The Debate on Economic Calculation Under Socialism

8.4.1. The dance begins

In most socialist interpretations of Marx’s political economy, socialism is considered to be incompatible with the market. Market relationships, even in their simplest form of the exchange of goods among autonomous producers, are presented in Capital as the nucleus from which, logically and historically, capitalism emerged.

After the October Revolution, the idea of central planning as the economic basis of socialism entered into the programmatic documents of many Communist parties. Any acceptance of the market mechanism was presented as a temporary concession, basically justified by the backwardness of the socio-economic conditions and the difficulties of the transition from capit­alism to socialism. It should not be forgotten, however, that in the period of the Second International, some of the reformist currents of Marxism, as well as some of the extreme left-wing ones, not to speak of the anarchist groups, had already criticised the view that State ownership and central planning is the best road to socialism. But with the victory of Leninism in Russia, all dissent was silenced, and socialism became identified with ‘democratic centralism’, ‘central planning’, and State ownership of the means of pro­duction.

Liberal thought entered the debate about planning and the market when von Hayek reproposed an article written by von Mises in 1920, in which the possibility of rational economic calculation in socialism was categorically denied: without a free market, there is no pricing mechanism; without a pricing mechanism, there is no economic calculation.

Numerous attempts were made to rebut this argument in the early 1930s, by F. Taylor, H. D. Dickinson and others. It is also worth recalling the challenge thrown down by Karl Polanyi against von Mises as early as 1922, during a seminar on guild socialism in Vienna. Polanyi’s attempt to construct a positive theory of the socialist economy was derived from his aversion both to the market economy and to centrally planned socialism, both of which he considered as forms of ‘illiberty’. The possibility of constructing an efficient socialist economy was, in those years, the subject of the most animated discussions among economists. Von Mises, on the strength of his academic status, declared the task impossible. At any rate, all the revolutions in central Europe had been defeated, the civil war had shattered the Soviet economy, and socialism was still not on the agenda of the Soviet republics.

8.4.2. The neoclassical socialism of Lange and Lerner

It was the Romanian economist Abba Lerner and, above all, the Polish economist Oskar Lange who gave the most vigorous reply to the arguments of von Mises and von Hayek. The ‘Lange-Lerner solution’ denied theoret­ical validity to von Mises’ argument by using the demonstration, elaborated by Barone in 1908, of the virtual equivalence between central planning and the free market in the efficient allocation of resources. Lange and Lerner, on the other hand, tried to identify a ‘practical’ solution in the famous iterative ‘trial-and-error’ procedure, according to which the central planning office would undertake the same function as Walrasian markets. Lange formulated two alternative models. In the first, consumer goods and labour services are allocated by means of the free market on the basis of monetary prices, while in the other, inputs are assigned accounting prices.

(1) Minimize the average cost of production by employing a combination of factors for which the marginal product in value of each factor equals its price.

(2) Fix the production level at the point in which the marginal cost equals the price set by the central planning office.

Similarly, by treating the announced prices as parameters, the households maximize their utility function. In this way, the functions of the demand for goods and of the labour supply are obtained. For each good and service, the planner aggregates the proposals received from the firms and households. If, for one good or service, there is positive (negative) excess demand, its price is increased (decreased). The new price vector is announced to the firms and households and the process is repeated, until all the excess demand vanishes. As Lange himself admitted, the procedure was exactly the same as Walras’s tatonnement.

In a second model, proposed in 1958, Lange did not assume the existence of any free market. The demand for consumer goods and the supply of labour are obtained by the planner starting from a social welfare function derived from individual preferences. The iterative process only endeavours to determine accounting prices and has a virtual nature. Once planned production has been carried out, the consumer goods can be sold on the real markets at actual prices that may not correspond to the accounting equilibrium values.

In the elaboration of the ‘trial-and-error’ procedure, the emphasis was placed, first of all, on the demonstration that planned socialism was able to allocate resources in the same way as a capitalist market economy. Subsequently, in the attempt to construct a normative model of market socialism, the project became more ambitious.

In Lange’s model, therefore, the market becomes a mere calculator to solve a system of simultaneous equations—an analogy that Lange was himself to suggest in 1965. Market socialism must be able to combine efficient alloca­tion of productive resources (and this requires rules established by the central office to prevent mono-oligopolistic behaviour) with a distribution of income which maximizes collective welfare (and this involves the elimination of inequalities caused by private ownership of means of production). An eco­nomy that operates on the basis of these principles would be open to inno­vations without being liable to the disasters caused by the cyclical fluctuations.

8.4.3. Von Hayek’s criticism

This model of market socialism was violently attacked from two opposing fronts: by those opposed to the adoption of the market in the socialist sys­tem, and by those who did not accept socialism. The first type of criticism made use of the consideration that what the model of market socialism ensures is, at the most, static, certainly not dynamic, efficiency; the model had nothing to say, for example, about the problem of the full utilization of potential resources. Such an objective can be achieved only by central planning, which would have been necessary, in any case, to avert the strong elements of instability linked to the problems posed by economies of scale. This was the argument put forward by, among others, Maurice Dobb in 1939 and Paul Baran in 1952—an argument which was, in the end, to force Lange himself to revise some points of his model.

The second line of criticism, which was to have the greatest influence, was principally linked to von Hayek’s arguments. His most recent essay on this subject had been ‘Socialist Calculation: The Competitive Solution’ (1940). Von Mises had argued that economic calculation needed to be guided by prices. As a centrally planned economy has no productive factor markets, it is unable to provide a price guide. Lange had reacted by arguing that there was no need for the prices to be those of the market; the guide to decisions could be given by the prices announced by the central authority and taken as references by the socialist managers; these prices would be used as para­meters exactly as a firm would do in perfect competitive conditions.

Recently, Hayek’s 1937 contribution has been taken up again, in a com­pletely different context, and used to criticize the theoretical relevance of the notion of perfect competition as well as to attack the centrality of the notion of equilibrium in economics. We will return to this question in Chapter 12, where we deal with the Neo-Austrian school.

8.5.