Apart from the dubious moral and philosophical arguments often presented by those in favor of socialism, widespread government intervention into the economy fails to live up to predictions of increasing economic activity and improving the standard of living for its citizens. From an economic point of view socialism, which eliminates a monetary exchange for factors of production, is so fundamentally flawed that its failure is easily predictable by those inclined to critically examine how decisions of economic calculation are made in such a system.
We often hear criticisms of “government planning” being inefficient and a hindrance to the economy; but why? The answer rests in the fact that prices in a socialist system are arbitrarily set by government bureaucrats and, thus, do not represent the true value of a good as determined by the supply and demand of producers and consumers. The fact that these prices do not provide any meaningful information about the desires of consumers and produces leads to a misallocation of resources resulting in surpluses in over-valued goods and shortages in under-valued goods.
Fluctuations and increases of prices are often the target of socialist critics of the free market. Greed and a desire to earn unabridged profits are said to drive prices up at the expense of the helpless consumer in a capitalist system. However, this statement ignores how prices are truly formed, what they actually represent, and thus the imperative role they place in economic calculation. In a free market, prices are used by consumers and producers alike to compare the benefit derived from various goods and to then prompt business leaders to divert resources to the sectors in which they will produce the most social benefit. Profit (that is, the difference between a producer’s expenditures and revenue) is, therefore, the reward granted to a producer for scarce resources in both an efficient and socially useful way.
Under a socialist system, government control of the economy operates without any regard to prices, and thus is unable to know whether or not it is encouraging the production of goods and services that will best meet the consumers’ demands. Without these indicators economic calculation is impossible and any attempt to conduct it is utterly futile. The inability of a socialist system to perform economic calculation does not derive from the fact that a governmental body is planning economic behavior, but instead from the fact that central planning, at any level, necessarily distorts prices by making decisions that are based on a perceived need. Using this ‘pretense of knowledge’, central planners are blind to the true distortions their actions are creating, and therefore can never set a country on a fundamentally sound economic path in the way capitalism does. As Mises wrote in Economic Calculation, “When there is no free market, there is no pricing mechanism; without a pricing mechanism, there is no economic calculation.”