Chapter 5 Mises in the 1920s: Scholar and Creator

The Bolshevik Revolution, as well as the growth of corporatist sentiment during and after World War I, transformed socialism from a utopian vision and goal into a spreading reality. Before Mises turned his great searchlight of a mind on the problem, criticisms of socialism had been strictly moral or political, stressing its use of massive coercion. Or, if economic, they had focused on the grave disincentive effects of communal or collective ownership (often expressed in the gibe, “Under socialism, who will take out the garbage?”). But Mises, addressing the problem in a paper delivered to the Nationalökonomisch Gesellschaft (Economic Society) in 1919, came up with the most devastating possible demolition: the impossibility of economic calculation under socialism. Mises’s paper was published the following year as “Die Wirtschaftsrechnung im sozialistischen Gemeinwesen” (“Economic Calculation in the Socialist Commonwealth”), in the Archiv für Sozialwissenschaft und Sozialpolitik. It was a veritable shock to thoughtful socialists, for it demonstrated that, since the socialist planning board would be shorn of a genuine price system for the means of production, the planners would be unable to rationally calculate the costs, the profitability, or the productivity of these resources, and hence would be unable to allocate resources rationally in a modern complex economy. The stunning impact of Mises’s argument came from its demolishing socialism on its own terms. A crucial objective of socialism was for central planners to allocate resources to fulfill the planners’ goals. But Mises showed that, even if we set aside the vexed question of whether the planners’ goals coincide with the public good, socialism would not permit the planners to achieve their own goals rationally, let alone those of consumers or of the public interest. For rational planning and allocation of resources require the ability to engage in economic calculation, and such calculation in turn requires resource prices to be set in free markets where titles of ownership are exchanged by owners of private property. But since the very hallmark of socialism is government or collective ownership (or, at the very least, control) of all nonhuman means of production—land and capital—this means that socialism will not be able to calculate or rationally plan a modern economic system.

Mises’s profound article had a blockbuster impact on European socialists, particularly in German-speaking countries, over the next two decades, as one socialist after another tried to solve the Mises problem. By the late 1930s, the socialists were confident that they had solved it by using mathematical economics, wildly unrealistic, neoclassical, perfect competition and general equilibrium assumptions, and—particularly in the schemes of Oskar Lange and Abba P. Lerner—by the central planning board’s ordering the various managers of socialist forms to “play at” markets and market prices. Mises expanded his arguments in journal articles and in his comprehensive critique, Die Gemeinwirtschaft (Socialism) in 1922. His seminal article was finally translated into English in 1935, and his Socialism a year later, and F.A. Hayek also weighed in with elaboration and development. Finally, Mises gave the final rebuttal to the socialists in his monumental Human Action in 1949.

While the official textbook line by the 1940s—when socialism had triumphed among intellectuals—decreed that Lange and Lerner had solved the crucial question posed by Mises, Mises and the free market have had the last laugh. It is now generally acknowledged, especially in Communist countries, that Mises and Hayek were right, and that the enormous defects of socialist planning in practice have confirmed their views. In virtually every Communist country there is a rapid movement toward free markets, and even of the reconstitution of a stock market, a market in titles to private ownership. In the meantime, socialist intellectuals in the West, more removed from harsh socialist reality, slough off the problem by repudiating the very goal of rational allocation and calculation altogether, and by speaking of instinct and irrationality being the nub and glory of socialism.

The nub and the essence of the later Misesian arguments are all foreshadowed and encapsulated in his original 1920 journal article. It is fashionable in some modern Austrian circles to pinpoint the crucial difference between Mises and the socialists as entrepreneurial uncertainty vs. perfect knowledge and general equilibrium on the part of the socialists. But this is not Mises’s account. Mises writes that he was led to consider the socialist calculation problem by his work on the Theory of Money and Credit. Here Mises realized for the first time with keen clarity that the money economy does not and cannot calculate or measure values directly: that it only calculates with money prices, the resultants of such individual valuations. Hence, Mises realized that only a market with money prices based on the evaluations and exchanges of private owners can rationally allocate resources, since there is no way by which a government could calculate values directly. Hence, for Mises his article and book on Socialism was part and parcel of the development of his expanded integration of micro and macro, of direct and monetary exchange, that he had begun but not completed in Theory of Money and Credit. Thus, the later Hayekian stress on decentralized knowledge and innovations were important glosses and elaborations on the main Misesian point, but they were not the central issue. The central Misesian point is that, even given resources, values and technology, even abstracting from their changes, even then, socialism, deprived of private ownership and free markets, could not calculate or rationally allocate resources. Of course, a fortiori, it could surely not do so in the real world of change. Thus, compare Mises’s following dismissal of the socialists with the contemporary Austrian exclusive focus on uncertainty:

They [the socialists] failed to see the very first challenge: How can economic action that always consists of preferring and setting aside, that is, of making unequal valuations, be transformed into equal valuations, by the use of equations? Thus the advocates of socialism came up with the absurd recommendation of substituting equations of mathematical catallactics, depicting an image from which human action is eliminated, for the monetary calculation in the market economy.^28,29

Mises’s book Socialism had an enormous influence during the 1920s and 1930s, not only in raising profound questions of socialists, but also in converting countless young socialist intellectuals to the cause of freedom and free markets. Brilliant young socialists Friedrich A. Hayek and Wilhelm Röpke in Germany, and Lionel Robbins in England, were among the many converted by Socialism, and who became for many years followers and disciples of Mises as well.³⁰

During the 1920s, Mises also continued to develop the business cycle theory that had emerged out of his integration of money into general microeconomics in Money and Credit. In journal articles and books, Mises expanded his theory, warned against the inflationary credit policy of that era, and engaged in a scintillating critique of the proto-monetarist stabilization views of that favorite economist of the New Era of the 1920s, Irving Fisher. Fisher and his disciples insisted that all was well during the 1920s because, for example, the price level in the United States remained constant. To Mises the important point was masked by level prices caused by increases in productivity: that the inflationary credit was creating unsound booms in capital investment and in the markets for titles to capital—stock markets and real estate. Mises’s warnings of financial collapse and depression were remembered after 1929, although they were generally scorned at the time.³¹

Mises’s earliest researches had taught him that government intervention almost invariably proved to be counterproductive; and his explorations into money and business cycles amply confirmed and reinforced this insight. In a series of articles in the 1920s, Mises investigated various forms of government intervention, and showed them all to be ineffective and counterproductive. (The essays were published in book form as Kritik des Interventionismus in 1929.) In fact, Mises arrived at a general law that, whenever the government intervened in the economy to solve a problem, it invariably ended, not only in not solving the original problem, but also creating one or two others, each of which then seemed to cry out for further government intervention. In this way, he showed government interventionism, or a “mixed economy,” to be unstable. Each intervention only creates new problems, which then face the government with a choice: either repeal the original intervention, or go on to new ones. In this way, government intervention is an unstable system, leading logically either back to laissez-faire or on to full socialism.

But Mises knew from his study into socialism that a socialist system was “impossible” for the modern world: that is, it was lacking the price system necessary to economic calculation, and therefore for running a modern industrial economy. But if interventionism is unstable, and socialism is impossible, then the only logical economic policy for a modern industrial system was laissez-faire liberalism. Mises therefore took the rather vague commitment to the market economy of his Austrian predecessors and hammered it into a logical, consistent, and uncompromising adherence to laissez-faire. In keeping with this insight, Mises published his comprehensive work, Liberalismus, on “classical,” or laissez-faire, liberalism, in 1927.

Thus, while Mises had not yet completed his comprehensive treatise on economics, he had, by the end of the 1920s, hammered out the complete, thoroughgoing political-economy part of his developing grand system. Laissez-faire, interventionism, and socialism were now compared and contrasted in detail, and a passionate commitment made by Mises to laissez-faire. Strengthening that commitment was an insight he had already set forth in Socialism: that the division of labor, and its concomitants, private property and freedom of exchange, were absolutely basic to civilization and to society itself. What Mises was consistently advocating, and what his opponents of other schools of political economy were undermining, were the very conditions necessary to the maintenance of civilization and of an economy that sustains modern high levels of population.

In his eloquent discussion of society and the division of labor, and in his Spencerian contrast of the industrial versus the militarist principle, Mises also builds on the crucial Austrian insight that both parties, the buyer and the seller, the employer and the worker, necessarily benefit from every act of exchange. Mises concludes that the adoption and the development of the division of labor rests on man’s reason and will, on his recognition of the mutual benefits of exchange. This emphasis on human reason and will, in the noblest traditions of rationalism, contrast sharply to the Hayekian or Scottish Enlightenment emphasis on society or the market as the product of some sort of tropism or instinct, e.g., Hayek’s emphasis on the tropistic, unwilled emergence of “spontaneous order,” or Adam Smith’s conjuring up of a spurious instinct, or “propensity to truck and barter,” as an explanation of exchange.³²

Indeed, seizing the occasion of writing a foreword to a reprint of Socialism published years after Mises’s death, F.A. Hayek significantly altered the unalloyed praise of the book that he had lavished at a tribute dinner to Mises over twenty years earlier. Now he severely criticized Mises’s reference in Socialism to “social cooperation (in particular, the market-economy) as an emanation of rationally recognized utility,” as an example of “extreme rationalism” and as factually incorrect. He went on to the insulting “explanation” that Mises had not been able to “escape from” such rationalism “as a child of his time”—a curious statement since Mises’s “time” was one of pervasive irrationalism. Hayek, in contrast, strongly asserts that “it certainly was not rational insight into its general benefits that led to the spreading of the market economy.” If not that, one wonders then how the market economy got established in the first place. For each individual exchange, no person would engage in it unless he knew consciously and “rationally” that he would benefit. And as for the market economy as a whole, Hayek who in his earlier writings had declared formally that ideas make history, fails to explain how the free market did come about. Moreover, Hayek thereby ignores over two centuries of a classical liberal movement in Western Europe and the United States dedicated to freedom and free markets. In neglecting the fundamental point that all human actions are determined by the individuals’ values and ideas, a “praxeological” insight at the heart of Misesian thought, Hayek can only believe, without explicitly declaring it, that human beings are not conscious actors and choosers but only tropistic stimulus-and-response mechanisms.³³

Remarkably, we have by no means exhausted the extent of Ludwig von Mises’s profound contributions to scholarship and to economics during the 1920s. From his earliest days, Mises had confronted and challenged the Historical School of economics dominant in Germany. The Historical School was marked by its insistence that there can be no economic laws transcending mere description of the circumstances of individual time and place, and that the only legitimate economics therefore is not theory but a mere examination of history. Politically, this meant that there were no inconvenient economic laws for government to violate, and to cause counterproductive consequences of governmental measures. It is no wonder that the head of the Historical School, Gustav Schmoller of the University of Berlin, declared that the function of German academics was to form “the intellectual bodyguard of the House of Hohenzollern.” During the 1920s, Institutionalism, an outgrowth of the Historical School but devoid of the latter’s scholarship or intellectual base, became dominant in the United States. Mises was certainly correct in referring to these groups, in his seminars, as “anti-economists.” But, in addition, Mises saw the economic methodology that had been habitually employed by Austrians and by many classical economists such as Say and Senior, attacked on different grounds by a new group, logical positivists, spawned in his native Vienna. Indeed, Ludwig’s own younger brother, by two years, Richard von Mises, a mathematician and aeronautical engineer, became a leading member of this “Vienna Circle.” In addition, one of the devoted students in Mises’s seminar, Felix Kaufmann, was later to write a positivist work on the methodology of the social sciences. This Vienna Circle, or “Schlick Circle” after their leader, was small in number but increasingly dominant in Viennese philosophical circles, and later gained virtually total dominance over the philosophical scene in the United States for decades after World War II, after emigrating to top academic posts in the United States.³⁴

A story Mises related to me about the logical positivists and their impact was characteristic of his wit and charm. He was walking around Vienna with his good friend, the German philosopher Max Scheler.

“What is there about the climate of this city,” Scheler waved around him, “that breeds so many blankety-blank logical positivists?”

“Well, Max,” Mises replied, “in Vienna there are two million people, and there are only twelve logical positivists. So it couldn’t be the climate.”

The logical positivists presented their own grave challenge to economic theory, charging that economic law could only be established tentatively and hesitantly, and then only by “testing” the consequences of such laws by empirical (in practice, statistical) fact. Based on their own interpretation of the methods of the physical sciences, the positivists tried to hack away at methodologies they saw as “unscientific.”

The onslaughts of the institutionalists and especially the positivists on economic theory forced Mises to think deeply about the methodology of economics, and also on the basic epistemology of the sciences of human action. Thinking deeply about the subject, he arrived at the first philosophically self-conscious defense of the economic method used by the earlier Austrians and some of the classicists. Furthermore, he was able to demonstrate the truly “scientific” nature of this correct method, and to show that the developing positivist methodology of much neo-classical economics was itself profoundly mistaken and unscientific. In brief, Mises demonstrated that all knowledge of human action rests on methodological dualism, on a profound difference between the study of human beings on the one hand, and of stones, molecules, or atoms, on the other. The difference is that individual human beings are conscious, that they adopt values, and make choices—act—on the basis of trying to attain those values and goals. He pointed out that this axiom of action is self-evident, that is (a) evident to the self once pointed out, and (b) cannot be refuted without self-contradiction, that is without using the axiom in any attempt to refute it. Since the axiom of action is self-evidently true, any logical deductions or implications from that action must be absolutely, uncompromisingly, “apodictically,” true as well. Not only is this body of economic theory absolutely true, but therefore any talk of “testing” its truth is absurd and meaningless, since the axioms are self-evident and no “testing” could occur without employing the axiom. Moreover, no “testing” can take place since historical events are not, as are natural events in the laboratory, homogeneous, replicable, and controllable. Instead, all historical events are heterogeneous, not replicable, and the resultant of complex causes. The role of economic history, past and contemporary, then, is not to “test” theory but to illustrate theory in action and to use it to explain historical events.

Mises also saw that economic theory was the formal logic of the inescapable fact of human action, and that such theory was therefore not concerned with the content of such action, or with psychological explanations of values and motives. Economic theory was the implication of the formal fact of action. Hence, Mises, in later years, would name it “praxeology,” the logic of action.

In his critique of logical positivism, Mises saw that a philosophy that treated people as if they were stones and atoms, whose behavior could be predicted and determined according to quantitative laws, was particularly likely to lead to the viewpoint of social engineers, who deal with people as if they were inanimate physical objects. Indeed, positivist Otto Neurath was one of the leading socialist theorists in Central Europe. Mises wrote that this allegedly “scientific” approach would study the behavior of human beings according to methods Newtonian physics resorts to in the study of mass and motion. On the basis of this allegedly “positive” approach to the problems of mankind, they plan to develop “social engineering,” a new technique that would enable the “economic tsar” of the planned society of the future to deal with living men in the way technology enables the engineer to deal with inanimate materials.³⁵

Mises began publishing his series of epistemological articles in 1928, and then collected and published them in his seminal philosophical and methodological work, Grundprobleme der Nationalökonomie (Epistemological Problems of Economics) in 1933.

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²⁸ Mises, Notes, p. 112. In contrast to Lavoie, who sees the entrepreneurial uncertainty aspect of the argument as central from the time of Mises’s first article, Kirzner correctly sees a shift of focus with the more “static” equilibrium argument dominant at first. Unfortunately, Kirzner regards the later emphasis on uncertainty and change not so much as an elaboration of the original argument (which it was) but as an improvement, because of the shift from equilibrium to more dynamic considerations. Thereby Kirzner misses the absolute centrality of the original “static” focus, which makes Mises’s impossibility of economic calculation (under given as well as under uncertain conditions) a far stronger argument against socialism than the later Hayekian or Kirznerian versions.
Mises’s first article is in F.A. Hayek, ed., Collectivist Economic Planning (London: Routledge & Kegan Paul, 1935), and his latest views are in Human Action (New Haven, Conn.: Yale University Press, 1949), pp. 694–711. Lavoie’s views are in his Rivalry and Central Planning (Cambridge: Cambridge University Press, 1985). Kirzner’s are in Israel M. Kirzner, “The Economic Calculation Debate: Lessons for Austrians,” Review of Austrian Economics 2 (1987): 1–18. The best and most comprehensive work on the socialist calculation debate is still Trygve J.B. Hoff Economic Calculation in the Socialist Society (London: William Hodge & Co., 1949).

²⁹ These conclusions are reinforced by Professor Joseph Salerno, who concludes from his studies that Hayek’s contributions, though seemingly more dynamic than Mises’s, are actually far more static in almost totally ignoring entrepreneurship. Hayek’s economic actors tend to be passive recipients of information instead of entrepreneurial appraisers and forecasters. Conversations with Professor Salerno.

³⁰ On the enormous impact of Mises’s Socialism on himself and his generation, see Hayek, in Mises, My Life, pp. 220–21.

³¹ Mises’s most important business cycle writings of the 1920s and early 1930s are translated and published in Ludwig von Mises, On the Manipulation of Money and Credit (Dobbs Ferry; N.Y.: Free Market Books, 1978).

³² See in particular, Ludwig von Mises, Socialism: an Economic and Sociological Analysis (New Haven, Conn.: Yale University Press, 1951), pp. 289–313. I am indebted to Professor Joseph Salerno for calling my attention to these passages.

³³ F.A. Hayek, “Foreword,” Ludwig von Mises, Socialism (Indianapolis: Liberty Press/Liberty Classics, 1981), pp. xxiii–xxiv. I am indebted to Professor Hans-Hermann Hoppe for calling my attention to this passage. Hayek’s tribute to Mises in 1956 is in Mises, My Years, pp. 217–23, and his discussion of Socialism in ibid., pp. 220–21. It is curious that Hayek does not even mention, much less try to rebut, Mises’s full presentation of the rationalist case in Socialism (1951), part III, chap. II, “Society,” pp. 289–313.

³⁴ The Vienna Circle included, in addition to Kaufmann and Richard von Mises, their leader Moritz J. Schlick, and Otto Neurath, Rudolf Carnap, Carl C. Hempel, Herbert Feigl, and Gustav Bergmann. Fellow travelers and also logical positivists with their own circles were Ludwig Wittgenstein and Karl Popper. (Fanatical Popperians assert enormous differences between the positivists and Popper, but from the present author’s perspective these are largely distinctions without a difference.)
The two Mises brothers seem to have been estranged from an early age. They formally reconciled after Ludwig’s marriage in 1938, but were never close. One time, when Richard’s book Positivism was published, I asked Ludwig what he thought of his brother’s book. Mises drew himself up into an uncharacteristically stern pose, eyes flashing: “I disagreed with that book,” he stated in no uncertain terms, “from the first sentence until the last.” It was not a tone that invited further inquiry.

³⁵ Ludwig von Mises, Epistemological Problems of Economics (New York: New York University Press, [1960] 1978), p. xiii.