Marx’s Capital Volume III – Chapter 5 – Economy in Employment of Constant Capital

~700 words, ~ 4 min reading time

Summary

Since workers create surplus value, it makes sense for capitalists to minimize how much they spend, relatively, on non-labor. (That is “constant capital” in Marx’s terminology.) In general, they can do this by increasing working hours. Since the same building can operate for 8 hours or 24 hours, a greater profit margin will be attained if work happens for more hours. In addition, capitalists look for ways to use the “excretions of production” – that is, by-products or “waste”.

Marx goes a bit deeper on a couple of examples. He discusses savings on labor conditions – pointing out that capitalists can decrease their expenses by tolerating unsafe or uncomfortable working conditions, and presents data showing that disease and mortality are more common among workers in industries where conditions are particularly bad. Marx also observes that large-scale production is encouraged, in part, by the way that power works in industrial machinery. It is often more economical to operate one large plant than multiple smaller ones. These economies of scale (to use the modern phrase) allow capitalists to economize on constant capital. Marx goes a bit deeper into the “excretions of production”. Strangely, he criticizes capitalism for not putting human feces on fields to use as manure. Finally, Marx observes that new inventions are often not economical – so that the first to buy a new product end up paying far more than when the product gets more developed.

Why It Matters

Here we’re getting much more to the practical criticism of the capitalist system that Marx provides. The most important part here is the criticism regarding requiring long working hours and the one about unsafe and unhealthy working conditions. These are the two activities that look the most like “exploitation”, and, I would suggest, are often at the heart of criticisms of a market system.

Where Marx Goes Wrong

Here, Marx’s wage theory is what creates the biggest problems. Since Marx buys into the classicals’ iron law of wages – that is that wages will stay at the level of subsistence – Marx misses the actual dynamics of what is happening. For example, people will trade off wages against other features of a job. So, for example, people may be willing to accept worse conditions – but they only do so if they are compensated for it financially. Conversely, it can sometimes be cost-saving for a company to offer more benefits but pay less – in fact, Marx himself points out a case where a business ended up saving money by installing safety equipment. Marx’s argument then, in this section, relies on the existence of two “irrationalities” – one of which Marx is explicit about, the other of which is missing from the explicit argument, as it is ruled out by Marx’s wage theory. The first irrationality: that capitalists habitually seek to avoid certain kinds of costs – specifically for safety devices. Marx reported one case where a group of manufacturers spent more paying lawyers to fight the imposition of safety regulations than it would have cost to simply implement the regulations themselves. A second is that workers care only about wages and pay no attention to the conditions of production. But these are unlikely to be true. There are systematic differences in certain wages which are explained by differences in job characteristics – sometimes explicitly. This makes perfect sense – people would be willing to be paid less for safe, comfortable jobs, other things equal – but doesn’t fit the iron law of wages which suggests that wages will fall to subsistence levels. In addition, employers take this fact into account when making decisions about safety procedures and the like. Do they get things wrong sometimes? Of course. But, it hardly seems accurate to suggest that employers regularly, irrationally avoid measures that are actually cost-saving – in a competitive world, such decisions put you at a disadvantage compared to your competitors. Which brings us back to a central issue with Marx – for Marx, competition between competitors seems to exist sometimes, but is not worked into the logic consistently. So, competition keeps prices of products in check – but doesn’t let wages rise above subsistence. Competition leads to capitalists being cost-minimizers – but they do so very poorly.

Marx’s Capital Volume III – Chapter 4 – The Effect of the Turnover on the Rate of Profit

~300 words, ~2 min reading time

Summary

The previous chapters were considering the rate of profit for a single “turnover” of capital – effectively a single productive period. In this chapter, Marx broadens the analysis to examine the annual rate of profit if there are multiple turnovers of capital in one year. For example, if I advance $100 in wages at the beginning of the year for wages, and workers make a product I can sell for $110 at the end of the week, then I can “turnover” the $100 from my revenue to pay for wages in the next week. As a result, the same $100 can be spent on wages 52 times over the course of the year, resulting in a profit of $520, while I only had to advance $100 – a 520% return. Marx shows that the annual rate of profit is simply the rate of profit for a single turnover multiplied by the number of turnovers in a year.

Why It Matters

If you’ve read his previous volumes, you’ll know that Marx is a bit obsessed with the idea of “turnover” with capital. The reason is simple: it is what makes capital self-replicating in the Marxian system. So, it makes sense that, as Marx is turning to questions of profit, that he would consider how profit is affected by turnover.

Where Marx Goes Wrong

Marx’s devotion to the labor theory of value muddies his analysis because his price theory is a bit goofy. Sensibly, if a particular set of labor and materials allows for twice as high a turnover, and therefore twice the rate of profit, it seems obvious that entrepreneurs would bid up the wages and material prices, which, in turn, lowers the per-turnover rate of profit. Marx’s system doesn’t seem to allow for this, because it is bound by the labor theory of value.

Marx’s Capital Volume III – Chapter 3 – The Relation of the Rate of Profit and the Rate of Surplus Value

~ 800 words, ~ 4 min reading time

Summary

If we define the rate of profit as the profit divided by the expenditure (not too far from profit margin by standard accounting, though also not quite the same), and the rate of surplus value as the amount of surplus value (that is, profit) divided by the wage bill (that is, the amount of variable capital), then we’ll find this relationship:

Rate of profit = rate of surplus value x (variable capital/total capital)

“Capital” here being the term that Marx uses for “costs” – including wages (that is variable capital), depreciation, materials, etc.

This chapter mostly focuses on different ways in which the rate of profit can change/differ. He considers a number of cases, but comes to this conclusion in the end:

(1) The rate of profit moves in the same proportion as the rate of surplus value if the share of variable capital stays constant.

(2) The rate of profit moves more than the rate of surplus value, but in the same direction, if the share of variable capital moves in the same direction as everything else.

(3) The rate of profit moves less than the rate of surplus value, but in the same direction, if the share of variable capital moves in the opposite direction, but less than, the rate of surplus value.

(4) The rate of profit moves opposite the rate of surplus value if the share of variable capital moves in the opposite direction and more than the rate of surplus value.

(5) The rate of profit stays constant if changes in the rate of surplus value are offset exactly by changes in the variable capital share.

Marx feels a need to explain #5. So, let’s look at Marx’s example (but I’ll use $ instead of pounds). Let’s say that, originally, the capital is divided as: $80 constant capital + $20 variable capital + $20 surplus value. In this case, the rate of profit is 20% ($20/$100), while the rate of surplus value is 100% ($20/$20). Then, let’s say that wages fall, so that you can produce the same stuff with just $16 paid in wages. Then, we’d have $80 constant + $16 variable + $24 surplus value. The problem is that this would mean that the rate of profit has increased 25%. For that not to happen, the constant capital has to have increased, for example, like so: $104 constant + $16 variable + $24 surplus value. Now, the rate of profit is $24/$120 = 20%. The change from $80 to $104 constant capital means that either labor productivity has dropped – that is, that workers need more materials to produce the same quantity of product, or that the cost of materials has increased.

Why It Matters

Marx’s big point from this chapter was to establish that it is possible for two capitalists to have the same rate of profit, but different rates of surplus value. The above examples shows how that can happen. Similarly, it is trivial now to show that two capitalists can have the same rate of surplus value, but different rates of profit. I’m still not 100% sure where Marx is going with this – but I suspect part of the point is to show that, since there is a tendency toward rates of profit to equalize, we’ll have capital-intensive firms (for whom the wage share is low) with relatively higher rates of surplus value. That is: an increase in capital intensity across the economy leads to greater labor exploitation. But, I’m just speculating about that at this point.

Where Marx Goes Wrong

This chapter was mostly mathematical identities. But, I do want to point out two oddities in Marx in this regard:

(1) Marx’s use of the rate of surplus value is really strange. Why “profit divided by wage bill” is meaningful at all is unclear to me. Even if we accept that constant capital should basically be discounted, and only consider a “value added basis”, it seems that the rate of surplus value should be “profit divided by value added by labor (that is profit + wage bill)”. No idea why Marx does what he does on this.

(2) Marx’s use of “labor productivity” is also a bit non-standard to the modern reader. Where we typically think of labor productivity as the ability of labor to make a product in a period of time, Marx is thinking in terms of relative value added (compared to the value already “embodied” in the means of production) – so a lack of productivity is seen more as a worker needing more tools/materials to produce the same thing, as opposed to the modern notion where a lack of productivity is seen more as a worker needing more TIME to produce the same thing.

As is always the case, a definition can’t be “wrong” per se. It’s just more or less useful. These are similar – but could cause confusion because of the difference between modern usage and Marxian usage.

Marx’s Capital Volume III – Chapter 2 – “The Rate of Profit”

~300 words, ~2 min reading time

Chapter summary

In this chapter, Marx distinguishes between the rate of profit and the rate of surplus value. In money terms, surplus value and profit are the same. But, they are different as rates. The rate of profit in Marx is the profit divided by the capital expended (including both constant and variable capital, that is non-wage expenses and wages). The rate of surplus value is the profit divided by the variable capital (the wage bill). Marx says that capitalists really only care about the rate of profit, as they don’t care what their expenditures are, exactly – they just care about the total expended. As a result, changes in the degree of exploitation (the rate of surplus value) are difficult to discern.

Why It Matters

I’m not quite sure where Marx is going with this at this point, but a point he emphasizes is that the same rate of profit may obscure significant differences in the rate of surplus value. So, for example, a firm that is capital-intensive may the same rate of profit as a labor-intensive firm. However, the rate of surplus value is higher for the capital intensive firm since it generated the same profit with a lower wage bill – so, more “surplus labor”.

Where Marx Goes Wrong

This chapter lacked theoretical substance, for the most part, so there wasn’t much wrong with it. The key problem of the labor theory of value runs through Marx, and that is no different here. If we start from the assumption of derived demand/value imputation, however, then everything turns on its head. What Marx calls “profit” is what Bohm-Bawerk identifies as “interest”. “Profit” then, is the result of capitalists delaying consumption for the money that they’ve tied up in the capitalist production process. It has nothing to do with the exploitation of labor.

Marx’s Capital, Volume III – Chapter 1 “Cost-Price and Profit”

~600 words, ~3 min reading time

Summary

In this chapter, Marx lays out the idea of the “cost-price” of a good. Suppose, for example, that a firm pays $400 for means of production (including some wear and tear on capital), $100 in wages, and sells the good for $600. By Marx’s terms, there were $400 in “constant” capital, $100 in “variable” capital (that is, labor), and $100 in “surplus value”.

Marx also considers how changes in the components above change the value (and therefore sales price) of the good. A change in the cost of the means of production would change the value – and therefore sale price – of the good. However, a change in the wage simply changes the division in how much of labor creates “surplus value”. This follows from two of Marx’s premises: (1) the price of a good reflects the value. (2) the value reflects the total labor content embedded in the good. So, if the cost of the means of production increases, then that is a sign that the value of the means of production increases – this value is then passed through to the final product. However, if wages change, that, in itself, doesn’t change the quantity of labor in a good. So, it doesn’t change the value of the good.

This chapter focuses on distinguishing cost-price from other ways of accounting. For example: we wouldn’t use the entirety of durable goods in calculating the cost – on the wear-and-tear portion transfers value to the finished goods. Also, Marx emphasizes that the sale price – NOT the cost-price indicates the real “value” of the good. Eliminating profit then would not eliminate the exploitation of labor. Rather than the surplus value accumulating to the capitalist, it would accumulate to the consumer.

Why It Matters

One of the most significant points that Marx makes in this chapter is that changes in wages do not change the value of the good (as stated above). So, for example, if wages get cut in half, then the value of the good will still be $600 (as above), but the money will be divided $400 for constant capital, $50 for variable capital (that is, wages), and $150 for surplus labor.

This has profound implications for things like minimum wages and labor union negotiations. Because, in the Marxian framework, wages do not affect prices, wages and surplus value are effectively just dividing up a fixed pie. So, imposing a minimum wage, or having powerful unions, would simply result in workers getting more money.

Where Marx Goes Wrong

The fundamental problem: this chapter is infused with the labor theory of value. This is the opposite of the more correct view – which is reflected both in Austrian economics and in mainstream microeconomics, though using slightly different language. Austrians discuss the idea of “imputation” – that is, that value starts in the mind of the consumer, and then is imputed to consumer goods and up the chain of production to the various producer goods and labor. In mainstream lingo, the demand for labor is a “derived demand” – specifically, it is derived from the demand for the goods being produced. Both of these show value coming from the final good to the goods being used to produce that. This is the exact opposite of Marx – where value starts in the labor that goes into the good – whether raw labor or labor embodied in the means of production.

To outsiders, this might feel like a very philosophical disagreement – but it has profound scientific implications. If Marx is right about the labor theory of value, then it DOES follow that the only effect of minimum wages would be a decrease in profit. If modern economics is correct, then minimum wages can create negative employment effects and price effects as well.

Redesigning Microeconomics – Part 1

~700 words, ~4 min reading time

Because I, apparently, don’t actually believe in breaks, I’ve decided to do a major redesign of the main course I teach: Principles of Microeconomics. This has been inspired by a few things – some of it being the research which I’ve linked and summarized here.

Thus far, I have redesigned my syllabi for both my online and face to face courses – including the “Honors addendum” for my face-to-face honors students. I’ll summarize a bit of what I’m doing here:

Assessment

Both face-to-face and online sections are now basically 40% engagement and 60% mastery.

In my online course, I’m using a point system. Students accumulate points in 3 ways: Knewton Homework assignments (100 points, based on successful completion), Short Papers (300 points total), and Engagement Activities (100 points).

Knewton is an adaptive online homework system designed to help students achieve mastery of the course material. The system tries to teach through trial and error. So, if a student answers questions in a topic correct consistently, they won’t see as many questions on that topic. If a student answers them incorrectly, then Knewton tries to adjust the difficulty level to where students can start seeing what a correct answer should look like, and builds them up to the point of mastery. I’m counting this as “engagement” because their grade, in the end, comes from their willingness to keep participating until they “get it” rather than from a summative assessment.

The Short Papers are three papers, each of which is designed to evaluate one of the main course learning objectives in an “authentic” setting. For example: the first paper asks students to choose a good and to make a forecast for the price of that good 1 year from now, and explain that forecast in terms of supply and demand elasticities and supply and demand shifts. In the Spring, I am modifying this assignment a bit by requiring a rough draft and self and peer assessments before the final copy is submitted.

The Engagement Activities give students an ability to customize the course to their own interests. These are generally completion based assignments. Right now, I offer three different options: Excel projects (which teach some basic Excel skills), Economics in the News, and Book Reviews. Students are also free to make their own, if I approve them. These are all completion based, and really just have the goal of convincing students to think a little bit about economics as a field.

My face to face course uses a weighted system, which explicitly separates “Mastery” and “Engagement”. “Mastery” is evaluated based on their performance on the multiple-choice final exam, which can be modified by an optional Grade Proposal – in which they provide evidence that they should get a specific grade for their mastery of course material. This idea was taken from “Rethinking Exams and Letter Grades…” by Kitchen et al. So students aren’t in the dark about the final, I will also have them participate in a “Midterm Diagnostic” which will look a lot like the final, but won’t count toward the course grade.

The Engagement portion is evaluated based on 4 things: (1) Class attendance, (2) Class Preparation Questions, (3) Short Papers (like I use in my online course – but, here graded more on participating in the process than for mastery), and (4) Engagement Choice Activities (which mirror the Engagement Activities from the online course).

For my Honors students, half of their Engagement Choice Activities points come from their Honors Project.

Weekly Rhythm

I’ve established a “Weekly Rhythm”.

For the online courses, the Weekly Rhythm is: Reading, Lecture Videos, Knewton Assignments, Short Paper Step.

For the face-to-face courses, the Weekly Rhythm is: Reading, Lecture Videos, Class Preparation Questions, Short Paper Step, Class Activities.

Next Step

Now that I have my overarching design set up (sequence of course topics, etc), and an assessment plan in place, the next step is to set up my assessments – so I need to write the final and the rubrics/checklists for the papers for my online class – this should help me align everything during the semester with how students will ultimately be evaluated. (YAY for backward design!)

Medicare For All Update – Getting the Math Straight

~600 words, ~3 min reading time

Okay, so I’ve been looking at the Mercatus numbers.

First, Think Progress IS wrong in their representation. (Think Progress makes the very simple error of acting like an ADDITION to cost is the WHOLE cost.)

HOWEVER,  my initial impression was also wrong. My error was a bit more complicated – I assumed constancy in some things that weren’t constant in the Mercatus estimates, and ended up misrepresenting the results, TOO.

So, let’s try to get it right, and we’ll just focus on one year.

Before we hop in, we need to figure out what we’re talking about. We’re going to look at National Health Expenditures (page 5 is my reference here). What this is: Personal Health Care Expenses + Government Administrative Cost + Net Cost of Insurance (Basically, private administrative costs, I would guess) + Government Public Health Activities

Mercatus starts by looking at personal health care expenses in 2022. They suggest these are projected, under our current system, as being $3.859 trillion. (Note: this includes both public and private systems.) With Medicare 4 All, there would be a big jump in healthcare utilization – amounting to $435 billion. This comes from the currently uninsured being covered and from Medicare covering things that some private insurance doesn’t, and from people using more medical care because they are no longer responsible for copays or coinsurance (so, on the margin, they go to the doctor more often – though I suspect this effect is small). BUT, providers would receive less because of M4A’s pay structure. That would cut $384 billion from provider payments, and $61 billion from prescription drug costs. Net effect: personal health care spending FALLS by $10 billion in 2021.

The other change is that total administrative cost is expected to fall by about $83 billion. Basically, we’re eliminating private health insurance costs,  but Medicare’s administration would have to eat that up – but with some economies of scale, there would be a net savings on the administrative side.

So, total effect: $93 billion in National Health Expenditure savings. The other years in the estimate project savings of up to $300 billion in NHE by 2031.

Now, Mercatus’s point is that, EVEN WITH this savings, the government would be spending an additional $2.535 trillion that year – since it is absorbing the private insurance industry’s costs. They want to know where the money is coming from, since doubling income taxes on both individuals and corporations wouldn’t be enough to bring in that money.

On the one hand, progressives can reasonably point out that we’re already spending this money, it’s just a matter of redirecting it. And there’s a point in that. This $2.535 trillion is not new to the ECONOMY, it’s just new to the GOVERNMENT BUDGET. Okay.

But, would progressives then suggest that we should just have the government absorb the health insurance premiums currently paid by employees, employers, and individuals? I suspect not. That would mean that each person’s premium would vary not based on income, but on their current employer. This would be an administrative nightmare, I suspect. So, while the money is there, there is still the practical question of how best to collect it in a way that isn’t politically disastrous.

Another big point: Blahous is very clear that he’s being generous in his estimates of savings because he wants to estimate the MINIMUM amount of additional tax revenue that would be required.

Letter to Mises U Students (2017)

To Mises U students – especially those planning to enter economics as a vocation – an autobiographical note:

TL;DR – You’re amazing. Act like it.

After this week, you may feel inspired and overwhelmed. This is normal. It happens to me, too. Still. Every year. The level of interest, talent, and devotion to the study of good economics that I see among the students and my colleagues on the faculty is inspiring. And overwhelming. I know there are many of you – and I’m speaking of the students and young faculty here, not just David Gordon – who have out-read me. Easily. Many – possibly most – are cleverer and more insightful than I. Many of you will out-write me – if you haven’t already.

I write these not as mere empty words of encouragement – I don’t believe in such things. I write them because they are true – and that is something that I find encouraging, and believe you should, too.

I also write these things with very little regret, regardless what the tone may sound like. The reality is that I love my life and the balance that I have achieved between the various aspects of it.

So, here is my advice to you based on my own – admittedly limited, but rapidly becoming less-so – experience:

(1) I was asked today what the threshold of significance is to write a paper and send it to a journal. My answer: Do you think it is worth your time to write it down? If so, then share it. The reality is that, early in your career, you haven’t the slightest clue how significant your ideas are. You don’t have the experience to make that call. That’s what editors and referees are for. So, simply tell yourself that the odds of rejection are fairly high (which is true even for excellent papers, by the way), do your best, and send the thing out. Yes, rejections hurt. Especially the first few. But, you will learn more from being shot down in a rejection than you will learn from any acceptance. Maybe what you learn is that that editor is a jerk, but far more often, you will receive feedback that will help you refine your ideas or the presentation of your ideas.

(2) At first, follow Carmen’s advice I mentioned in another post – that is, add to what the Masters are doing. Expand, explain, defend, and apply (in no particular order). I especially advise doing this with people who are currently alive. One paper I’m still working on connects Mark Thornton’s Skyscraper research with some basic, fairly mainstream, urban economics and Rothbard’s theory of wages. I presented a draft of this paper at the Austrian Economic Research Conference. What happened? Mark Thornton asked me to coauthor a response to a critic of the theory. It should be obvious but, DON’T SAY NO TO THAT. Coauthoring with an established economist is amazing. It’s far less work than working alone. You get the benefit of their name attached to what you’re doing. You get to observe their research process. And you get to build a relationship with them that can lead to further projects.

(3) Get started early. You’re lucky. Austrian economics is still a small field. As a result, we, frankly, can’t afford to be as credentialist as most other fields. You don’t have a PhD. So what? Look at the Quarterly Journal of Austrian Economics. It’s pretty common for there to be articles in there that are not written by PhDs – they might be grad students, or even undergrads. But, they all go through the same double-blind review process. Yes, if you have a PhD, your odds of acceptance are higher – but that’s because people with PhDs probably have more experience with academic writing and publishing than you do. So, get that experience. Read academic articles – I mean QJAE, not Mises Wire, for this purpose – and try to write them, too. You’ll learn.

(4) Go ahead and write popular pieces – like for Mises Wire and others. This is good practice for writing clearly – something that is far too often missing in academic writing. Confession: when I was a Fellow at the Mises Institute in 2004, I spent a great deal of time commenting on the Mises Blog. This caught the attention of Lew Rockwell, who asked to see me in his office. Yes, I thought I was in trouble for not taking the Fellowship seriously, and spending too much time arguing with people in comment threads instead of doing real economic research. Instead, he said he was going to set me up with a password so that I could post on the Mises Blog on a regular basis. This writing was important for my development, as I had to think far more about being sure that I was clear. Now, it’s true, I haven’t written a popular piece – self-published or published by anyone else – in a LONG time. But, that’s not my focus right now, and it doesn’t take away from the fact that you may learn a lot from doing it.

(5) Keep your life in balance. What that means is purely up to you. But don’t wear yourself out, beat yourself up, or put yourself down just because you don’t write 80 pages a day like Murray Rothbard did. You aren’t Murray Rothbard. Now, that doesn’t mean you aren’t as brilliant as he. But, it does mean that you very well may have different preferences. If you do, don’t pretend otherwise. Austrian economics may be a small field – but there are far more of us than there were just 20 years ago (before I even knew of Austrian economics). We each have a part to play in the division of intellectual labor. Take a break when you need to, and let others take on their roles.

It has been 14 years since I was in your shoes. From this side, it’s a very short time. Make the most of your time – whatever that happens to mean to you. I can only hope that, in 14 years, when you have filled my shoes again (and likely have outgrown them!), you will also find yourself inspired and overwhelmed – but, most of all, encouraged by the days ahead and the bright minds that will lead us there.

Hayek’s The Meaning of Competition

~300 words, ~2 min reading time

Summary of the full article. Article available from the Mises Institute.

In modern economic theory “competition” is used to describe a state of affairs that is probably best thought of as being the CONCLUSION of a competitive process adjusting to fixed underlying conditions. Something as simple as charging the same price is unlikely outside of the most organized markets. Yet, this is a key feature of the perfect competition model.

The common speech sense of competition understands competition to be a dynamic process – one that is typified by people finding and exploiting differences between themselves and their competitors. This is directly opposed to the perfect competition model which assumes a similarity between firms (and certainly between products!).

Making a fetish of the perfect competition model can lead to odd results – in particular, the suppression of an actual competitive process by the use of regulation to impose standardization.

A more productive path than comparing the real world to a hypothetical world of perfect competition is to compare the real world with competition as commonly understood with the real world with competition (as a process) suppressed by legislation. If we allow the competitive process to occur, entrepreneurs will continually adjust their products and processes to try to produce goods that best serve consumers at the best possible prices. Failure to serve consumers’ demands for quality and price will result in losing business to competitors. On the other hand, suppressing competition – perhaps by using price regulation to enforce a common price – will tend to suppress the desire to serve consumers well and efficiently.

Mises’s Economic Calculation

~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.