October 21, 2015

Entrepreneurs and Socialism

By In Articles, Brian Jacobson, Economics

This is a continuation of my series on Entrepreneurs, Profits, and the Social Welfare see part 1, part 2, part 3, part 4, and part 5

In the last piece in this series I looked at profit-oriented firms versus government agencies that do not own their capital, sell their products or services on the market, or have the ability to have profits and are therefore bureaucratic in nature. In a truly centrally planned economy such as socialism all the means of production are fully own by the State. The idea was that the community would determine the production of consumer goods, which of course means not the community but a small special body of officials tasked with these decisions. Production would be for use not for profit. This difficulty aside (how a small minority group can carry out the communal will) we pursue concrete criticisms of socialism and its centrally planned economy that naturally arises out of Mises’s conception of the entrepreneur and consumer sovereignty. One of Mises’s most innovative and profound contributions to economics was his work on the impossibility of economic calculation in a socialist society.

The socialist calculation problem is unique to Mises in regards to free-market economic schools criticisms of socialism. Many, especially establishment economics, saw nothing economically wrong with socialism and focused their criticisms on the incentive problems within socialism. Its problem was largely political. Under from each according to his ability to each according to his need why would engineers, doctors, or high-skilled persons work very hard or endure long hours of study and preparation if they cannot reap the benefits? Or, as Rothbard quipped: who, under socialism, will take out the garbage? But leftist economist and socialist were convinced that the dawn of their system would bring about a new man, one that didn’t care about his title or pay. They would even abolish the division of labor, he could be a fisherman in the morning and field worker in the afternoon. There may be some malfeasants, especially in the beginning, but once people tasted of the new economic policies he would be a changed man. He would swap material incentives for moral incentives and become the New Socialist Man (perhaps a distant cousin of Nietzsche’s übermensch).

Yet we may even cede the radical Marxist here, it bears no relation on Mises’s socialist calculation problem. Even supposing the central planning board is made up of angels devoid of greed and desire for personal gain, supposing they even have an army of this New Socialist Man, how will the planners decide what to do? Mises’s argument was not merely that this system would be difficult or inefficient or even that it would become quickly corrupt. Mises’s argument was that without market prices derived from the genuine exchanges of goods by their owners it was impossible to conduct rational economic calculation that was not arbitrary or chaotic.

The problem for Mises lies not so much in consumer goods but in the intermediary markets, the market for the factors of production (land and capital goods). In consumer goods Mises conceded there may be a set of amount of goods per person discounted for age/gender/family/etc and small amounts of direct exchange or there may be a quasi-faux (like the soviet Ruble) which comrades can use for certain items. They may come to a price of cigarettes in terms of cigars or the price of ham in the terms of canned beans and so on. There may then be some sort of price which households may use on a small scale to calculate and economize.

However in the case of the production factors since the State is the owner of the means of production it is both buyer and seller. Since the socialist state is the sole owner and arbiter of the factors of production there can be no exchange. You cannot exchange with yourself. As Mises says “because no production good will ever become the object of exchange, it will be impossible to determine its monetary value…Calculation in terms of money will here be impossible.”

Without exchanges, and therefore prices, there is no intelligible production costs and no conceivable opportunity costs (what you could have done). There is no way appraise the value attributable to the next best alternative which the central planning board has foregone by choosing one production route over another. There is no way to calculate whether increasing the amount of steel in a bicycle is a better use of resources than if that steel had gone to cars, or even if producing X amount of bicycles is better than the proportionate amount of cars you could have made instead. The central planning board cannot know without prices whether the value added of an extra car or bike produced is worth the cost of using up the scarce resources under their control.

This is not to say that production is impossible under socialism but that economizing resources and using them efficiently is. They may certainly be able to produce bicycles but without prices and economic calculation of profit and loss they will not know how the bike should be constructed or if it was worth it(even according to their own value scales). In eliminating the possibility of ownership of the means of production they have eliminated exchange and thus–the entrepreneur.

Profitable entrepreneurs are those who arrange the material resources in a society to the optimum types of goods and the most efficient methods of producing those goods. When thinking of this concept, of the maximum social utility and an optimal diffusion of satisfactions of a certain good we would do well to remember that most factors can be employed by a wide variety of firms, let alone industries. For instance, one may complain about the price of car tires and the malicious restriction of tire output. However it is not simply tire companies bidding over the use of rubber, but also the makers of hydraulic hoses, gardening hoses, rubber bands, shoemakers, and so on. These all bid and set the price and distribution of rubber throughout an economy through their own entrepreneurial decisions. Through economic calculation using the price structure entrepreneurs allocate how much rubber they can feasibly use. Producers of refrigerators and car manufacturers may compete over the same limited supply of metal, machines, skilled-laborers, and transportation in an economy towards totally different products.

No one person is in charge of carefully setting aside enough metal to make so many refrigerators and so many cars. In the first place this exchange economy “renders it possible to base the calculation upon the valuations of all participants in trade. The subjective use value of each [actor] is not immediately comparable as a purely individual phenomenon with the subjective use value of other men. It only becomes so in exchange value, which arises out of the interplay of the subjective valuations of all who take part in exchange.” In socialism, there is only one will acting, whether that be the will of a dictator or a board of democratically elected economic planners either way the factors of production are beyond the arena of exchange. The market however allows a price to emerge due to the interactions of multiple actors asserting their valuations and appraisals of certain goods.

Mises likened the markets for production factors to a great public auction. “The bidders,” he said “are the entrepreneurs. Their highest bids are limited by their expectation of the prices the consumers will be ready to pay for the products. The co-bidders competing with them, whom they must outbid if they are not to go away empty-handed, are in the same situation.” Since by their buying or abstaining consumers set the prices of good Mises concludes that “all these bidders are, as it were, acting as mandatories of the consumers.”

This in turn places limits on the feasible uses of factors by entrepreneurs. The price of silver places a serious control on its use of being made into furniture. In this prices carry information to entrepreneurs. Mises went so far as to say they speak and call out to entrepreneurs. “A factor of production through its price sends out a warning: Don’t touch me, I am earmarked for the satisfaction of another, more urgent need.” It is as if the capitalist-entrepreneurs were to go down an aisle at Home Depot the various materials would be calling out to him “use me,” or “don’t use me”.“But under socialism these factors of production are mute. They give no hint to the planner.”

Without economic calculation how does socialist economies plan production? The Soviet Union provides many examples of irrational production that became even its own economist planned chaos. Arbitrary planning lead to the now iconic photostock images of rusting tractors sitting in a field full of unharvested wheat even as citizens in urban centers waited in bread lines. They had allocated too much labor into producing steel which produced tractors that went unused because there was not enough labor or not enough gasoline to utilize the equipment since they had brought too many laborers to work the steel factory and not enough refineries or farms. They relied on what they called Gross Output Planning. Various industries were given targets which Joseph Salerno describes as “mutual lying.” Ministers of these industries and commissars would intentionally report exaggeratedly low capacities which would in turn be upped by those higher in command allowing them to still meet their quotas and avoid a trip to the great white north.

One problem was that quality was hard to set in quotal terms in comparison with quantity. Much of soviet output had no relation to use. Women were pictured walking around in dresses five sizes too big because the textiles industries quotas were in yards and larger dresses made it much easier to achieve. In a famous speech by Nikita Khrushchev to the politburo he derided the chandelier industry complaining of chandeliers so heavy “that they pull the ceilings down on our heads” because industries were measured in terms of weight of output. This famous soviet nail factorycartoon to the right depicts the manager of nail factory being congratulated for meeting his quota with one single nail. On the hand if the measure was individual units they made tiny useless easily producible nails. Often when these gimmicks failed soviet economists would resort to, as Mises called it, “playing market” and would actually look at prices in the West in order to make economic decisions. It was also reported in the press that black markets had been established all over the Soviet Union which they were essentially allowing because it allowed them to see the price of some items. Even more dramatic was the CIA’s discovery of the ordering of thousands of Sears catalogs by Communist China to be used for gauging prices.

Only as those states were surrounded by a sea of capitalism and markets were they able to provide even a subsistence level of living for half a century before either utter collapse and ruin or slow evolution into state-capitalism like in China. This is why Mises critique is so important and unique that a “socialist economy itself is ‘impossible’ (“unmöglich”)—not just inefficient or less innovative or conducted without benefit of decentralized knowledge, but really and truly and literally impossible.” Other schools (even free-market ones) ceded the economic possibility of socialism and focused on the incentive problems and corruptions that were likely to occur within socialism, but this is to miss the point. Let me borrow an analogy from Robert Murphy’s Choice. Consider how the game of basketball might be changed if instead of keeping score by shooting baskets the score was kept by the amount of times the ball was dribbled by each team. Wouldn’t it be moot to argue about the merits and incentives to score baskets being reduced? In the socialist commonwealth it is not simply that there is less incentive to be productive it is that you do not even know what productive is or what it would like or how to measure it? 

Yet it is held that is much more morally superior and socially responsible when profits are done away with as a possibility, but it is not considered that this also does away with losses, and economic calculation as a whole. An economy under full state-intervention yes may be free from greed or profits but what is lost in losing losses?  Is this a more efficient system at achieving optimal social utility, is it even possible to know or measure? Is it more moral? Is the control of multiple complex and variant industries and plants by a single board of central planners far removed from the processes of production more moral than those who take ownership over the factors of production and take upon themselves any loss from a mistake that they may make in entrepreneurial judgment? How can any endeavor be gauged as successful? How can any process be judged efficient? “Success and failure remain unrecognized in the dark.” Mises concludes with a devastating critique of the one tenant many concede to be socialism’s advantage, even if limited. “The advocates of socialism are badly mistaken in considering the absence of discernible profit and loss an excellent point. It is, on the contrary, the essential vice of any socialist management. It is not an advantage to be ignorant of whether or not what one is doing is a suitable means of attaining the ends sought. A socialist management would be like a man forced to spend his life blindfolded.”

Written by Brian Jacobson

Brian Jacobson works as a quality technician for a manufacturing company in St. Louis, Mo where he lives with his new bride. He studied biblical and theological studies at Reformation Bible College under R.C. Sproul in Orlando, FL. He’s an Old-School Presbyterian who enjoys the simple means of grace, Machen, and living the high life on a budget. Follow him @briankjacobson on Twitter.