The Economic Calculation Problem

The economic calculation problem (ECP) is the critique of centrally-planned economies forwarded by Mises in his Economic Calculation in the Socialist Commonwealth. Simply put, the argument points to the fact that if you do not have access to any prices in the factors of production because they aren’t being traded, that you then cannot perform any profit/loss calculations. Without said profit/loss calculations it becomes impossible to know whether or not you are allocating means efficiently—you are, in the words of Mises, left “groping in the dark.”

Consider the case of a capitalist businessman who wishes to produce cars. He is faced with the choice between building the frame out of aluminium or titanium.¹ His engineers may be extolling the wonderful properties of titanium, explaining that any car made from it would be vastly more durable, more fuel efficient, and easier to handle than any other option they have tested. This could all be true, but this does not imply that titanium is the superior choice. For it might be that titanium is extremely rare and is needed in the production of incredibly expensive capital. Thus its price is bid up very high—this price represents its relative scarcity. On the other hand, aluminium might be abundant, and good enough for the task at hand. If the capitalist wants to discover whether aluminium or titanium is superior he cannot simply consult which other lines of production they are used within and their material properties—he would have to perform economic calculation. Very simply, he compares the input cost vs the profits he can make to see which is superior:

In this example, even though the titanium has superior material properties, it would lose him money. This is a clear signal that said titanium would be more value-productive in alternative arrangements, so the capitalist should not use it here. This calculation could not be performed if he did not know the cost of his materials in the first place. You will notice also in this example that even though he is able to make a greater profit on the cars sold due to their superior quality, this greater profit is not enough to offset the greater cost of the titanium. Thus, merely knowing what it is that consumers want is not enough—one must also have access to the prices of the various factors of production that would go into making the end product.

The beauty of this argument is that it works even if one grants the fantastic notion of the “new socialist man” posited by the utopians. Previously, the best economic case against socialism was the incentive problem—that without the ability to gain an income for oneself, there is no incentive to do the “dirty jobs.” The utopians countered this by asserting that when socialism is achieved men would band together for the common good and willingly engage in such activities without any profit motive. This counter–though ludicrous already–can be freely granted and still the ECP is not solved. The central planner could be a truly benevolent, angelic super-intelligence, and every man could be completely aligned in following its commands. Still, there could be no economic calculation, thus there could be no process of economisation and no “economy” in the strict sense.