Mises’ Economic Calculation Problem: An Answer to “Is it possible to have an economic system with no money?”

This answer was originally posted on Quora in September.

Short answer: No

Long answer: This proposition was disproved theoretically by Ludwig von Mises in the first half of the twentieth century. He is known for having elaborated the “economic calculation problem”, first in his 1920 article “Economic Calculation in the Socialist Commonwealth” and expanded upon in his “Socialism” in 1922. Though his rebuttal is against “Socialism” explicitly here, and not just any economic system without money, it is based on the problems that come with the absence of money as a medium of exchange, serving as a case in point the problems of having an economic system without money. Mises claims that five conditions are necessary for successful economic calculation, and that “rational economic activity is impossible in a socialist commonwealth” because all the means of productions are owned by the state, and without money as a medium of exchange, none of the five conditions are fulfilled.

The five conditions are the following:

  1. Being able to compare heterogenous goods;
  2. Being able to relate utility to capital and consumption goods;
  3. The existence of genuine entrepreneurship and market rivalry;
  4. Being able to plan coordination among those who plan production; and
  5. Financial markets existing and being able to function properly.

(1) In a market free economy, money is used as a means of exchange of goods and services. The price signal allows the buyer to compare the costs of goods without needing the knowledge of the conditions of production or supply. In a system where there is no money, such as socialism, however, this option simply isn’t on the table, and has to rely on a calculation in kind, not having sufficient knowledge to be considered “rational”. This creates problems for all buyers, both consumers of goods and services, and producers and employers looking for capital and employees.

(2) With money as the medium of exchange, the buyer only needs to focus on the relation between the cost and his benefit from the purchase, which further sends that data to producers about the current demand as a sign of the people’s current subjective value of the good or service. The producers thus have a way to tell how the consumer welfare is doing, and the degree to which consumers are satisfied with the current supply. Without the price mechanism, says Mises, “socialism lacks the means to relate consumer satisfaction to economic activity.”

(3) In a market economy, entrepreneurs seek profit by supplying unfulfilled needs (Kirzner 1973, Lavoie 1985). Thereby, the economy approaches economic equilibrium, where supply and demand meets, increasing the utilitarian significance in the markets. In a socialist economy, entrepreneurs lack the profit motive to take risks. Without money, you can’t match consumer utility to incentives for production, making it very unlikely that the state planners will be willing to invest in the ideas.

(4) Prices in the sense explained in (3), works as a guide for producers for which lines of production ought to be expanded and which curtailed, coordinating the economy towards economic equilibrium (though the economy may rarely reach or even maintain the equilibrium, as subjective value changes changes over time, shown by the demand). Plan coordination in a “planned” economy, however, is much more difficult. Friedrich von Hayek, who expanded upon Mises work, wrote extensively about the “local knowledge problem.” To coordinate an economy properly, a lot of information is required, and this doesn’t become a problem in market economies, as the price signal works wonders in easily transferring the appropriate information. In a planned economy, however, Hayek argues, the amount of information needed for central planners to adequately coordinate the economy, is so large and spread among so many people that it becomes impossible to gather. In his words:

One reason why economists are increasingly apt to forget about the constant small changes which make up the whole economic picture is probably their growing preoccupation with statistical aggregates, which show a very much greater stability than the movements of the detail. The comparative stability of the aggregates cannot, however, be accounted for—as the statisticians occasionally seem to be inclined to do—by the “law of large numbers” or the mutual compensation of random changes. The number of elements with which we have to deal is not large enough for such accidental forces to produce stability. The continuous flow of goods and services is maintained by constant deliberate adjustments, by new dispositions made every day in the light of circumstances not known the day before, by B stepping in at once when A fails to deliver. Even the large and highly mechanized plant keeps going largely because of an environment upon which it can draw for all sorts of unexpected needs; tiles for its roof, stationery for its forms, and all the thousand and one kinds of equipment in which it cannot be self-contained and which the plans for the operation of the plant require to be readily available in the market.

In that sense, it is a microeconomic counterargument against the macroeconomic arguments for central planning. He also pointed out that “individuals possess useful knowledge but do not realise its importance, may have no incentive to transmit the information, or may have incentive to transmit false information about their preferences” thus making the necessary information unattainable. These arguments came before the age of computers and the research of chaos theory, so perhaps it will work better now? Not so fast. Alec Nove claimed in 1980 that even the best computers available at the time would have to spend millions of years to calculate all the information. The only way socialists could get around this was to adopt money in a form of market socialismOscar Lange, for instance, a neo-Marxian economist, proposed this idea, and thought he had thereby solved the problem of economic calculation. He even said that “a statue of Professor Mises ought to occupy an honorable place in the great hall of the Ministry of Socialization or of the Central Planning Board of the socialist state” for having created this great challenge for the socialists to long struggle over. The only way to “fix” Socialism, it turned out, was to make it more capitalistic. Hayek responded, however, by saying that the simulation of markets in socialism would fail due to lack of genuine entrepreneurship and market rivalry (i.e. condition 3). The money would therefore not be very economically meaningful.
(5) Financial markets work based on speculators investing in capital of businesses they think will grow in the future. The economic efficiency is very dependent on investors avoiding errors in their speculation, and they must anticipate future trends in consumer demand to have any chance to succeed. The stock market work as a “continuous future market” (Lachmann 1978) that entrepreneurs can use to plan their production. Future markets determines the future prices of goods and services, and the stock market is a useful guide for entrepreneurs because investors lose money if they make errors in predicting future consumer demand. As businesses who don’t follow consumer demand goes bankrupt in a market economy (unless they’re subsidized), and can then only achieve profit by taking it into account, the stock market thus become very handy for them. Mises argued therefore that this trial-and-error method in the financial markets tends to lead to efficiency, because of the risk-benefit decision in investments. In socialist economies, Mises claimed, “the egalitarian nature of socialism prohibits speculation in financial markets,” of which he inferred that the system lacks any clear tendency toward improvement in the capital structure of industry.

There you have it folks, the reasons why an economic system without money as the medium of exchange doesn’t work, which also turns out to be a reason why a socialist economic system doesn’t work. Mises showed many examples of how this would work out in practice. Here’s one of them:

It will be evident, even in the socialist society, that 1,000 hectolitres of wine are better than 800, and it is not difficult to decide whether it desires 1,000 hectolitres of wine rather than 500 of oil. There is no need for any system of calculation to establish this fact: the deciding element is the will of the economic subjects involved. But once this decision has been taken, the real task of rational economic direction only commences, i.e., economically, to place the means at the service of the end. That can only be done with some kind of economic calculation. The human mind cannot orient itself properly among the bewildering mass of intermediate products and potentialities of production without such aid. It would simply stand perplexed before the problems of management and location.

2 thoughts on “Mises’ Economic Calculation Problem: An Answer to “Is it possible to have an economic system with no money?”

  1. Mises demonstrates that prices are necessary to make the calculation problem solvable. But does it follow that the medium of exchange must be money?

    Consider – we both understand, roughly, what “$18 worth of gasoline” means. We might therefore come to an arrangement where I pay you in gasoline rather than money. If we disagree about the appropriate price of gasoline, we could look to a nearby gas station for guidance.

    So, what if dollars only exited as a pricing unit, but no physical money ever existed? Obviously we’d do a lot of bartering, and certain commodities would be settled on as frequently accepted trade-stock and serve as a store of value. Financial markets could still exist; in fact, I’d expect stock certificates to be used as trade-stock since anyone can look up a stock price. I see no reason why market rivalries wouldn’t emerge, either.

    And how would the prices of trade-stock be set? As with the current mechanism, the prices would rise when nobody’s willing to accept a commodity, and fall when nobody’s willing to trade it away.

    There are some difficulties with this, like figuring out how big a dollar is when establishing the system in the first place. Nonetheless, “impossible” is a strong claim and I think it’s likely wrong here.

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    1. “…does it follow that the medium of exchange must be money?”

      The general definition of money is that it is a medium of exchange, i.e. that some article is used neither for the sake of consumption or as capital, but as something one can obtain other goods and services with. The most common type of money today is fiat (paper money), though in many countries there are still coins left from what was previously the gold standard. However, there are many other types of money. You could trade with natural resources like gold, silver, or even goods like sugar and tobacco. I recommend checking out Doug Casey’s article on the topic (https://www.caseyresearch.com/casey-daily-dispatch/doug-casey-on-why-gold-is-money/) which cites Aristotle on the five criteria needed to be “good” or “proper” money. For instance, if we agreed upon it, we could arrange our exchanges so that we used water or milk as the medium of exchange, with deciliters as the measurement of value. Not many would agree to such an arrangement, however, since it only fits two of the five criteria. It is divisible and intrinsically valuable, but it’s rather inconvenient and it would require a lot of maintenance to keep it durable and consistent over time. Thus we don’t tend to use that as money, but rather with coins and bills.

      “…what if dollars only exited as a pricing unit, but no physical money ever existed?”

      I suppose what you mean is that prices are listed in the form of dollars, but the only way to exchange would be to engage in barter and use the dollar price as a standard for value. Even if such a state of affairs would even be possible, it’s highly unlikely that it would last very long. To illustrate, let’s look at an example where someone wants to exchange eggs with bread. In such a scenario you don’t have a seller and a buyer, because both of them are both a seller and a buyer since they’re engaging in barter. I’ll therefore term them for simplicity Trader A and Trader B. The question of economic calculation for Trader A here is what quantity of bread one would want to offer for what quantity of eggs. Trader B, similarly, wonders what quantity of eggs he would like to offer for what quantity of bread. Trader A wants as high a eggs/bread-ratio as possible, while Trader B wants as high a bread/eggs-ratio as possible. So they agree on a trade from there. Did you notice? The value of the dollar played zero impact on the trade, and if it did it would only be a detour. This is, of course, since there is no dollar to compare it to in this scenario. Without being used as a medium of exchange, it is meaningless as a pricing unit.

      “There are some difficulties with this, like figuring out how big a dollar is when establishing the system in the first place.”

      The difficulties are big indeed, and I hope the explanation above has been sufficient to clarify the issue.

      “Nonetheless, ‘impossible’ is a strong claim and I think it’s likely wrong here.”

      I agree that it’s a strong word Mises used here, but one ought to be curious enough to wonder why he would say so. Mises wasn’t generally the type to exaggerate. What he meant is that, ceteris paribus, under state ownership of *all* industries and means of production, there would be no way to tell what or how much ought to be produced because one doesn’t have a common denominator such as a price to compare them with. Additionally, the profit and loss system, which I delineate in another article, is unavailable in this scenario, and generally in state-owned enterprise and other government activity. One could criticize Mises use of the term “impossible” with references to how long Communist countries like the Soviet Union have lasted, but there’s one important caveat with this objection. For why would they be able to use economic calculation at least to a certain extent? Prices still existed elsewhere in the world! With the existence of capitalism abroad, communism could survive domestically, so long as it lasted, though it naturally had horrible consequences both for political reasons (dictatorship) and economic reasons (incentive problem + lack of economic calculation).

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