Socialism Is as Socialism Does

Since I tell my students not to write mystery novels when presenting an argument, here is my proposed definition: socialism is the prohibition of free entry into markets. This definition is functional in that it focuses on what socialism does. Many define socialism according to its aims, motives, or goals. But individuals can act selfishly or altruistically in the context of any political or economic system. Some socialists promise material abundance, while others extoll the virtues of asceticism. And socialists seek to implement their ideal system through a variety of means, from authoritarian central planning to anarchic communes. By stressing what socialism does, I hope to identify a common thread across these visions. If it walks like socialism and it breaks eggs like socialism, it is socialism.

Why not stick with the tried and true “common ownership of the means of production?” I in no way reject the usefulness of this definition and consider mine complementary to it. But ownership can be understood in a wide variety of ways. Were Soviet factories really owned in common, or were they effectively under the control of party elites? And by focusing on the immediate effects of socialism, I hope to provide a diagnostic tool for various policies and institutional arrangements that de facto operate in a similar way.

To arrive at this functional definition of socialism, I revisit the socialist calculation debate. Not because it is my favorite thing to talk about—though that may be true—but because it concerned a variety of ways in which socialism might be implemented. In what sense do these very different systems all lay claim to the title?

Mises: No Calculation in natura

Though a number of texts predate it, the beginning of the socialist calculation debate is typically attributed to Ludwig von Mises’s 1920 “Economic Calculation in the Socialist Commonwealth.”1 The core of his argument is quite simple. Under socialism, because there is no private ownership of the means of production, there will be no markets for those means. In the absence of markets there will be no prices for these capital goods. And in the absence of prices, it is impossible to determine what how to most economically produce goods and services. In particular, Mises identifies three advantages of market prices for economic calculation (p. 97-98):

• 1. A market price “renders it possible to base the calculation upon the valuations of all participants in trade.”
• 2. Profit and loss calculations allow anyone who engages in production to determine “whether he has worked more economically than others.”
• 3. Lastly, such calculation “makes it possible to refer values back to a unit.”

In a world of scarcity, any act of production involves an opportunity cost. What else could these resources have been used for? As the complexity of production processes increases in deploying a diverse array of capital goods, it becomes impossible to reckon such cost without a common denominator. Should we build the train tracks around the mountain and use up more steel, or through the mountain and use up more drilling equipment? Market prices do not represent some external standard of the truth about opportunity cost, but they do provide an indication of what other individuals think are the best alternative uses of resources. The process of buying and selling aggregates these judgments into an individually usable measure of what we forego and what we gain from production processes.

Mises discusses several alternatives to market prices, arguing that they cannot solve the problem of economic calculation. His primary targets are Marxists and Otto Neurath. Both of these approaches to socialism posit in natura (“in nature”) calculation. Such theories argue that socialist regimes could calculate based on something intrinsic to the nature of economic goods, rather than the extrinsic exchange value assigned from market prices. For instance, Marxists [see Karl Marx] often posited that labor inputs should and could serve as the ultimate unit of economic calculation and distribution. Mises points out the fundamental problem that just as there are a great diversity of capital goods, there is great diversity in labor. In natura approaches contrast most sharply with Mises’s insistence on exchange value and thus prices as the only way to reckon opportunity cost in a complex economy. I am not concerned here with the substance of Mises’s critique, but only that it took aim at these in natura arguments.

A Lange-Winded Response

In 1935, F.A. Hayek published an edited collection Collectivist Economic Planning, which includes an English-language translation of Mises’s 1920 article. In response, Oskar Lange tries to rehabilitate socialism in a two-part essay the Review of Economic Studies.2 Lange’s opening move is bold: he admits that Mises is right. Economic calculation is vital to the success of a socialist economy, and it does require money prices. No money prices, no calculation of opportunity cost, no material abundance.

Where Lange disagrees with Mises is in the necessity of market institutions. Lange argues that prices for the various factors of production could be set by socialist central planners. In a perfectly competitive market equilibrium, he points out, we know that two conditions obtain (pp. 58-59). First, the average cost to produce a given unit of a good will be minimized. That is, when considering the cost of production of all cars, the cost per unit will be as low as humanly possible. Second, the marginal cost of producing the last unit of a good will equal the price of that good. If it takes ₽5,000 to make the last car produced, it will sell for ₽5,000. Producers will have squeezed every last bit of consumer surplus out of the market. These twin relations are shown in Figure 1, which haunts the nightmares of many Econ 101 students. (If you think economists get excited when two curves intersect, just imagine how happy they are when it’s three curves.)

After reviewing these conditions, Lange offers a fairly straightforward proposal (pp. 60-66). Free markets in consumer goods and labor would remain. A Central Planning Board would set accounting prices for capital goods. Production plant managers—the equivalent of entrepreneurs, but government officials instead of private owners—would use those accounting prices to calculate the least cost method of production (minimizing average cost). Directors of industries, such as the car czar, would expand or contract the number of production plants so that marginal cost equals the price. In essence, Lange proposed to use the theory of how markets work as a substitute for actual markets. Hence, market socialism. The calculation problem: solved.

How would the Central Planning Board set prices? Don’t even worry about it, says Lange. They definitely wouldn’t need a complex set of simultaneous equations (pp. 66-67).3 They could even pick prices arbitrarily. If those prices turned out to not be equilibrium prices, they would be able to observe surpluses and shortages of goods. Just like markets do, they would approach equilibrium through a process of trial and error. The system might even approach equilibrium faster since the planners would be adjusting multiple prices at once instead of just one.

Hayek’s Rejoinder

There are many potential objections to Lange’s proposal. I want to focus on one in particular. Several of Hayek’s most famous articles—”Economics and Knowledge,” “The Use of Knowledge in Society,” and “The Meaning of Competition”—can best be understood against the backdrop of the calculation debate.4 In these articles, Hayek articulates a view of how a competitive process makes use of widely dispersed knowledge about economic conditions.

A lot of ink has been spilled about the extent to which Hayek’s rejoinders to the market socialists are similar to or different from the argument put forward by Mises. Some insist that Mises’s calculation argument has nothing to do with knowledge.5 When considering this possibility, is important to keep in mind that Mises and Hayek were taking aim at two very different proposals for implementing socialism. Mises sought to answer the question: what can socialism use to calculate, if not prices? Hayek had to answer the question: what makes market capitalist prices different from market socialist prices?

One answer is to retreat to incentives. Socialist plant managers, industry czars, and central planners simply will not have the incentives that private owners of capital would have in a market system. This rejoinder is true, but I have never found it satisfying. This is the “socialism is great in theory, but not in practice” response. It is a retreat from the original Mises-Hayek view, which is that socialism is, in fact, bad in theory.

Hayek’s tack is different. Echoing Mises’s 1920 claim that there is an “intellectual division of labor” (p. 102) at play in market societies, Hayek insists on the importance of the division of knowledge (p. 50). Knowledge about the relative scarcity of factors of production is not given to any one mind in its entirety. This often idiosyncratic or even tacit knowledge is dispersed throughout society. Market capitalist prices reflect—however imperfectly—this broadly dispersed knowledge. Market socialist prices reflect only the knowledge of the Central Planning Board. Don Lavoie would later come to call this the knowledge problem.6 Market socialism can introduce a common denominator for economic calculation, but the prices expressed in that denominator do not reflect economic reality to nearly the extent that free market prices do.

Kirzner’s Synthesis

Decades later, Israel Kirzner offers a helpful clarification of the difference between market socialism and market capitalism. In an article building on Don Lavoie’s Rivalry and Central Planning, Kirzner argues that it is no accident that Mises’s post-debate work placed entrepreneurship at the center of the market process.7 The entrepreneur, for Mises, is “the first to understand that there is a discrepancy between is done and what could be done” (p. 336).8 Entrepreneurship drives the market towards increased levels of coordination, driving the prices of production goods to more accurately reflect their relative scarcities.9

In a second article, arguing for the essential continuity between Mises and Hayek’s views, Kirzner draws these threads together.10 Misesian entrepreneurs solve Hayekian knowledge problems. Real, existing prices are never equilibrium prices that would result in perfect coordination between market participants. They need not even be “proximate” or “close” to their equilibrium values. Nonetheless, they reflect “the best available entrepreneurial knowledge concerning market conditions” (p. 223). Because entrepreneurship wins profits or incurs losses, those entrepreneurs most attuned to the conditions of the market will typically have more resources at their disposal than those who are less alert. Market prices are not perfect but they do reflect knowledge that is dispersed and judgment that has passed a selection test.

The key condition for this “marvel” is freedom of entry. “It is only the possibility of unrestricted entrepreneurial entry which permits more alert entrepreneurs to deploy their superior vision of the future in order to correct the misallocations of resources reflected in the false prices which characterize disequilibrium” (p. 216). Prices do not move by magic. They move when entrepreneurs bid them up or mark them down. It is only prices that are subject to such revision that can effectively guide economic calculation.

Entrepreneurship, for Mises and Kirzner, is not the province of an elite class of businessmen. It is a part of human action. “In any real and living economy every actor is always an entrepreneur and speculator” (Mises 2007, p. 252). The more expansive freedom of entry is, the more likely is it that errors will be detected and corrected. We do not know ex ante whose knowledge will prove relevant to producing what we want at least cost. Freedom of entry means that anyone can have a go, tapping maximally into the dispersed knowledge of a modern society.

Following Kirzner, then, an essential component of a free economy is freedom of entry. By contrast, as Murray Rothbard notes, “a centrally planned economy is a centrally prohibited economy (p. 831).11 In order for there to be a central plan at all, private entrepreneurs must be prohibited from driving production decisions. A Central Planning Board may still act entrepreneurially in changing The Plan. But they will act without prices shaped by other entrepreneurs’ knowledge, alertness, and judgment. It is precisely the prohibition on exercising the entrepreneurial function that makes calculation in a socialist economy arbitrary.

De Facto and De Jure Socialism

Having made my argument as to why socialism can be understood as a prohibition of free entry, I now turn to why such a definition might be useful. Political economists are wont to distinguish between de jure edicts—what official law or policy declares to be the case—and de facto realities—what in fact is the case. By focusing on what socialism does rather than how it is constituted, the prohibition view allows us to distinguish between socialism in name and socialism in practice.

This definition does confront an important ambiguity that must be noted. Prohibitions are rarely, if ever, complete. As with all definitions of socialism, the prohibition view admits of degrees and of variation. Governments try to prohibit drugs, but they often remain available. Black markets also thrive in socialist countries. Some level of private enterprise is usually tolerated while the “commanding heights” remain under government control. Likewise, there are variations in the degree of prohibition. The most socialist states ban many forms of private enterprise outright, though even there a private individual might gain the ear of a high official and be allowed to proceed. Less stringent implementations make entrepreneurs go through a lengthy and costly process of introducing a new enterprise.

The prohibition view of socialism is thus congenial with Gary Anderson and Peter Boettke’s observation that Soviet socialism was not, for most of its existence, central planning per se.12 Rather, it was a decentralized but heavily interventionist system of extraction by elites of wealth that was largely produced in black and gray markets. Elite party members had de facto control of large and visible productive resources (contra the common ownership view) and prohibited entry into those markets. There was a formally socialist economy that existed parasitically on top of informal economic activity.

What about fascism? Contemporary socialists get quite agitated when proponents of economic liberalism identify national socialists as socialists. In a fascist economy, productive resources are privately owned, but their decisions are coordinated with one another and the central government. Rather than focusing on ownership and coordination, the prohibition view asks a different question: was someone who thought they had a better idea of how to organize production free to have a go? Were they permitted to buy productive resources and deploy them according to their own vision of the future? If not, then fascism counts as socialism.

Finally, let’s turn back to Lange. One might object that market socialism doesn’t really count as socialism, since consumer and labor preferences and quasi-market forces still shape production decisions. But it still shares the same functional limitations as cruder forms of central planning. The central planning board promulgates commands to industry czars and plant managers about how to combine resources in a way that is supposed to substitute for how freedom of entry shapes the size of industries (pp 58-60). In this formulation, Lange ignores the most important feature of freedom of entry, that it brings new ideas into an industry.

Even the managers in Lange’s scheme lack much capacity for entrepreneurship. Those who make production decisions are not to treat prices as Misesian entrepreneurs do. In the Mises-Kirzner view, entrepreneurs treat prices as inputs into decision making but not determinants of decision making. Indeed, a key function of entrepreneurship is to identify where current prices are sending incorrect signals. By contrast, for Lange “the parametric function of prices must be imposed on [managers] by the Central Planning Board as an accounting rule” (p. 63). Lange’s managers are prohibited from making use of their idiosyncratic knowledge, alertness, and judgment.

Not all socialists ascribe to the ideal of central planning. Common ownership can be understood in a wide variety of ways, and implemented in more or less decentralized fashions. Some stress ballot democracy, others deliberation, and still others are just fine with an elite vanguard shepherding the people. What all these alternatives share, however, is the idea that individuals are either outright prohibited from or must seek permission to act on their imaginative views of how to serve others. Socialism is as socialism does, and what it does is outlaw the creativity that enables economic adaptation and progress.

Footnotes

[1] Ludwig von Mises, “Economic Calculation in the Socialist Commonwealth,” in Hayek, ed. Collectivist Economic Planning. George Routledge and Sons, 1935.

[2] Oskar Lange, “On the Economic Theory of Socialism,” The Review of Economic Studies, Volume 4, Issue 1, October 1936

[3] It is hard to see how central planners could avoid the use of some formulas. A key insight of price theory is that markets are interdependent. The price of beef is affected by the prices of pork and of hamburger buns. Without appeal to some mathematical tools, the Central Planning Board really would be blindly groping.

[4] Collected in F.A. Hayek, Individualism and Economic Order, University of Chicago 1948.

[5] Mises might be surprised by the claim that knowledge was not central to his original argument. Economic calculation “affords us a guide through the oppressive plenitude of economic potentialities” (p. 101). “The human mind cannot orientate itself properly among the bewildering mass of intermediate products and potentialities of production without such aid [of calculation]” (p. 103). “Every graded system of pricing proceeds from the fact that men always and ever harmonize their own requirements with their estimation of economic facts” (p. 107). “We cannot act economically if we are not in a position to understand economizing” (p. 120).

[6] Don Lavoie, National Economic Planning: What is Left? Cato 1985.

[7] Israel Kirzner, “The Economic Calculation Debate: Lessons for Austrians,” in Peter Boettke and Fred Sautet, eds., Competition, Economic Planning, and the Knowledge Problem, Liberty Fund 2018.

[8] Ludwig von Mises, Human Action: A Treatise on Economics, Vol. 2, Liberty Fund 2007.

[9] This is not to say that this is all that entrepreneurship does. Calm down, Schumpeterians. Joseph Alois Schumpeter, 1883-1950.

[10] Israel Kirzner, “Reflections on the Misesian Legacy in Economics,” in Peter Boettke and Fred Sautet, eds., Ludwig von Mises: The Man and His Economics. Liberty Fund 2019.

[11] Murray Rothbard, Man, Economy and State. D. van Nostrand, 1962.

[12] Gary Anderson and Peter Boettke, “Soviet Venality: A Rent-Seeking Model of the Communist State,” Public Choice Vol. 93, 1997.)