912 book “The Theory of Money and Credit”), Mises focuses on producer goods. His central thesis on the “Economic Calculation in the Socialist Commonwealth” is that such goods, being privately owned, are also subject to be exchanged in the market, and therefore may also be associated with prices that reflect preferences.

For Mises, it is of utmost importance that production goods have prices, as this allows to do all sorts of mathematical calculations to guide the overall production in an economy. He gives the example of the construction of a new railroad: “Should it be built? And if so, which of all conceivable roads should be built?” The prices of producer goods associated with the different possible routes can be combined to obtain monetary calculations of the costs and benefits of each of them. Such calculations may determine that, for example, route A is better than route B, as it requires fewer resources or gives higher profits. The possibility of doing such a calculation applies regardless of whether one is looking to produce pencils or space telescopes. 

There are countless ways to produce all the goods in an economy, but the price system brings some order to this tangle of possibilities by reducing its complexity. Or, in other words, the price system helps simplify a problem that, in principle, is unfathomable and makes finite a problem that, in principle, is infinite.

Anything is possible (including socialism)

I like Mises’s observation of the market because he displays it as a computing machine that is supplied with certain “inputs” and produces a specific “output.” As such, we can study the market as a form of technology with strengths, limitations, and potential improvements. Mises is way too descriptive of how the market takes all those consumer preferences and transforms them into a series of prices, a complex phenomenon called “price formation” that requires advanced mathematical modelling. But let’s say that Mises is an early reference to this fundamental aspect of societal dynamics, and he deserves praise for it.

However, Mises’s ambition was not simply to say what the market made possible but rather to turn the argument around and conclude that socialism was impossible. 

Specifically, Mises says that in a socialist society, it is impossible to do this “economic calculation”; that is, there is no way to reduce the complexity of the different variations of production processes through a price system. The reason why these prices cannot exist? As all the means of production belong to the state, there is no possibility that they are subject to commercial exchange in a universal monetary unit, and therefore there is no formation of prices that reflect their scarcity or their level of demand. End of the argument.

Digging in the essay, one finds that Mises’s argumentative principle is basically “capitalist society achieves such thing; since socialism is not capitalism we conclude that socialism cannot achieve such thing.” Arguing in this way is perfectly wrong, so much so that it has its own classification among logical fallacies: denying the antecedent. If A happens, then B happens; since A does not happen, then B does not happen (if I win the lottery, then I become a millionaire; if I do not win the lottery, I do not become a millionaire).

Denying the antecedent is a common fallacy, I think, because the first sentence (if A happens, then B happens) is true, and we are baffled when thinking that something true can lead to something false. In Mises’s argument, this first sentence is a novel and significant observation about the market. It is also shocking, as one realizes that what the “capitalist society achieves” is nothing less than solving a problem of such complexity that it could well have no solution at all. He explicitly says:

“The human mind cannot orient itself properly among the bewildering mass of intermediate products and potentialities of production without [the help of an economic calculation]. It would simply stand perplexed before the problems of management and location.”

What all the fallacies of denying of the antecedent have in common is that they ignore all other alternatives that drive or explain a phenomenon (I can become a millionaire with a very lucrative job, with a generous inheritance, or by betting on the horses, not only by winning the lottery ). To the complex problem of guiding production, Mises confronts it with a couple of possible socialist solutions. Since these do not contemplate private property or market exchange, he creates the illusion that no socialist solution can solve that problem. You can see it directly in the essay, just a couple of sentences after the one I quoted previously:

“As soon as one gives up the conception of a freely established monetary price for goods of a higher order [i.e., producer goods], rational production becomes completely impossible. Every step that takes us away from private ownership of the means of production and from the use of money also takes us away from rational economics.”

Mises and many of his followers insist without blushing that this argument demonstrates the impossibility of socialism. And make no mistake, they are not using that word, “impossibility”, with the lightness that one uses it when he says, for example, “it was impossible to find a parking space.” No, for them, “The Economic Calculation in Socialist Commonwealth” demonstrated such impossibility with the rigour you would find in a mathematical argument.

A few months ago, I dedicated two entries in this blog to reflect on the concept of “impossibility” and how difficult it is to establish the impossibility of anything. Not even in the realm of physics, one can dare to say that something is impossible. After all, all we have are models of reality, not intended to be universal but rather to accommodate a series of experimental observations. Trying to say that something is impossible in social science is almost a joke because even the terms cannot be defined unambiguously. It is then no coincidence that every time Mises’s argument was refuted, his defenders moved the goalposts and redefined what was meant by “socialism” or “private property.”

There is no 100% socialist society, nor is there a unique way of implementing a socialist mode of production. If Mises wanted to show that socialism is impossible, he had to show that none of its infinite possible implementations successfully guides the production.  

The “impossibility” of socialism reminds me of Marx’s “contradictions” of capitalism, those that are supposed to bring its impending collapse. Both ideas suggest that they have clean abstractions that perfectly encapsulate social dynamics instead of recognizing that they are only first-order approximations. I am always flabbergastered with the fascination that some economists manifest for appearing more rigorous than their field allows or needs, but hey, who am I to judge. 

Mises did not prove that socialism is impossible, so to the disappointment of some and the enthusiasm of others, we must continue to assert that socialism is possible. But this phrase should not cause great emotions; after all, to affirm that something is possible is actually to say nothing because anything is possible in this universe.

That Mises had a flawed argument does not mean that there were no repercussions after his work. His contribution led some socialists to wonder if there wasn’t something technical – not just moral or political, but purely technical – that they forgot and that they should somehow correct to achieve the socialist dream.

Thus began the Socialist Calculation Debate.