Socialist  Controversy



1.    The roots of the controversy

Oldrich Kyn and Drago Fiser


Although the real controversy about socialism and market started only after the World War I, it will be useful to start with a review of its early prehistory. Theoretical foundations for the controversy were laid already at the end of XIX century. The knowledge of these foundations can also give us the key to the understanding of various directions it developed.

Quite diverse views about the way, how the socialist economy should be coordinated can be found already in the writings of the XIX century socialists. The majority of them assumed that the market mechanism would vanish with all or at least some of its features. However, the views diverged into centralized and decentralized models of socialism. The decentralized model as represented by some utopian socialists or by anarcho-syndicalism of Proudhon was relatively minor compared to the centralized one.


One of the first theorists of economic centralism was an English Ricardian socialist John Gray (1799 – 1850). Already in his „Lectures on the human happiness“(1825), he saw the social limits of capitalistic system in competition. (Gray, pp. 65-67) Why did Gray reach such a conclusion? Because according to him production is limited by demand, demand depends on the total income of population and competition restricts incomes. Therefore in the market economy competition limits the size of production. (Gray, pp. 69-72)

His idea of the social organization that would remove „the social limits of wealth“ is presented in his book „Social System, the Treatise about Principles of Exchange“ from 1831. He sees the solution in creation of the „association of producers“ covering the whole country, and having the central body – the Chamber of Commerce – that would control all the economic activity.


The task of association would be: With the help of well organized plan of production, exchange, distribution and accumulation to reach the maximum possible efficiency of labor and capital. (Gray p.96) Principles No. V – IX of the Gray’s Social System are particularly interesting. The following excerpts show it:

V. The Chamber of Commerce is responsible for the control and auditing of all agriculture, industry and trade.
VI. The Chamber of Commerce hires for fixed salary managers who manage individual agricultural, industrial and trade enterprises.
VII. All the output of enterprises is sent to state warehouses.
VIII. The retail trade that is also under the control of the Chamber of Commerce is supplied from the state warehouses.
IX. All wages and salaries must be paid by money that has no intrinsic value. The retail prices are calculated so that they cover cost of material, wage cost and profit.


It is known that Karl Marx wrote nothing about the concrete organization of the socialist economy. He considered such thoughts utopian. However, it is possible to deduce from his more or less general remarks about socialism that he believed that in a socialist economy the function of the market mechanism would be replaced by rational central control of production.

Instead of the anarchic market, in which the social character of labor is established only ex post, there will exist a system of planned use of the individual labor powers as a single social labor power. (Marx p. 96)


Somewhat more specific formulations can be found in the writings of Engels. (for example Engels p. 244) Specifically his well-known statement from Anti-Duhring, namely that in the socialist economy people will agree on plans simply and „without the famous value“ (Engels p 268) became later a convenient object of Hayek’s critique. The more recent Marxists had similar views.

This demonstrates that the socialists of XIX and the beginning of XX century had no idea what difficulties would the actual functioning of the socialist economy generate. They assumed that after the socialization of the means of production it would be just simple to control the economy according to the plan, without the help of market. This is also the source of believes, that the core of planning is in material balancing of products.


Already at the end of XIX and beginning of XX centuries several nonmarxian economists -  for example Wieser, Pareto, Barone and Cassel – wrote about the problem of economic coordination in the socialist or as they called it collectivist economy.  These authors attempted to prove, that it is not possible to coordinate the production by physical balancing  without prices and other instruments of the market. The doubts that the conscious central decision-making can substitute for the market were expressed also by other economists. For example by H.H, Gossen already in 1854 and later by Cannan and Boehm-Bawerk.

 Pareto and Barone also showed that values that the socialist society would have to attach to goods must depend on the same factors as in the competitive economy. This conclusion was reached using the marginalist theory of value, according to which the social role of prices is to represent the valuation of the scarcity of the factors of production with respect to consumer preferences (the so called scarcity prices). This lead the mentioned economists to the understanding that the attribution of certain value to goods is a common problem that appears everywhere, where the multitude of aims is competing for limited quantities of resources.


The mathematical theory of general equilibrium contributed greatly to the understanding of how the socialist economy can be coordinated.

While Leon Walras, the founder of this theory, build his model only as a model of the pure market economy, his immediate follower, Vilfredo Pareto found out that the central control of production (in the collectivist system) must be described by the identical system of equations as the general equilibrium in a market economy. .

 And he also reached the conclusion that both system of equations give the same solution, if the socialist „ministry of production“ wants to reach maximum of collective welfare (that is maximum of utility for consumers)It follows from the model of the general equilibrium, that the free market under the perfect competition leads to the „Pareto optimum“, that is to the maximum of welfare given the limited resources and given the distribution of income.Pareto optimum under perfect competition can differ from the collective optimum calculated by the „ministry of production“, because the collectivist system would lead to different distribution of income, but not because of the different mechanism of functioning of the economy. F. Wieser in his theory of natural value came to the similar result.


It does not mean, that Pareto regarded both mechanisms as equally good. The central control of the whole economy would require solution of millions of simultaneous equations, which is practically impossible. He wrote that even if it would be possible to collect all necessary data, the solution of the “small” problem with 100 persons and 700 kinds of goods would require simultaneous solution of 70699 equations, and the more realistic problem with 40 millions of people and several thousand kinds of goods would be just beyond any imagination.

Umberto Ricci, one of the Pareto‘s students adds: „ It would be naive to argue in favor of the collectivistic organization of the society, only because equation 10 on the page 94 of the volume II of the „Cours d‘économio politique“ has the same solution as the equation 2. on the page 89. The minister of production of the socialist government can found himself in such a difficult situation, that the faults of free competition … would be negligible. That can happen because the savings would contract, because the supply of labor would fall, because the number of bureaucrats the Ministry of Production needed would exceeds the number of all managerial employees in the liberal state, and even if the collective enthusiasm of the officers of the Ministry of Production would be more ethical than the greed that activates private entrepreneurs, it would hardly have the same productive effect.“ (Ricci, str. 13—14.)


Another Pareto’s student Enrico Barone investigated this problem even in more detail. His essay „The Ministry of Production in a Collectivist State“ played an important role later in the controversy. Barone constructed three mathematical models: (1) for a system of free competition; (2) for monopolistic market economy; (3) for a collectivist regime. From the first model he derived the known result that market mechanism under perfect competition reaches Pareto optimality. The second model indicated that under monopoly conditions the market equilibrium was different;

 the economy did not reach Pareto optimum and therefore monopoly caused the „destruction of wealth“, which means that the scarce resources were not used in the best way to achieve the maximum of peoples welfare.


The third model assumed that in the socialist economy market exchange was eliminated, there did not exist prices, interest or money and the Ministry of Production tried to coordinate the economy by balances in kind. Barone showed that it is impossible to reach the optimum purely by balancing in kind. Therefore some additional parameters need to be added to the model. These parameters represented certain equivalent ratios between different kinds of products, „premium“ for savings e.t.c. Only after inclusion of such parameters it became possible to find the optimal plan of production that maximizes welfare of population. By comparing the results of this model with the solution of the model of market equilibrium Barone demonstrated that the parameters introduced to allow for the solution are equal to prices of market equilibrium and that the „premium“ for savings is equal to the equilibrium interest rate. On the basis of this analysis Barone concluded that prices are needed even for socialist planning and that for finding optimum plan the prices must be the same as in the market economy.


Barone also shows that prices must contain valuation of scarce resources and therefore cannot be determined just according to the labor theory of value. He doubted, as Pareto did, that it could be possible to solve for optimum on paper. Not only because it would require unbelievable number of calculations, but also because the optimum requires that the best technologies that minimize the cost be applied in the economy. But it is not possible to find the best production techniques just by theoretical considerations; they have to be tried in practice. In this context Barone criticized those socialist authors who thought that by central control it is possible to avoid losses that in the competitive market economy are caused by bankruptcies of some firms. According to Barone such bankruptcies are inevitable consequence of the experimental search for the best methods of production. If the central direction of the economy would eliminate these losses, it would cause much greater harm by slowing down the technical progress and causing economic inefficiency. And Barone concluded, that the theories according to which the coordination of the economy can be done in the collectivist system very differently than in the „anarchic“ production, are completely falls.  If the Ministry of production wants to reach collective maximum, it has to reinvent all the economic categories of the old regime, that is prices, wages, interest, rents, profits, savings etc. although it may call them by different names, (Barone, str. 289.)


Walras, Pareto and Barone, showed that the functioning of the market mechanism can be described as simultaneous solution of the large number of equations and therefore hypothetically it may be possible to solve the problem of the optimal allocation of scarce resources by central computations rather then by spontaneous market. Here is the source of the ideas about the possibility of socialist calculation that appeared in 1929.


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