10. A Copernican Shift

0:00Chapter 10. A Copernican Shift. Their ascension to power at the ballot box had taken the socialists by complete surprise. They were suddenly in charge and had to act, but it turned out that they had no idea how to put their ambitious program of socializing the economy into practice. The socialist literature of the previous fifty years had never dealt with the question of of how society, that is, in practice, the socialist government, should manage the economy. Such questions were deemed to be unscientific because the advent of socialism would come by inexorable law of nature. Marx, Engels, Taney, Lasky and all other socialist intellectuals until the early 1920s were convinced that socialism would eventually just be there, are all blown and ready to be admired. In the words of a writer highly sympathetic to their cause, they have not sufficiently considered the economic conditions that must be satisfied if a socialist state is to equal or to improve upon the standard of life provided by capitalism, nor have they given adequate attention, from the technical point of view, to the economic

1:11advantages and disadvantages of socialism as compared with capitalism. Yet unless they They have some understanding of the economics of a socialist state, and unless they are able to present its case on economic grounds, they can hardly hope to persuade the mass of men to believe in the state which they advocate. By 1919 the socialist movement had swept the political scene in Germany and Austria, but none of its leaders had given any thought to this problem. The greatest champion of of Wartime Central Planning, Walter Ratanau, 1867-1922, was fully convinced that the central direction of the economy should rest with the State, that is in practice in his own hands. He celebrated war socialism and made the case for omnipotent government in times of peace. His writings in the period of 1917 to 1919 in particular were the literary equivalent of Carpet Bombing and Shaped the Ideals of the Coming Generation, Fr. Hayek among them.

2:13This enormous literary output could not fail to provoke various critical reactions. Other statists had championed this same approach. In the aftermath of the war, then, there seemed suddenly to be a radical socialist mass movement that expected immediate action. There were There were short-lived communist governments in Hungary and Bavaria that by and large continued and amplified wartime central planning. Mises' old nemesis Otto Neurath became a leading member of the Bavarian government and published success stories of his experience and plans for a new society. In the few months until the late summer of 1919, the gates were wide open for complete communism, but the socialist leaders Carl Koltzky, Otto Bauer and Max Adler had no plan for how to satisfy this popular demand. One thing was clear. In distinct contrast to Ratenau, the Vienna socialists, the Austro-Marxists, were not at ease with the notion that central planning meant omnipotent government. They wanted the central plan, but the planning was somehow supposed to be done by all of society, not just a technocratic elite.

3:23In January 1919, Otto Bauer published a series of articles that he reprinted in a booklet with the title Der Weg zum Sozialismus, The Road to Socialism. Bauer advocated the piecemeal expropriation of industrial firms along syndicalist lines. The assets of the firms should henceforth be managed by the workers or by committees composed of workers, consumers and civil servants. But neither Bauer nor any of the other intellectual leaders of the socialist movement had given any thought to the effectiveness of their scheme. None of them had cared to compare and the performance of socialist and capitalist economies. This point has been underlined by socialist historian Edvard Mertz. This turned out to be the crucial strategic weakness of their ideal.

4:10In the fall of 1919 the situation in Austria was miserable, particularly in Vienna. Food was scarce, rooms were cold and the lights were dim or out. Mises had suffered from flu for a couple of weeks, his desk was full and he did not want to work. It was during this time that he completed one of the greatest economics articles ever written. He had promised Lederer that he would write a series of articles for Weber's Archiv für Sozialwissenschaften und Sozialpolitik, where Lederer was about to succeed Werner Sombart as the executive editor. On November 14th, 1919, Mises told him the title of the first of these pieces, Economic Calculation in the Socialist Commonwealth. This was to be the The centrepiece of the general treatise he was working on, which would contain a systematic and comprehensive critique of all varieties of socialist schemes. He must have begun this project soon after finishing Nation, State and Economy, and it would take him two more years to complete the manuscript. The timing was important. Friedrich von Mises was close

5:16to retirement, and although Mises was far from convinced he had much chance of following In Mises' old position, it was not unreasonable to hope that an impressive book publication shortly before the appointment could tip the balance in his favour. For various reasons, however, he might have thought it useful to publish the central argument beforehand in a separate work. One was the hope of having an immediate impact on Austrian policies, but there was also a pedagogic rationale from the early publication of the chapter on economic Calculation. Mises intended to prove that pure socialism was an economic impossibility, and this proof relied on a consideration that had so far escaped the notice of economists. In fact, his proof squarely contradicted one of the most cherished doctrines of the dominant Vizierian paradigm, Mises' theory of imputation. The advanced publication of the calculation chapter would give his readers time to absorb the central thesis of his larger treatise on Socialism. To prepare himself for the likely criticisms he would encounter from the economic

6:17establishment and other interested parties, Mises made use of his seminars to discuss the fundamental problems of the theory of distribution, and more particularly of imputation theory. A short lecture by the mathematical economist Dr Ernst Zeidler opened the first three sessions of the university seminar in October 1919. These were entirely dedicated to the problem of imputation. It is likely that Mises confronted his students at this point with his new ideas. Unfortunately, no records of the meetings have survived. The discussions must have touched on the more subtle problems of economic theory, problems beyond the grasp of most of the students. This was probably Mises' motivation for starting a separate, smaller group limited to more advanced members.

7:05The 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. Josef Schumpeter, Alfred Hamon, Max Adler, Dylan 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

8:15sake. The socialist reply was that people currently loathed hard work only because of the market economy in which they were objectively alienated from their labour 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 the 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.

9:12Mises now presented an elaborate 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 and 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 In 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.

10:05But 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. 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 economising 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, and 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.

11:16The individual economic plan and the distribution of goods between production and consumption is then based on previous accounting. Mises went on to stress the subjective element in this process. Accounting is not perfect. The exactness of its numbers, which strongly impresses the uninitiated, is only apparent. The evaluation of goods and claims that it must work with is always based on estimates, resting on the interpretation of more or less uncertain elements. 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 practised 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 epitomised rationality in economic affairs.

12:12Where 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 But 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

13:21its 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 Mises for factors of production, which can only come into existence where factors of production are privately owned. Insofar as the money calculus epitomises economic rationality, socialism is inherently irrational. It was immediately clear to the audience that Mises was treading completely new ground. Socialism had been criticised from many angles, but hardly anyone had doubted that the central planners could achieve gains in efficiency. Mises' 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' presentation. In short, Mises' 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 of the war had become universally accepted. It later turned out that Mises had an important

14:34predecessor in Nicolaas G. Pierson, the eminent Dutch economist who was also Minister of Finance and Governor of the Dutch Central Bank. In an exchange with Austro-Marxist Karl Kautsky, Pierson had argued that any economic system would have to solve the problem of value determination, and that the socialists would have to demonstrate how this determination could be achieved without and the system of market prices. Pearson's original 1902 essay was written in Dutch and therefore did not reach a wider public in Germany and Austria. It was translated into German and English only after Mises' essay had started the debate independently. The ensuing debate both clarified the critical aspects of Mises' 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.

15:32Mises later summarized the discussion in a letter to Ledo. My first concern is to show that economic calculation as it is practised 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 and the Nationale Ökonomischen Gesellschaft 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

17:16any conceivable economic calculation that the socialist Commonwealth could adopt. I believe that this presents the most important problem of socialisation, a problem far more important for socialist theory than, formally, the problem of the average rate of profit. Mises's comparison in the last sentence refers to a debate initiated by Boehm-Bawerk, who had subjected Marxist theory of the average rate of profit to scathing and devastating criticism. 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. 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,

18:26months and years, when it became increasingly obvious that the objections of his opponents were spurious and that he had already anticipated most of them. Amy Lederer's comments are a case in point. He did not attend the January 1920 meeting of the Nationale Ökonomie Gesellschaft, but sent Mises his typewritten comments in an An Undated Letter Just as Adler and Hillenbauer 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, Lederer claimed that a future socialist economic calculation would be essentially different from capitalistic calculation in that many moments would be included in the calculation, some would be lacking, and some would be evaluated differently. This all points to another kind of system, but a system nevertheless. It is at that point, within a system, where universal factors are found, that operative methods of calculation for the system originate.

19:30Lederer also observed that capitalist accounting does not give photographs of reality, but only stylised models, which heavily depend on the subjective element of the entrepreneur's 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. Finally, Leder misinterpreted Mises' claims that socialist economies could not be rationally directed to mean that socialist societies would not produce any rational leaders, but Mises' 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 organise the structure of production in an efficient way. Mises wrote, It is not

20:34Not 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. A good assumption indeed. Mises here sums up the essence of political leadership in the age of the omnipotent state. The Intellectual Context The political implications of Mises' argument were obvious. If Mises was right, full socialism was not a viable option. Only capitalism or some mixed economy that accommodated the market remained on the menu of feasible political constitutions. Yet Mises' socialist calculation argument had a much wider theoretical significance than was apparent to most economists in the 1920s and 1930s. It was in fact the first and decisive step toward building the theory of production on completely different foundations Thanks in particular to the writings and towering personal influence of Friedrich von Mises, most Austrian School economists had unwittingly come to accept John Stuart Mill's dogma that production and distribution are two separate spheres of human life, which are separable

21:51in both economic analysis and political practice. In Mill's view, production was essentially is truly a matter of technology, whereas distribution was a question of distributive justice, and economic science dealt exclusively with one particular distributive system, namely the market economy. Says Mill, It is evident that of the two great departments of political economy, the production of wealth and its distribution, the consideration of value has to do with the latter alone, and with that, only so far as competition and not usage or or custom is the distributing agency. The conditions and laws of production would be the same as they are if the arrangements of society did not depend on exchange, or did not admit of it. Accordingly, questions of ownership and of appropriation were deemed to be the proper subject of legal scholarship, not economic analysis. This account of the relation between production and distribution did not comport well with Carl Menger's theory Theory of the order of goods, according to which higher order goods derive their value

22:53from lower order goods, and thus ultimately from consumers' goods. Factors of production are valuable only because they serve to produce consumers' goods. The value of streets, machines, cars, petroleum, etc., is thus derived from the value of the enjoyment that they help bring about. This common sense observation turned classical economics on its head. The The Cost of Production Theories of Value held that consumers' goods are valuable only because they are produced with valuable inputs. It was not a straightforward task to explain precisely how factors of production derive their value from the value of consumers' goods. What does it mean to derive value or, in other words, what does it mean to say that an actor imputes the value of a consumer's good to a factor of production?

23:40Carl Menger had only very briefly dealt with the problem of imputation. Zurechnung. Notice, however, that Menger had no predecessor for his solution of the problem of joint production. It is safe to say that he and Boehm-Bawerk believed that the value of consumer goods depended on the legal situation of the acting individuals. Hence, in their view, production was interrelated with distribution. But in their writings, both focused heavily on the conditions existing in a market economy and neglected the question of how the results The importance of the analysis were modified under the impact of different legal frameworks. The only early Austrian who addressed the problem of the relationship between value and distribution in any systematic way was Friedrich von Mises. He recognized the importance of the question and proposed an original answer that he based on an elaboration of Menger's theory of value imputation. Menger had based his analysis of imputation on the premise that value is a quantity, or at any rate some sort of extensive entity. This assumption

24:43was necessary for his imputation theory, because if value did not have such an extended nature, it would be unintelligible from what it was that was imputed to something else. It was also an assumption shared by the greatest authorities in German economics. Consider the number one German economics textbook of Menger's day, Karl Heinrich Rao, Grundsätze and the Volkswirtschaftslehre. On page 166 he says,

25:35Strength and Duration Wieser unquestioningly adopted Menger's premise that value is a quantity, and added further speculations on the nature of value to the Mengerian fabric. In particular, he came up with two new claims about value that would prove to have great significance for the political implications of his own value theory, and which foreshadowed the way economic analysis would be practiced during the rest of the twentieth century. First, Wieser advocated the use of the fiction that one could meaningfully speak of value without respect to the wealth or income of the acting person. He himself recognized his stipulation as a fiction, and he justified the use of fictions as a necessary device of scientific analysis. In fact, as significant as the political implications of Visa's natural value theory are in their own right, it is equally important to stress the impact of Visa's methodology on the wider profession. Mathematical economics had made no secret of the fact that their reasoning relied on fictions, even though they believed that the

26:36error introduced by unrealistic stipulations was negligible in most cases. In contrast, verbal economists like Menger stressed the necessity for science to describe reality. They were reluctant to use mathematical tools precisely because they saw no way to reconcile the use of such tools with their quest for realism. Mises broke with this tradition by by consciously insisting on the legitimacy of deductions from fiction. The value that is independent of income and wealth is natural value. Of course, the natural value of capital goods is derived from the natural value of consumers' goods. How the natural value of consumers' goods is imputed to capital goods is the subject matter of imputation theory. Second, natural value is objective in the sense that it is the same for All Persons. For example, Wieser claimed that an increase in the quantity of money entails the same decrease of the value of money for every individual, and he therefore also held that the marginal value of any given amount of money is lower for a rich person

27:41than for a poor person. Thus, in spite of some statements in which he stressed that value was always related to an acting individual, in his theory of natural value Wieser completely dissociated the value of goods from any context of concrete human action. This was the starting point for his theory of the shortcomings of capitalism and also for his policy recommendations. It is obvious that real-life monetary economies are not likely to bring about the same results as an economy in which natural value reigns. According to Wieser, only if all members of society are perfectly equal in their wealth and income position do the values of a monetary The Theory of Money and Credit The practical nub of Mises' theory and his great innovation was to turn upside down the roles of value theory in production and distribution. In Mill's scheme, value theory played no role in production, but exclusively concerned distributive questions in the contingent framework of a market economy. In contrast, Mises pointed out that while the value of goods could be

29:06neglected in decisions about their distribution, the question of value was central to decisions Modern marginal value theory not only served to explain the value of all goods in all types of social organization, but could also be applied in all conceivable societies to solve the problem of evaluating and allocating factors of production. Contrary to Mill, therefore, value theory was a truly universal theory, and, we might add, it was a truly scientific Theory, because it did not commit the academic economist to any particular political program, just as Maxwell's equations did not commit a physicist to any political party. Wieser fervently denounced the intimate relationship between the various schools of economic thought and the political agendas they were backing up, criticizing these schools for not pursuing pure knowledge, that is, for Wieser knowledge untainted by political implications.

30:06In contrast, his approach covered a certain most inner domain of economic truths, truths relating to elements that remain common to all social organisations. Clearly this guaranteed political impartiality and therefore, in his view, scientific objectivity. Capitalist calculation in terms of money prices was only one particular application, and a rather deficient one, of the general principles of value calculus. By the end of the First World War, Wieser's analytical framework had become orthodoxy. The best illustration is the fact that Max Weber invited him to write a general treatise on economics for the prestigious Grundriss der Sozialökonomik series, which was supposed to portray the present state of the social sciences. Wieser thus wrote his Theorie der gesellschaftlichen Wirtschaft. The work was first published in 1914 and remained the main Work of Reference in German Language Economics until the early 1930s. A second edition appeared in 1924. It is true that the technical details of his imputation theory were challenged and that it competed with Boehm-Bawerk's slightly different approach. Works on the technical

31:18problems of imputation theory abounded from the 1890s and proliferated until the 1930s without leading to any solution. But the general postulates and distinctions on which which value imputation theory relied, had not met with serious resistance from any major champion of theoretical economics. Most notably Boehm-Bawerk had no substantial objections to offer. He was not enthusiastic about Wieser's emphasis on the use of fictions in economics, but he too adopted Menger's conception of value as an extended entity that can be imputed to other objects. Thus he compounded the confusion that Wieser had created among younger economic Theorists The only theoretical challenge to the Vizierian orthodoxy came from a young Russian Marxist who for some time had been a member of Boehm-Bawerk's seminar and who later became Soviet Russia's top economist. In his Economic Theory of the Leisure Class, which was first published in Russian in 1917, Nikolai Bukharin presented an all-out attack on the new marginalist price theory, selecting as his prime target the Austrian School because it is generally known that the most powerful opponent of Marxism

32:32is the Austrian School. One of Bookerin's main objectives was to explain why the Austrian pretensions to the universality of the value theory were untenable. He observed, While Marx is concerned with the historically determined relations between men, Berm Bawerk presents universal forms of the relations between men and things, but he went on, these universal Capital forms are not sufficient to explain market prices because market prices result, among other things, from certain contingent features of the capitalist system, most notably private property and the production of commodities. Said Bukharin, it is obvious that even the most fundamental phenomenon of political economy, that of value, cannot be explained on the basis of the circumstance common to all times and People's That Commodity Satisfy Some Human Need. Yet, this is the method of the Austrian School.

33:28We therefore reach the conclusion that the Austrian School is pursuing an absolutely erroneous methodological course in ignoring the peculiarities of capitalism. Mises's socialist calculation argument buried the old Vizierian approach, but it also overturned the doctrines of Mill and Marx as well. First, Mises joined with Bukharin in his critique of of the Older Austrians by arguing that there can be no general principle of value calculation because there is no such thing as value calculation in the first place. There is only price calculation, and it comes into existence only at those times and places where the means of production are privately owned. The existence of economic calculation is a historically contingent event. Second, Mises showed that this very historical contingency of the economic calculus played made out against Marx and the Marxists. Rationality in economic affairs exists only to the extent that capital goods are privately owned, and the reverse holds true as well. The more socialist any given historical order was, the less rational it was. A rational economic order is not a

34:36fact of nature, but depends entirely on fragile institutions that need to be cultivated through a sustained cultural and political effort. Third, Mises smashed Mill's dogma of the separate realms of production and distribution. Production in capitalism is guided by the individual businessman's calculations, but these calculations are contingent on the existence of private property in the means of production. They cannot be performed in systems lacking such property rights. It follows that production does depend on distribution and distribution Mises' case for the impossibility of socialist calculation relied on two insights of previous authors which he had integrated into his brief exposition on value theory in chapter 2 of Theory of Money and Credit. The first of these insights originated from the works of Georg Simmel and Josef Schlumberger, who had characterised the essence of economic action as exchange.

35:34Every human action exchanges a supposedly superior state of affairs against an inferior one. Today one would of course say choose rather than exchange, but the point is the same. As Mises later argued, this essential feature of human action is also the foundation of the phenomenon of value. In the few passages that he devotes to value theory and theory of money and credit, Mises decisively elaborates on Menger's definition of values as the importance Menger also defined value as a judgment economising men make about the importance of the goods at their disposal for the maintenance of their lives and wellbeing. Hence value does not exist outside the consciousness of men. In Menger's definition of value, which contrasted But somewhat with his actual analysis of value, value was a characteristic feature of a single economic good. In contrast, Mises defined the value of one good in explicit context with the value of another good with which it was compared, and he stressed that this comparison was based on choice as it involved acts of valuation. In short, Mises agreed with Schumpeter

36:52that value had nothing to do with want satisfaction or any other feelings, and that therefore Economists did not have to engage in psychological analysis. Value is ordinal, it is relative, it is a relation, it is not a quantity. Mises emphasized these heterodox observations, then went on to define value as being inextricably bound to human choices. Every economic transaction presupposes a comparison of values, but the necessity for such a comparison, as well as Because the possibility of it is due only to the circumstance that the person concerned has to choose between several commodities. With these lines, Mises set the Austrian Theory of Value, the cornerstone of economic analysis, on a completely new trajectory. Carl Menger had resolutely rejected the notion that the phenomenon of value could somehow depend on human choices. He believed that any reference to free will in this context would deny economics altogether the status of an exact science, he went on.

37:57Whether and under what conditions a thing is useful to me, whether and under what conditions it is a good, whether and under what conditions it is an economic good, whether and under what conditions it possesses value for me, and how large the measure of this value is for me, whether and under what conditions an economic exchange of goods will take place between two economising individuals, and the limits within which a price can be established, if an exchange does occur. These and many other matters are fully as independent of my will as any law of chemistry is of the will of the practising chemist. Menger therefore stressed the will-independent factors determining the pricing process. Market prices resulted ultimately from individual needs that had to be satisfied with scarce means. He realised that human beings had to have knowledge of this causal connection between means and ends.

38:55But the Mengerian analysis of the pricing process paid scant attention to this subjective factor. The posthumous second edition of his principles, 1923, reinforced the stress on the objective factors of the pricing process. Among other things, Menger here distinguishes between imaginary and real human wants. See our discussion in chapter 14. In Menger's account, the theory of value and prices was a subdivision of a Platonic theory of good. With Mises, it became part of a reality-based theory of human action. Second, Mises combined this choice-based theory of value with Franz Kuhl's insight that the value's underlying individual decision-making cannot be measured.

39:41After reviewing the works in the field, he was convinced that Franz Kuhl was correct in his emphasis of value as a purely ordinal relationship between economic goods, always tied to the context given by a concrete person at a concrete time and a concrete place. Acts of valuation are not susceptible of any kind of measurement. It is true that everybody is able to say whether a certain piece of bread seems more valuable to him than a certain piece of iron, or less valuable than a certain piece of meat, and it is therefore true that everybody is in a position to draw up an immense list of comparative values, a list which will hold good only for a given point of time, since it must assume a given combination of wants and commodities, and economic activity has no other basis than and the value scales thus constructed by individuals.

40:32An exchange will take place when two commodity units are placed in a different order on the value scales of two different persons. In a market, exchanges will continue until it's no longer possible for reciprocal surrender of commodities by any two individuals to result in their each acquiring commodities that stand higher on their value scales than those surrendered. If an individual wishes to make an exchange on an economic basis, he has merely to consider the comparative significance in his own judgment of the quantities of commodities in question. Such an estimate of relative values in no way involves the idea of measurement. In these passages, Mises almost anticipates his socialist calculation argument. His 1920 essay on the calculation problem under socialism merely spelled out an important implication In the early 1920s, almost nobody understood value the way Mises defined it. It was certainly not difficult to overlook a revision of value theory that was buried in a book on money.

41:52Moreover, most of his readers were only superficially acquainted with theoretical problems in the first place. Those with interests in monetary theory typically had only a thin background in general value theory, and economists interested in general value theory were unlikely to search for and ponder the value-theoretical disquisitions of a young monetary economist. As time went on, Mises's position became even more marginalised, with the result that Triumph By the beginning of 1922, Mises had finished the manuscript of his treatise on socialism and was looking for a good academic publisher. He had published parts of it beforehand, the chapter on economic calculation. He also tried to publish chapter three, The Social Order and the Political Constitution, in a Festschrift vor Max Weber, but this project did not materialise because socialism appeared before the other book.

42:58Dunkel und Ruhmlot in Munich declined because of the difficult inflationary situation that had begun to wreck the German economy, making the publication of a 500-page scientific treatise a major risk. Moore in Tübingen was interested, but asked Mises to cut 20% of the manuscript. Mises kept looking. In February, he signed a contract with Gustav Fischer in Jena. Their contract had made only vague stipulations about the adjustment of Mises' royalties to the ongoing inflation. This fact is revealing as to Mises' priorities and his sense for business. When prices rose dramatically between a conclusion of the negotiations in February and the completion of the production process in July, Mises was very happy that Fischer raised the honorarium on a courtesy basis by 50%. Mises received 19,200 marks for the book in July 1922. This was the equivalent of $38.92. A few months later, by October 1922, the marks still in precipitous decline, the dollar equivalent of Mises' Honorarium shrank to $6.04. We may suppose, however, that Mises was quick to exchange his marks against Cronin, which

44:12which had a stable dollar exchange rate, thus Fischer turned out to be a good choice and remained Mises's book publisher throughout the 1920s. The book turned out to be a great success. One decisive factor in its sweeping victory was the growing sense among German economists that the reigning historicism and the Kathedra Socialism had done far more harm than good. Already before the war there were signs of The Decline in German Socialist Orthodoxy The Defeat in the First World War accelerated the fall and a wider academic audience became receptive to alternative paradigms. In this situation, Mises' main thesis was confirmed and endorsed by two great authorities in German social science, Max Weber and Heinrich Herkner.

45:01In his Wirtschaft und Gesellschaft, Economy and Society, published posthumously in 1922, Weber argued along the same lines as Mises in his 1920 article, that a socialist planning board could not base its allocation of resources on economic calculation. Contrasting capitalist money price calculation with calculations in kind that authors like Otto Neurath had proposed, Weber observed that the comparison of different kinds of processes of production with the use of different kinds of raw materials and different ways of treating them is carried out today by making a calculation of comparative profitability on terms of money costs. For accounting in kind, on the other hand, there are formidable problems involved here which are incapable of objective solution. In the spring of 1990, Neurath was a member of a short-lived revolutionary Bavarian government in Munich, acting as director of the Zentrale Wirtschaftsamt, Office of the Centrally Planned Economy. After the suppression of the revolution, Marx Weber defended him in court. Weber's ensuing discussion showed that he had fully grasped the nature of the problem, its concrete manifestation, and its capitalist solution.

46:14An enterprise is always faced with the question as to whether any of its parts is operating irrationally, that is, unprofitably, and if so, why. It is a question of determining which which components of its real physical expenditures, that is, of the costs in terms of capital accounting, could be saved and, above all, could more rationally be used elsewhere. This can be determined with relative ease in an exposed calculation of the relation between accounting costs and receipts in money terms, the former including in particular the interest charge allocated to that account. But it is exceedingly difficult to do this entirely in terms of an in-kind calculation, and indeed, it can be accomplished at all only in very simple cases. This, one may believe, is not a matter of circumstances, which could overcome by technical improvements in the methods of calculation, but of fundamental limitations, which makes really exact accounting in terms of calculations in kind impossible in principle.

47:15Even the introduction of non-monetary systems of remuneration could not overcome the problem System of Eradicating Irrationalities, because these measures would be unsuitable to identify irrationalities in the first place. The essential question is that of how it is possible to discover at what point in the organisation it would be profitable to employ such measures, because there existed at that point certain elements of irrationality. It is in finding out these points that accounting in kind encounters difficulties, which in exposed calculation Imputation in money terms does not have to contend with. Weber then went on to point out the crucial fact preventing the application of schemes for calculation in kind, namely that only money imputation works.

48:00Utility imputation is a camera. The fundamental limitations of accounting in kind as the basis of calculation in enterprise of a type which could include the heterocephalus and heteronomous units of production in a in a planned economy are to be found in the problem of imputation, which in such a system cannot take the simple form of an exposed calculation of profit or loss on the books, but rather that very controversial form which it has in the theory of marginal utility. In order to make possible a rational utilisation of the means of production, a system of in-kind accounting would have to determine value indicators of some kind for the individual capital goods Indications which could take over the role of the prices used in book valuation in modern business accounting, but it is not at all clear how such indicators could be established and in particular verified. Whether, for instance, they should vary from one production unit to the next on the basis of economic location, or whether they should be uniform for the

48:59entire economy on the basis of social utility, that is, of present and future consumption Requirements. They were warned against the misconception that this problem was of a merely technical nature, one that could eventually be overcome once enough human resources were invested in finding a solution. Nothing is gained by assuming that, if only the problem of a non-monetary economy were seriously enough attacked, a suitable accounting method would be discovered or invented. The problem is fundamental to any kind of complete socialisation. We We cannot speak of a rational, planned economy, so long as in this decisive respect we have no instrument for elaborating a rational plan. Apparently, Weber and Mises had developed substantially the same ideas in complete independence from one another. Weber died on June 14, 1920, and thus might have read Mises's archive paper, which had come out in February or March of that year. The editors of Economy and Society He referred to Mises's work at the end of the chapter on calculation in kind, stating,

50:03During the printing of this work, an essay by Ludwig von Mises dealing with these problems came out. It is likely, however, that Mises provided the initial inspiration for Weber in their many hours of conversation during Weber's visit to the University of Vienna in the summer semester of 1918. Both men were among the faculty of a course for army officers that dealt with various fundamental political problems. In one of the sessions Weber delivered a lecture on the general problems of socialism. It was subsequently published with his approval from stenographical notes. It is significant that Weber does not even hint at the issue of economic calculation in this lecture. Be that as it may, the important fact is that when Weber died at the age of 56 on June 14, 1920, he and Mises agreed on the socialist Calculation Question, and when Weber's Magnum Opus was eventually published in 1922, it weighed in with the full authority of its author on the side of Mises, causing great

51:01consternation among mainstream economists in Germany who were still steeped in the Catella Socialist tradition. As if to reinforce Weber and Mises, Vladimir Lenin, leader of the world's model of socialism, announced a partial retreat on the economic front. Soviet Russia would to begin a new economic policy bringing greater freedom for trade and commerce. Attempts to abolish money and markets had produced precisely the chaos that Mises argued was inevitable under full socialism. But the real knockout for academic socialism in Germany came at the hands of its own vicar. Heinrich Herkner had succeeded Schmoller in his position at the University of Berlin and Schmoller was the president of the Verein für Sozialpolitik. For practical purposes this meant he had become Schmoller's heir as head of the historical school and of the German social policy movement.

51:56In September 1922, at the Vereins fiftieth Jubilee meeting in Eisenach, it became obvious that Herkner had to be counted among those who abhorred the excesses of historicism and academic socialism. He called for more moderation, which meant, in practical terms, a reconsideration of the tenets of classical economics. Heckner stated that even the great Schmoller had convided to him shortly before his death, that he was concerned about the inability of the younger generation to think in terms of free trade. This inability, Heckner argued, had led to exaggerated views about the power of the state relative to the operation of economic law, and the nefarious consequences could be seen. These views had already become acceptable. Heckner's speech was received with great applause. In the following year, in a widely read paper on the changed implications of economic science for social policy, Kirchner argued that the labour unions had severely hampered economic reconstruction after the war. This concerned in particular their resistance to longer working hours and to any limitations on their power to strike. They were the prime

53:07movers behind the political forces that subjected the German economy to an ever more complex and its web of regulations. Historically astute economists had apprehensions about the ultimate result of this movement, either some perverse guild oligarchy or a mercantilist police state. As an actual reaction to such excesses, there would be excesses in the opposite direction. The influence of the dreaded Manchester School would rebound. Then Harkner singled out Mises's is socialism as the single most important work of this liberal resurgence, endorsing virtually all criticisms that Mises had levelled against socialism. Hayekler urged his colleagues to thoroughly examine the ideas of these new theoretical economists, stating, We encounter by far the most important performance of this line of research in the brilliantly written and inspired work by the Vienna economist Ludwig Mises, Die Gemeinwirtschaft, with full Full command of the most recent scientific achievements, and partly on the basis of new points of view, the author quite devastatingly criticises all variants of socialism and everything that he considers to be socialism.

54:24This took Mises' socialism from the limited exposure of the ivory tower and made it infamous throughout the socialist movement. The unheard of concessions and even praise for one of and the hated theorists caused outrage in the labour unions and angry reassessments of Herkner's position in official socialist circles. Yet Herkner's authority also forced the German mainstream economists to re-evaluate their cherished scientific and political tenets. The influential Heinrich Pesch recognized Mises as the head of the new Manchesterism. He explained, because of his clever and original critique of socialism, Mises has met with with regard and approval even among those authors who, in distinct contrast to him, advocate the legal protection of children and women, and compulsory workers' insurance.

55:15Peche was the leading champion of solidarism, a version of socialism that Mises had criticised in his book. Many of these authors now began to see that the unsuccessful application of socialist schemes in the post-war period had nothing to do with a lack of psychological or ideological preparedness on the part of the population, it sprang from the inner deficiencies of those schemes themselves, flaws highlighted in the works of Mises and Weber. More and more scholars came to renounce their former socialist ideals. This process came to be known as the Crisis of Social Policy. How much Mises and his work stood at the centre The nature of this crisis can be inferred from the fact that by October 1924 more than 20 monographs and papers had been published on the sole subject of economic calculation.

56:07Some 35 years later, Mises evaluated the impact of his socialist calculation argument and found it had shifted the terms of subsequent debate. He observed that all arguments advanced in favour of the Great Reform, collapsed. From that time on, socialists no longer based their hopes upon the power of their arguments, but upon the resentment, envy and hatred of the masses. Today, even the adepts of scientific socialism rely exclusively upon these emotional factors. The basis of contemporary socialism and interventionism is judgements of value. Mises is praised as the only fair variety of society's economic organisation. The Incomplete Revolution The kernel of Mises' theory of calculation is this. While calculation in terms of money prices is the essential intellectual tool of entrepreneurs acting in a market economy, calculation in terms of value is impossible.

57:09A calculus can only be performed with multiples of an extended unit. For example, one can can add one apple to another apple, or one grain of silver to another grain of silver. In contrast, one cannot add a telephone to a piano concerto, and still less can one add wittiness to silence. These things are incommensurable, and therefore cannot be linked through mathematical operations. So it is with value. One cannot quantify the value of a thing, because value Value is not extensive and therefore not measurable. However, value can be qualitatively imputed from consumer goods to factors of production in the sense of a value dependency. Those factors of production are valuable only because they serve to produce valuable consumer goods.

57:59But there is no such thing as quantitative value and thus no value calculation. There There is only price calculation. In the 1940s Mises expressed this idea with great clarity in his economic treatise, which summarised a lifetime of reflection on this problem. One can add up prices expressed in terms of money, but not scales of preference, that is, value scales. One cannot divide values or single out quotas of them. A value judgement never consists in anything other than preferring A to B. The process of value imputation does does not result in derivation of the value of the single productive agents from the value of their joint product. It does not bring about results which could serve as elements of economic calculation. It is only the market that, in establishing prices for each factor of production, creates the conditions required for economic calculation.

58:54Economic calculation always deals with prices, never with values. A few years later he wrote, Value is not intrinsic, it is not in things and conditions, but in the valuing subject. It is impossible to ascribe value to one thing or state of affairs only. Valuation invariably compares one thing or condition with another thing or condition. It grades various states of the external world. It contrasts one thing or state, whether real or imagined, with another thing or state, whether real or imagined, and arranges both in a scale of what the author Whether of the judgment likes better and what less. These insights opened up new perspectives on the social sciences and on the evolution of human societies. If compelled to single out the idea that best characterised Mises' overall contribution to human knowledge, one would have to name his general theory of economic calculation. The 1920 article on socialist calculation was the first step toward the elaboration of this theory.

59:59Just virtually the entire profession of academic economists, who since the days of Adam Smith had reasoned on the tacit premise that all human action can be based on some sort of economic calculus. Mises held that this possibility exists only in a market economy. Outside the market there are only personal value judgements. Economic rationality is politically and historically contingent. The extensive and intensive division of labour, capital-intensive production, the rational allocation of factors of production, all the economic premises of human civilisation have existed only in those societies that protected private property rights in the means of production. Yet when Mises published his original essay on economic calculation under socialism he did not express himself as unambiguously as he would later. In 1920 it was clear to his readers that he thought that it was impossible to measure value, yet he seemed to conceive As a value cannot be measured. It is, however, possible to compare it with other similar feelings. Significantly, in the second edition of 1924, Mises adopted a non-psychological

1:01:13theory of value conceiving a value as an act rather than a feeling. He deleted the above sentence from his book and replaced it with the following. Acts of valuation are not susceptible Mises' own wording actually encouraged speculations of this sort. In the early 1920s, he did not stress that economic calculation always deals with prices, never with values. Quite But to the contrary, in the very article in which he pointed out the problems of economic calculation in socialist regimes, he repeatedly characterised economic calculation as a value calculation or calculation of value.

1:02:06To some extent, this confusion came out of the terminology. Mises used the word value in two distinct ways. The term viat has the same ambivalent meaning in German as its English Translation Value. It means value in a qualitative sense, but can also mean an exchange ratio on the market. But beyond the issue of terminology, there was genuine, substantial confusion on Mises's part. For example, in his 1922 treatise on socialism, which was, after all, based on the 1920 essay, he wrote, under capitalism, capital and labour move until marginal utilities These are everywhere equal. This statement cannot be reconciled with the impossibility of value calculation. His younger readers, who were most familiar with Friedrich von Mises' exposition of Austrian value theory, must have assumed that Mises and Mises were in substantial agreement on value theory. After all, Mises did not contest the notion that economic calculation was essentially a value calculus. He merely pointed out that that only in the market economy was there an arithmetic unit price that allowed for the

1:03:12calculated use of factors of production, whereas socialist regimes lacked such a unit. Ironically, the only reviewer who recognised the critical difference between a cool Mises theory of value and the dominant Miserian theory was Carl Landauer, a fanatical socialist who loaded his two reviews of socialism with personal invectives against the author. Landauer wrote, With his basic thesis, Mises enters into complete opposition to the main idea of the marginal utility school that economic calculation in terms of marginal utility is not a feature of any particular economic order, but can and must be applied in the communist order just as in the capitalist one. The statements Mises made around 1920 in his writings and correspondence lead to the conclusion that he himself did not yet fully grasp the connection between his value theory and his theory of economic calculation. In none of these early writings could he bring himself to the categorical judgement that economic calculation always deals with prices, never with values. It is hardly surprising, then, that his readers and students missed the point

1:04:22as well. They mistook the 1920 essay for a clever technical challenge to the socialist leadership. They did not see, and possibly could not see, the depth of the issue. Mises had made the first step toward a revolutionary revision of economic science and political philosophy, but he was unable to communicate the full message. As a consequence, he lacked and the necessary impact to turn the rising generation of Austrian economists away from Viserion economics. Brilliant young men such as Hayek, Haberler, Machlup, Morgenstern and other fourth generation Austrian economists were schooled in the notion that value calculation was an uncontested tenet of economic science. When Mises recognised his pedagogical shortcomings and spelled out the epistemological implications of his value theory in a series of papers that were published in the late 1920s and early 1930s. It was already too late.

1:05:24Friedrich von Hayek had already begun to rethink and reformulate the socialist calculation argument from a Miserian point of view, which made the argument much weaker than it had been in Mises's hands. Characteristically, Hayek himself believed that he was merely Clarifying the Misesian Position. This confusion plagued the Austrian School for several decades until the important differences between the Misesian and the Hayekian approaches were highlighted in the early 1990s.