~300 words, ~2 min reading time
This summarizes a section of Ludwig von Mises’s Socialism titled “Economic Calculation”, available from the Mises Institute and Amazon.
Value is fundamentally subjective. For a single consumer, comparing the values of different consumer goods is fairly straightforward. Similarly, comparing the values of factors of production in fairly simple production processes is also fairly straightforward, as the connection between the factors of production and the resulting consumer goods are clear. However, once the production processes achieve any significant degree of complexity, a direct value comparison becomes impossible – especially since there are typically a multitude of possible methods of producing any particular good. In order to deal with this situation, we need economic calculation – the calculation of profits, losses, and equity.
Economic calculation requires two conditions: first, there must be exchange of the factors of production. (This is why socialism – which Mises uses in the strict sense of government control of the means of production – can’t calculate. With government controlling all the means of production, there can be no exchange of them.) Second, it must be a monetary economy. With these two conditions, factors will have money prices, which can be used to calculate costs, profit, and equity.
Economic calculation is not perfect. It cannot account for certain “non-economic” considerations. (Mises cites the example of a productive process that destroys the beauty of the natural landscape.) However, without economic calculation, there is no clear guide for how to produce what we would like to produce.
Socialism can stumble along for a bit, if it holds to the old pattern of production. Since preferences and resources usually don’t change very quickly, the old pattern of production won’t be far from the right one at first. However, in the real world, change happens – which means that holding to the old production patterns would cease to be rational as time passes.