Chapter VII

CHAPTER VII RESERVES, PROFIT AND RISK IN THE SOCIALIST STATE WE NOW come to the calculation of means of production, in Professor von Mises' opinion Socialism's greatest problem. In the socialist state there is, by definition, no right of private ownership of means of pro duction and hence neither markets nor prices for them. Consequently, Professor von Mises asserts, economic calculation, and with it economic activity, is impossible in a socialist community, l and for that reason he maintains that any form of socialism is impossible. We shall not express an opinion about this till we have discussed the various objec tions to it and the attempts that have been made to solve the problem Mises has pointed out. First, however, we shall discuss some factors of calculation which any socialist state will have to take into account if it is to follow "the economic principle" and wishes to aim at economic progress. These are interest, rent, risk-and depreciation quotas.

It is natural to ask why these quotas should necessarily be included in the calculation of production and why the socialist state cannot cover them by taxation, as do the capitalist societies with their expenditure for social and cultural ends. They can, of course, but as in the socialist community the state is the only employer, it would merely mean that the state would have to reimburse the taxpayer by paying him corre spondingly higher wages or in some other way. Such a method of procedure does not absolve the central authority from having to deter mine the size of the quota. Both in order to save themselves the trouble and expense entailed in collecting extra taxes, and to spare the members of the community the annoyance of paying taxes, it would be simpler fot the central authority to withhold sufficient of the production to cover these quotas and to distribute to the members of the com munity only what was sufficient for their consumption.

In early socialist literature it is maintained that the workers in the socialist state will be paid "the whole output of production". It has even been advanced that the workers should be allowed freely to dispose of the whole product of the mine or factory in which they work. The absurdity of this interpretation is obvious. Even if only work were recognized as a factor of production, the workers in a" factory producing finished goods would at any rate have to give a part of the product to the workers who produce the raw materials, ICf. Socialism,p" 119, and CollectivistEconomicPlanning,p. 9.2. 82 RESERVES, PROFIT AND RIS K 8; semi-manufactured goods or machinery, or in other ways took part in the. earlier stages of ·production. Even for workers engaged at the same stage of production, the result would be nonsensical.. The workers in a rich mine would receive higher rewards than those in a poor one, those in a molybdenum mine higher than those in an iron ore mine, and those in the best situated vineyards. much more than the workers in the potato fields. (See also Chapter V.) If the entire result of the community's economic activity were shared among all the workers, the result would be less nonsensical, but not even that can be done in practice, if the community in question aims at economic and cultural progress. If that is its aim, the central authority will have to withhold part of the product and set aside certain amounts for various ends. The matter is quite clear in regard to cultural and social ends. Provided the socialist state wishes to maintain or to create a certain cultural and· social level,' reserves will have to be set aside. This amount will be determined more or less arbitrarily. This is also the case in capitalist societies, but nevertheless there is one great difference. The capitalist· state has certain· cost data on which to .base its calculations. Its public authorities can invite tenders and learn in advance, for example, what a hospital of such and such a size, with such and such equipment, erected in such and such a locality, will cost in comparison with a library of a certain size and with a certain stock in a given locality. In the socialist community there will be no such data expressing the relative scarcity of the resources existing at any given time and to what degree these resources are in demand for various other ends.

Arbitrary as is the method in the capitalist state for determining cultural quotas, it will be considerably more so in the socialist state, unless it can find some other method of procuring similar cost data. To set aside a certain percentage of the community's income will lead nowhere. In order to make comparisons as indicated above, absolute figures are needed. While most people will admit that there is justification for setting aside funds for cultural and social purposes, few socialists will admit the necessity of profit in a socialist state. Such a claim may admittedly prima facie ·appear surprising. It is obvious that the state, having absolute monopoly both as producer, dealer and employer, can· secure a profit .. But does it needto, as long as its aim is the satisfaction of the needs of the members of the ~ommunity? The answer depends on how profit is defined. Profit is one of the more difficult and obstinate concepts in the doctrine of value and distribution. It can be a kind of income, a part of an income or a way of regarding an income. Profit-income is a 84 ECONOMIC CALCULATION IN THE SOCIALIST SOCIETY residual income which falls to the owner of the business as the owner of that business. He does not need to be sale owner of the individual means of production. They can be borrowed or mortgaged, but the means of production and .the combination of them are his and the surplus which may remain after the costs of production and the reward for his own work (not merely wages for work contributed, but for professional knowledge and for his contribution as co-ordinating factor) are paid, falls to him as owner with all the advantages-and risks-this may entail.

One characteristic of profit is that it results from buying at a lower . price than that at which the article is sold (after all costs are covered). This characteristic makes one think of middlemen and professional speculators, and as neither they nor the owners of private business undertakings have· any place in the socialist state, one might well believe that there would therefore be no question of profit. Neverthe less, if the central authority allows the retail shops independently to raise the prices of necessaries in strong demand (as mentioned in the previous chapter), it thereby gives the shops an opportunity to make an income, for which there is no other suitable name than profit. The case would be the same, even if the central authority itself ordered the increase in price and appropriated the additional income. Further, it is ohvious that there must he question of profit, if the central authority allows free competition among business units, as some of those taking part in the discussion have advocated. (See Chapter XIII.) Profit is, however, something else and something more than a difference in price or a trading surplus resulting from efficient conduct and organizing ability. It can also be regarded-and in fact represents -a risk premium. As risk-quota the socialist community cannot neglect to take profit into consideration in its calculations (or, if you like) that element in profit which is made up of the factor of risk).

There are two reasons why the calculation of profit in the form of a risk-factor is indispensable. If no account is taken of risk in the socialist community, it will in the first place appear quite natural to employ resources in any branch of production whatever, even where there is infinitely little chance of there being a demand for the product.! In the second place "(he risk factor of profit is necessary to stimulate activity intended for the future and which is thus ipsofacto risky. H. D. Dickinson thinks that a socialist society can eliminate many risks, among them those due to "simultaneous action of a number of entrepreneurs ignorant of each others' decisions", 2 hut he admits that ICE. "Price Formation in a Socialist Community" by H. D. Dickinson in Economic Journal, 1933. 20p. cit., p. 245.

RESERVES, PROFIT AND RISK in a community where there is a free choice of occupation and goods, there will occur an element of risk which must be taken into account. It is, however, not the opportunity of free choice which is the decisive factor or the only one to create risk. Whether or not there is free choice of occupation and goods. the central authority must, in a dynamic· community aiming at economic progress, undertake invest ments to which there are risks attached. The exploitation of new in ventions and new methods necessitatesinvestmentsand reconstruc tions which are time-consuming and therefore include an element of risk. In the capitalist community this risk is borne partly by those engaged in regular productive activity, who are afraid of being left out if they do not use the latest methods, and pardy by speculators who own, or can borrow, the necessary capital and who think they can make a profit.! As the socialist state has monopolized all business activity, the central authority must itself undertake this risk. This involves difficulties of various kinds. The first consists in the fact that in a socialist state there will by definition be no individual able to engage in productive activity which will bring him either profit or loss.

The discussion on socialism has largely turned on how far the individual can be expected to work his best, when he cannot enjoy the fruits of his labour. This is a question of psychology, which we shall not discuss in all its implications here. We are still using the (un realistic) assumption that egoistic individualism has no place in the socialist community, and that the individual will give of his best, even if the surplus goes to others. We are here not discussing the capacity and will of employers, but the changed conditions resulting from altered institutions. Even if we assume that sabotage is out of the question in a socialist state and that each will pull his weight according lIt is immaterial what those who carry the risk are called. Ifone says that the chief characteristic of a speculator is that he acts on the basis of a comparison between present and future values, anyone engaged in long-term economic activity may be called a speculator. If speculators are not merely investors, but what the Americans call "promoters", those who bring together the representatives of technique (in ventors), capital, commercial instinct and legal knowledge and get them to work together, they are making a contribution, the importance of which laymen often undervalue.

Experts in the sphere of risk-taking recognize, however, the importance of the promoter. Professor A. S. Dewing concluded a long description of the special attributes promoters must have, with the following words: "It is this prophetic imagination of the promoter that blazes the paths of industrial progress. Through the economic changes that follow in the march he leads, civilization moves." (Cf. The FinancialPolicyofCorporation,New York, 1919, p. 166.) On the previous page he quotes from Professor E. F. Mead, who wrote Corporation Finance, 1915: "The promoter performs an indispensable function in the community by dis covering, formulating and assembling the business propositions by whose develop ment the wealth of society is increased."

86 ECONOMIC CALCULATION IN THE SOCIALIST SOCIETY to his capabilities, it seems most unlikely that individuals who have no interests of ownership will reach exactly the same decisions as those that have. One may be for or against private ownership, for or against its consequences, but presumably everyone will admit that elimination of private ownership must have an effect on decisions taken in regard to investments to which an element of risk is attached. Actually, the way in which chances and possibilities are weighed against each other in the capitalist economy is quite peculiar. On the one hand there is a possibility of profit which-at any rate in part falls to the person who takes the risk, while on the other hand, he is penalized with the loss of his own property if things go wrong. It is difficult to judge the full implication of this dual incentive to activity and caution. It can certainly not be measured quantitatively, if only for the reason that the result does not necessarily take the form of action. A decision to turn down a project may be just as far-reaching.

Many people will reg~rd it as an advantage that the estimation of risk is left to those who themselves carry the loss if their judgment should prove wrong, and who harvest the advantages when their judgment is right. One should remember in this connection that correct estimation of risk means correct estimation of needs which will be backed by the means to satisfy them (effective demand) by a future distribution of income, which (if the accepted end is satisfaction of needs) will involve a rational employment of resources (with this distribution of income given). Others will take the opposite point of view, and, pointing to the recurrent periods of depression and the permanent state of misery in many quarters, maintain that the system has condemned itself. It is true that there does not seem to be any simultaneous inclination for activity and caution. A business cycle is, in the main, characterized either by optimism, or by pessimism. Those who are concerned with economic activity, whether private or public, seem to be strongly inclined to act alike. The reasons for this-in other words the problem of the trade cycle-will not be discussed here. But this much can be said for the capitalist economy: even if faith in the future, and so the volume of activity, are subject to great variations, the private entre preneur will, even in optimistic periods, know that it is his own means which are lost if things go wrong, and he will, even in the most pessimistic periods, be on the look-out for possibilities which appear profitable.

No matter which argument one finds the most convincing, it is obvious that the socialist economy will have to End another way of judging risk than that of the capitalist economy. The task is clearly one to be assumed by the central authority. To leave the decision to atomistic business-leaders would imply a competition incompatible RESERVES, PROFIT AND RISK with socialism, but it is worth noticing that it would seem to entail less risk-taking and slower economic progress, irrespective of whether the leaders. of the socialist undertakings are assumed to be egoistic or altruistic. If egoistic they have no inducement to take steps involving risk, as they have no prospect of making a profit for themselves. If they .are assumed to be altruistic, the result is likely to be the same. Correct estimation of risks will give the concern in question an advantage over its competitors, which could cause them unpleasantness and possibly even endanger their position. Thus, an altruistic manager, out of consideration for his colleagues, wl11 be chary of taking any risk which might put him ahead of them.

Risk will have to be estimated by the central authority, and this will create difficulties of various kinds. There are no sure criteria of how far a community should go in taking risks. The risks taken will partly depend on the factor of time, that is to say, on the speed with which it is hoped to attain a certain desired standard of living. A high level of industrial research will give, if not the certainty, at least the hope, of speedier technical development. One danger will be that too many risks are taken, with the result that the losses, which must follow when risks are taken over a longer period, grow so large that the possibility of satisfying the needs of the contemporary generation is "unreasonably" reduced. There is also a possibility of too few risks being taken, which would mean that the community does not achieve so rapid a development in technique and in regard. to new possibilities for satisfying needs, as would otherwise have been possible.

In this connection it must be kept in mind that with the given end production for needs-the risk will be determined by the degree in which the final products are accepted by the members of the com munity. Should they not want the products which are the final result of an investment on which a risk was taken, it will have been a bad investment. The risk will be less in a community with an undeveloped industry and large resources, than in one with relatively few natural resources and· in an advanced stage of technical development. In the former, the central authority can embark on new ventures in practically every field with the certainty of satisfying needs and no great risk of. going wrong. In the latter community this risk will be very great. The extent of the risk will also depend on the degree to which there are alternative uses for the resources employed, should the first use of them prove unfortunate. There is less risk in building factories and producing machinery which can be used for several purposes, than if they can only be used for a single purpose and have to be scrapped if there is no demand for the goods they produce.

88 ECONOMIC CALCULATION IN THE SOCIALIST SOCIETY There are even difficulties in the way of a purely technical fixation of the risk-quota. Actually, it is misleading to use an expression like risk-quota, as this can give the impression that the problem is solved once the size of the quota has been fixed, e.g. as a percentage of the community's income. This is not the case. There are still many problems to be faced, both technical and of calculation. Dickinson says that the task is difficult, because the risk has to be computed for "each transaction and type of transaction".! He hopes that the socialist community "should in time evolve a statistical treat ment of risk based on the frequency distribution of sales and price changes" .2 This is to underestimate the difficulties. The risk-quota cannot be fixed for one "type" of transaction any more than it can be determined in advance, but it must be fixed-as Dickinson says to begin with-for each individual case. Even if it is a question of exactly the same object (e.g. a clutch on a machine which can be used exclusively for the production of a certain article of a certain quality) the costs of research for improvements will vary from time to time, not only with the extent of the experiments made,. but because the price of the same quantity of material and labour can fluctuate, either because of the community's monetary policy or with the technical· developments and the size and age-composition of the population.

The central authority can put aside a certain sum for scientific research and for laboratories for applied science. That part is simple. The difficulties occur when one has to decide, whether a proposal from one of these laboratories, or an idea of some inventor, is to be experi mented with and developed or not. Such a step may involve new methods, new factories, new machines and new goods; there is no past experience to go by and no certainty that the result will correspond to the effort involved. When it is a question of new methods entailing a saving, one would think that it was easy to determine the quota. To decide whether it would pay to make alterations which would entail, for example, a saving of 25 per cent., one must nevertheless know what the alterations will cost, and here one comes up against the old difficulty that there are no prices for means of production (prices to show whether the materials could have been better used for other purposes). Even if we make the (unrealistic) assumption, that the extent of the experiments and all data as to cost are known in advance, this would merely help the central authority to decide its attitude to inventions for the im provement of methods of production. When it is a question of activity, which in thelast resource aims at necessaries, there will still remain one lOp. cit., p. 245.

2/bid., p. 245.

RESERVES, PROFIT AND RISK large and incalculable factor, viz. the reaction of the members of the community.l There are wider implications to the acceptance (I) of "maximum production for needs" as the aim and (2) of the reaction of the public as the yardstick. It implies that technical perfection is not the decisive factor, for, on the assumptions made, a technically outstanding in vention or method should not be used unless the requisite labour, time, energy, machinery and materials would satisfy more of the needs' of the citizens than they would if used in any other way or in any other combination. 2 .If the central authority's calculators are to be able to draw up such a balance, they must have data which will give them a picture of the relative scarcity of resources existing at any one time, and also fresh and reliable data as to the consumers' preferences for the different articles and qualities.

An anticipatory estimate of a risk for a non-instantaneous transaction will be difficult and uncertain in any society whatever. To this extent IThe difficulty of estimating in advance the rentability of an invention is illustrated by an enquiry made some years ago in America, which showed that of the money invested in inventions over a certain period 93.5 per cent. had been lost. The special difficulties in the way of judging public taste in advance can be seen from what Professor A. S. Dewing says: "After all has been said one must conclude that the exploitation of a new inven tion, intended to meet a general demand-like a new collar button, a new hairpin, or even a new camera-is at best a mere gamble. The psychology of the 'people' is so complex that the value they will place on a new article is absolutely unpre dictable. " Ope cit., p. 157. That in spite of these obvious risks it is still possible to get new inventions financed in a capitalist society, is due partly to the fact that an invention which really takes on, can bring in an enormous return and partly to the fact that there is a number of people who seem to be irresistibly attracted by risky investments of this kind. This attraction may be due to the hope of large profits. In the case of small savers it is often due to the belief that money which has been earned with toil and saved by self-denial deserves a larger return than the banks offer. It may also be due to a more ideal desire to let humanity benefit by new ideas and new inventions.

Quite apart from the motive, it is an interesting psychological phenomenon that people of this type will time and again invest their savings in inventions, even though such earlier investments have only brought them loss. This type of person will also be found in the socialist community, but it will not be possible to make use of their peculiar attributes and self-sacrifice, as the socialist community does not allow commercial activity on one's own account. 2Anyone who has studied or occupied himself with the exploitation of inventions, will know how there usually occurs a clash between the inventor, striving for technical perfection, and the financier, who attaches most importance to cost and .1"entabiIity.The present trend in the world from price-economy to a "planned" economy gives the "engineer mentality" more and more scope. In communities like the socialist-where it is sought to eliminate completely considerations of "profit" and "rentability", there is a danger of unilateral importance being attached to the technical side. A product which is technically perfect is ex hypothesiideal for its purpose from the technical point of view: it gives joy to the engineers and technical experts and can even give laymen resthetic pleasure, but it must be insisted that the production of a technically perfect article is economically irrational and an economic misuse of labour and material, if these would have satisfied more needs had they been used for another putpose.

G 90 ECONOMIC CALCULATION IN THE SOCIALIST SOCIETY the capitalist and socialist communities are alike. The markets of the former, however, do give data which make it possible to calculate what a transaction or experiment will cost. Even though there is no knowing whether a new product will bring in an income large enough to cover the expenditure, one does at any rate know what the expendi ture is going to be. Even future costs, at any rate for a period of six to twelve months, will be known in the capitalist society, because of its forward .markets where prices are quoted for future delivery. This means that one is able to eliminate part of that risk which is always attendant on the future. There are various factors which determine forward prices (as for instance the price of the goods for immediate delivery and various costs connected with warehousing, inter alia interest), but it is worth noting that forward markets presuppose the existence of private traders and speculators who are willing to bear the risk of the future. It is also worth remembering that (I) the cost-data with which one calculates in a capitalist society take the form of a more or less complete result of the conflict between an offer, which registers the scarcity of existing resources, and a demand, registering the strength of various needs, and (2) that a socialist community with free choice of goods also needs such data for calculating the risk-quota.