De Soto Exposes the Failures of Socialism

[Socialism, Economic Calculation, and Entrepreneurship by Jesús Huerta de Soto (Edward Elgar, 2010; ix + 310 pp.)]

Last Saturday, I attended a lecture at the Mises Institute by the great Spanish economist Jesús Huerta de Soto, who is Professor of Political Economy at the Universidad Rey Juan Carlos. He delivered the lecture with his unique brand of intensity and enthusiasm, and this led me to reexamine his book, Socialism, Economic Calculation, and Entrepreneurship, which came out some years ago and is an indispensable guide to understanding Ludwig von Mises’s socialist calculation argument.

As most readers will know, Mises showed in his fundamental article “Economic Calculation in the Socialist Commonwealth” that, lacking market prices, a socialist system would inevitably collapse into chaos. Mises’s article appeared in 1920, and the argument was extended in his great book Socialism, published in 1922.

At first, socialists responded to the argument by claiming that calculation in prices was not necessary. Goods could be exchanged in kind or “calculated” in labor units or units of utility. But this response to Mises was of no avail. “Labor” is not a homogeneous commodity; labor of one kind is very different from labor of other kinds, and there is no measure of either intrapersonal or interpersonal utility, which is purely subjective.

The socialists soon shifted to an argument that proved much more longstanding, one which—at least until the collapse of the Soviet Union in1991—led most economists to think that Mises’s argument had been refuted. Huerta de Soto calls this reply “the argument of formal similarity.”

According to this argument, it can be proved mathematically that the conditions for equilibrium in a market economy and in a centrally-planned economy are exactly the same. The battle between which system was better must then take place on other fronts. Those who defended this solution often claimed that Enrico Barone had proved the point about equilibrium in 1908, thus refuting Mises in advance. Those who made this allegation ought to have noticed that Mises cited Barone in his 1920 article: evidently, he did not regard it as a refutation.

But why not? Did Mises uncover a flaw in Barone’s reasoning? Not at all. The vital issue is that Mises was not concerned with the conditions of equilibrium. At a given time, the market tends toward equilibrium, but each successive time changes the data and equilibrium is never reached. The question that must be addressed, then, is not how equilibrium can be attained but rather how an economic system can be adjusted to the constantly-changing demands of consumers. Entrepreneurs—ever-alert to profit-making opportunities—are the agents of the process of adjustment, which Huerta de Soto felicitously calls “dynamic efficiency,” by contrast with the “static efficiency” of the equilibrium theorists.

He derives this concept from Israel Kirzner, for whom the activity of the entrepreneur is always to the forefront. In Kirzner’s words:

That [Oskar] Lange did not understand the nonparametric function of prices must certainly be attributed to a perception of the market system’s operation primarily in terms of perfectly competitive equilibrium. (Indeed, it is this textbook approach to price theory that Lange explicitly presents as his model for socialist pricing.) Within this paradigm, as is now well recognized, the role of the entrepreneurial quest for pure profit, as the key element in bringing about price adjustment, is completely ignored.

Huerta de Soto presents a detailed analysis of the economists who pursued the equilibrium path, including Fred M. Taylor, G.D.H. Dickinson, and—by far the most influential—Oskar Lange. It is interesting to note that Taylor was not a socialist:

[Taylor] was a great defender of laissez-faire and the gold standard, but his methodological leaning toward equilibrium analysis (in his case partial and Marshallian) inexorably led him to assume that the problem of economic calculation could be resolved without much trouble.

Huerta de Soto’s demolition of Lange—paragraph by paragraph and sometimes line by line—is especially detailed and devastating.

Unfortunately, the debate over Mises’s argument did not center on the rejection of equilibrium, and, in part, the blame for this rests on a misstep by Friedrich Hayek. He fully accepted Mises’s argument and was well aware that equilibrium is never reached and is not a welfare goal. But he was interested in what he used to call “point by point refutation,” and he asked, what would happen if, contrary to fact, we do accept equilibrium as the goal. Would the socialist plans work? Hayek unleashed a barrage of arguments to show that they would not.

But, although Hayek had never intended this, and had in fact said the opposite, the socialists took him to be conceding that they had successfully answered Mises on the theoretical level and that the argument was merely over whether it was practical to implement central planning. In one of his arguments, Hayek maintained that it would require a vast number of equations to “solve for equilibrium” and that this was beyond human capacity; but maybe future advances in computers could remedy this deficiency.

Hayek protested against this misconstrual without success. Hayek said that,

I feel I should perhaps make it clear that I have never conceded, as is often alleged, that Lange had provided the theoretical solution of the problem and I did not thereafter withdraw to pointing out practical difficulties. What I did say in Individualism and Economic Order was merely that from the factually false hypothesis that the central planning board could command all the necessary information, it could logically follow that the problem was in principle soluble. To deduce from this observation the “admission” that the real problem can be solved in theory is a rather scandalous misrepresentation. Nobody can, of course, transfer to another all the knowledge he has, and certainly not the information he could discover only if market prices told him what he was looking for.

Readers can gain a great deal from careful study of Socialism, Economic Calculation, and Entrepreneurship, and I trust they will not be deterred from this study because the author has a higher opinion of a contemporary political figure that they might not share.