The Calculation Problem

PICTURE YOURSELF AS the head planner of a global socialist state. The recent spring months in the Northern Hemisphere have been unusually hot and dry. Your minions come to you to ask how to adjust the agricultural plan for the upcoming summer. All of the farm managers are crying out for more water, but there is not enough to meet all of their requests, while still supplying the city-folk with drinking water and keeping the factories that use water up and running.

Your alternatives are legion. To help comprehend the multitude of options facing you, consider some of the numbers involved. In 1999 there were over two million farms in the U.S. alone. If the growing season was dry across the Northern Hemisphere as a whole, then millions of other farms will have been affected.

Since water is extremely divisible, you could allocate to any particular farm perhaps one of millions of different amounts of water. Of course, to be useful, the water must arrive at the farm. There are probably many ways to deliver it. For any particular farm, you might decide to re-route city drinking water to it, build an aqueduct servicing its area, construct a de-salinization plant nearby, have trucks regularly deliver it water, or some other method of which I haven’t conceived. Each strategy will differently affect other water users.

A particular farm, given its allotment of water under the new plan, might cope in a variety of ways. Water conservation devices could be installed, different crops raised, less total weight of crop produced, or, I’m sure, the reduced supply might be dealt with by other means that a farmer could tell you about but I can’t. The central plan must take into account all such possibilities. And you, as the central planner, might also consider closing some farms, thereby freeing resources for other employment. Just what is the number of possible solutions you might consider? Is it in the trillions? Quadrillions?
How can you decide which course of action you should take? Unfortunately, there aren’t any rational means by which you can decide. You must simply venture a guess as to how the plan should be adjusted, then order your minions to so adjust it. You can’t arrive at a reasoned answer to your dilemma because you lack market prices for the factors of production to which you must assign a use. Market prices are the foundation of business accounting. Without them, there can be no meaningful calculation of the profit or loss resulting from any enterprise. (Sometimes socialists claim that is unimportant, since profit and loss are concepts that only apply to the market economy. As we have seen, that is not true: all human action aims at profiting the actor and seeks to avoid loss. Socialism cannot dodge the fact that the means we use to achieve our goals are scarce, and, therefore, must be economized.)

The central feature of socialism is that the factors of production must not be under private control. If they were, then greedy capitalists would use their ownership of those goods to exploit the workers. Instead, capital goods should be controlled by “the public,” which always, in practice, means the state.
Therefore, the market process, the ceaseless striving of entrepreneurs to locate price discrepancies and profit from them, thus better adjusting production to the wishes of the consumers, is absent from the socialist economy. Unfortunately for the hopes of socialists, there is no adequate substitute. The mathematical equations describing the equilibrium prices of the evenly rotating economy are of no use in determining what actions, if undertaken in the real world, would move prices toward that equilibrium. Attempts to create “pseudo-markets” among socialist managers, hopefully resulting in “market-like” prices, are similar to playing chess against one’s self: without the real competition that exists among private property owners, the socialist managers lack both the incentives and the feedback necessary to drive the market process towards the discovery of better prices.

To aid in understanding this crucial fact, let’s now envision a drought in a place where water is bought and sold on a free market. (The U.S. is not such a place, as local, state and federal agencies all continually intervene in the market for water.) There, it is the interplay of the choices of all affected individuals that determines the response to a drought. Most of those individuals are better aware of their own circumstances and options than is anyone else. Perhaps Farmer Joe has some rolls of black plastic sitting around in his barn. When water prices rise in response to the drought, he finds it worth his while to unroll them and lay them around his crops, thereby reducing his need for water. For some time Farmer Mary has been thinking of installing a drip irrigation system; in response to the price rise she calculates that it is now profitable to do so. Other farmers may dig deeper wells, or invest in a water cooperative that will build an aqueduct, or plant a different crop that needs less water. Entrepreneurs operating in the water market will be on the lookout for local price variations, which are a sign of differing, but as yet unmet, urgencies in the demand for water. They will attempt to take advantage of price discrepancies by diverting water from places where the price is lower to those where it is higher.
Some farmers may need extra cash to see them through the drought period. Which are worth investing in, and which ones will not weather the crisis even if granted credit? A local water dealer decides the question based on his personal knowledge of how long a farmer has been his customer, how strong the farmer’s ties to the community are, and how quickly he has paid his bills in the past. People who have dealt with local merchants long enough to become a “regular customer” know that they try to determine which customers should be extended credit during a rough time, in the hope of retaining them as patrons when better times return.

Suppose that as a socialist state’s chief central planner, you are considering how to allocate your country’s steel supply. You know of a multitude of things that might be made with it. You also know that your subjects want cars, tractors, microchips, strong buildings, and electrical wire, among the many goods that could be made from that steel. However, because you don’t have an infinite amount of steel, to say nothing of the complementary goods and services that are needed to produce useful items from steel, you must decide which of its possible uses are most important. You hope to use it to produce, at the least cost, those things most desired by the consumers in your country.
You are faced with a hopeless task! Lenin promised that under socialism “the population will gradually learn by themselves to understand and realize how much and what kind of work must be done, how much and what kind of recreation should be taken.” But such learning cannot occur if there are no market prices alerting individuals to the opportunity to profit by adjusting their actions to better meet the wishes of their fellows. You, the planner, will end up in a fix like the one Mises described in Economic Calculation in the Socialist Commonwealth:
There will be hundreds and thousands of factories in operation. Very few of these will be producing wares ready for use; in the majority of cases what will be manufactured will be unfinished goods and production goods. All these concerns will be interrelated. Every good will go through a whole series of stages before it is ready for use. In the ceaseless toil and moil of this process, however, the administration will be without any means of testing their bearings. It will never be able to determine whether a given good has not been kept for a superfluous length of time in the necessary processes of production, or whether work and material have not been wasted in its completion. How will it be able to decide whether this or that method of production is the more profitable? At best it will only be able to compare the quality and quantity of the consumable end product produced, but will in the rarest cases be in a position to compare the expenses entailed in production.

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