The Argument

During the first weeks of the winter semester, Mises fine-tuned his article on economic calculation, addressing various criticisms and remarks from his seminars. He eventually gave the first formal presentation in early January 1920 in a meeting of the Nationalökonomische Gesellschaft. In the assembly were some of the world's best economists and Marxist scholars. Joseph Schumpeter, Alfred Amonn, Max Adler, Helene Bauer, and several other participants at this meeting had known Mises for many years as a passionate champion of individualism and a fierce critic of socialism. He was considered more challenging than most critics, who tended to focus on the past failures of applied socialism. Mises knew in detail socialism's abysmal record, but he focused his criticism on theory, not history. Advocates could always dismiss past failures as irrelevant to the viability of a future socialist commonwealth, but Mises challenged the very possibility of their plans ever succeeding.

In his Nation, State, and Economy, he had discussed the standard criticism that the socialists overstated the extent to which people would enjoy work for its own sake. The socialist reply was that people currently loathed hard work only because of the market economy, in which they were objectively alienated from their labor and its products. The future would bring forth a New Socialist Man, who no longer indulged in selfishness but found instead his greatest satisfaction in the good of the collective. Mises countered that no country had ever enjoyed the altruism of so many New Socialist Men more than the German Reich under Wilhelm II. If a socialist government could not succeed in Germany, where else could it possibly ever do so?

This was a good point, but it was a trivial argument compared to the one Mises brought up in that January 1920 meeting. He now proceeded to explain why socialism was economically inferior regardless of the psychological condition and motivations of the population. Even if the future were to produce the New Socialist Man, central planning still suffered a fatal shortcoming.

Mises now presented an elaborated discussion of a problem that he had only briefly touched on in Nation, State, and Economy, when he mentioned the role of value and monetary calculation in allocating resources within a national economy. He had observed that capital goods constantly had to be replaced, not just to extend the structure of production, but merely to maintain the existing productive apparatus. Which capital goods should be replaced when? As with all economic decisions there were necessary trade-offs and questions of priority. A rational solution to this problem presupposed that one had clear criteria for judging the extent of wear and tear on the current capital goods. “In a static society” in which capital goods “always are to be replaced only with others of the same kind,” Mises argued, one had a physical yardstick, namely, the existing structure of production. But in “an economy subject to change, this simple method does not suffice for most means of production, for the used-up and worn-out means of production are replaced not by ones of the same kind but by others.” In such a dynamic context, “Calculation in physical units, which suffices for the primitive conditions of a stationary economy, must therefore be replaced by calculation of value in money”⁹ Mises went on to describe the social function of the businessman's calculations:

Individual capital goods disappear in the production process. Capital as such, however, is maintained and expanded. That is not a natural necessity independent of the will of economizing persons, however, but rather the result of deliberate activity that arranges production and consumption so as at least to maintain the sum of value of capital and that allots to consumption only surpluses earned in addition. The precondition for that is the calculation of value, whose auxiliary means is accounting. The [social] economic task of accounting is to test the success of production. It has to determine whether capital was increased, maintained, or diminished. The [individual] economic plan and the distribution of goods between production and consumption is then based on [previous accounting].¹⁰

Mises began his January 1920 talk along the same lines, stressing the vital importance of the economic calculus for the allocation of factors of production. His audience concurred. Most of them regretted that economic calculation as it was actually practiced was a “profitability calculus” that reflected the mere private interests of capitalist investors, but none of them questioned the fact that calculation of some sort epitomized rationality in economic affairs. Where all other criteria might be challenged, algebra and arithmetic stood fast. Now Mises came to the heart of his argument, which he presented in two bold theses:

(1) Socialist societies could not rely on economic calculus, such as it is known in market economies, because entrepreneurial calculations are based on money prices for factors of production. Such prices cannot exist in socialism because prices can only come into existence through exchange, and exchange presupposes the existence of at least two owners. Now, the very nature of socialism—its usual definition in fact—is that all means of production are under a unified control. They all belong to one economic entity: society, “the people,” the commonwealth or the state—whatever collective entity is named. The crucial fact is that, from the economic point of view, there is in any socialist regime only one owner of all factors of production. Therefore, no factor of production can be exchanged, and there can be no money prices for factors of production. And therefore no socialist community can allocate its factors of production on the basis of economic calculation, as it is known in capitalist markets.

(2) There are no other means of economic calculation. Such economic calculation requires money prices for factors of production, which can only come into existence where factors of production are privately owned.

Insofar as the money calculus epitomizes economic rationality, socialism is inherently irrational.

It was immediately clear to the audience that Mises was treading completely new ground. Socialism had been criticized from many angles, but hardly anyone had doubted that the central planners could achieve gains in efficiency. Mises's thesis, if true, would strike at the heart of the socialist agenda. It would elegantly and crushingly refute Marx and his modern heirs, the English Guild Socialists and the fashionable Austro-Marxist theoreticians, many of whom were in the audience at Mises's presentation. In short, Mises's paper was an all-out attack on the very foundation of the economic case for socialism—a refutation of its central tenet, which by the end of the war had become universally accepted.¹¹

The ensuing debate both clarified the critical aspects of Mises's argument and foreshadowed the various tacks that socialist theorists would take in the coming years as they attempted to defend the viability of their system against the revelation of its fundamental economic irrationality. Mises later summarized the discussion in a letter to Lederer:

My first concern is to show that economic calculation, as it is practiced in the free economy, is inconceivable in a socialist commonwealth because it is built on the premise that money prices are formed for the means of production. This part of my presentation has generally met with full consent in the discussion in the Nationalökonomischen Gesellschaft. Even Max Adler and Helene Bauer have made objections on merely one point, namely, that economic rationality will choose other ways and means in the socialist commonwealth than they will in the free economy. But what these means will be, they could not specify.

Amonn too fundamentally agrees with my argument. I have just told him on the telephone that you would like him to put together some remarks on my paper for the Archiv. He replied he could not comply because he fundamentally agreed with the negative side of my argument, but was unable to make a positive proposal for the institution of an economic calculation in the socialist commonwealth.

Schumpeter made the following proposal: The socialist commonwealth gives each comrade a certain amount of accounting money as income and then leaves it to free pricing to bring about prices through exchanges. This proposal is however unsuited to circumvent the problem I have pointed out. For the higher-order goods remain extra commercium; consequently it is impossible to sort out prices for them even in terms of this accounting money, and thus economic calculation becomes impossible in the sphere of production.

The substance of my argument, which I believe to have evidenced in my proof, is precisely this: that economic calculation in the free economy is not applicable in the commonwealth; and I also do not see any conceivable economic calculation that the socialist commonwealth could adopt. I believe that this presents the most important problem of socialization—a problem far more important for socialist theory than, formerly, the problem of the average rate of profit.¹²

This was the beginning of what turned out to be the protracted socialist-calculation debate, which continues to be “one of the most significant controversies in modern economics.”¹³

The meeting of the Nationalökonomische Gesellschaft had ended in triumph for Mises. He had turned the obligatory rearguard action that everybody expected him to deliver into a surprise attack against the very heart of socialism. Vienna's Austro-Marxist elite was left speechless. They had believed that the intellectual war had long been won and that all that was left was the resistance of special interests and the unenlightened. His triumph would become ever more complete over the following weeks, months, and years, when it became increasingly obvious that the objections of his opponents were spurious—and that he had already anticipated most of them.

Emil Lederer's comments are a case in point.¹⁴ Just as Adler and Helene Bauer, he waxed eloquent about the blessings of an as-yet-unknown socialist calculation system, which would incorporate alternatives to capitalist money calculation. But he did not state what such a system would consist in.¹⁵ Lederer also observed that capitalist accounting does not give photographs of reality, but only stylized models which heavily depend on the subjective element of the entrepreneurs' judgments. But Mises had already conceded these points, which were irrelevant to his thesis. In fact, he did not claim that economic calculation was more objective in capitalism than in socialism, but that any economic calculation required the existence of money prices for capital goods. It is true that in capitalism the relevant prices—future money prices—had to be guessed, but the point was that only in capitalism were there any prices to be guessed at all.

Similarly, Lederer misinterpreted Mises's claim that socialist economies could not be rationally directed to mean that socialist societies would not produce any rational leaders. But Mises's real point was that socialism would be deprived of any criteria whatsoever for the rational allocation of resources. Without such criteria even the greatest leader would be unable to organize the structure of production in an efficient way. Mises wrote:

It is not at all my contention that a socialist commonwealth would not develop leader types. I assume though that these leaders will not excel in the rational, but in the sentimental and intuitive sphere.¹⁶

A good assumption indeed. Mises here sums up the essence of political leadership in the age of the omnipotent state.