The Intellectual Context

The political implications of Mises's argument were obvious. If Mises was right, full socialism was not a viable option. Only capitalism or some mixed economy that accommodated the market remained on the menu of feasible political constitutions.

Yet Mises's socialist-calculation argument had a much wider theoretical significance than was apparent to most economists in the 1920s and 1930s. It was in fact the first and decisive step toward building the theory of production on completely different foundations from those dominant in the economic mainstream—of which the Austrian School was still a part. Thanks in particular to the writings and towering personal influence of Friedrich von Wieser, most Austrian School economists had unwittingly come to accept John Stuart Mill's dogma, that production and distribution are two separate spheres of human life, which are separable in both economic analysis and political practice. In Mill's view, production was essentially a matter of technology, whereas distribution was a question of distributive justice. And economic science dealt exclusively with one particular distributive system, namely, the market economy. Says Mill:

It is... evident that of the two great departments of Political Economy, the production of wealth and its distribution, the consideration of Value has to do with the latter alone; and with that, only so far as competition, and not usage or custom, is the distributing agency. The conditions and laws of Production would be the same as they are, if the arrangements of society did not depend on Exchange, or did not admit of it.¹⁷

Accordingly, questions of ownership and of appropriation were deemed to be the proper subject of legal scholarship, not economic analysis.

This account of the relation between production and distribution did not comport well with Carl Menger's theory of the order of goods, according to which higher-order goods derive their value from lower-order goods and thus ultimately from consumers' goods. Factors of production are valuable only because they serve to produce consumers' goods. The value of streets, machines, cars, petroleum, etc., is thus derived from the value of the enjoyment that they help bring about. This commonsense observation turned classical economics on its head: the cost-of-production theories of value held that consumers’ goods are valuable only because they are produced with valuable inputs.

It was not a straightforward task to explain precisely how factors of production derive their value from the value of consumers' goods. What does it mean to “derive” value or, in other words, what does it mean to say that an actor “imputes” the value of a consumers' good to a factor of production? Carl Menger had only very briefly dealt with the problem of imputation (Zurechnung).¹⁸ It is safe to say that he and Böhm-Bawerk believed that the value of consumers' goods depended on the legal situation of the acting individuals—hence in their view production was interrelated with distribution. But in their writings, both focused heavily on the conditions existing in a market economy and neglected the question of how the results of the analysis were modified under the impact of different legal frameworks.

The only early Austrian who addressed the problem of the relationship between value and distribution in any systematic way was Friedrich von Wieser. He recognized the importance of the question and proposed an original answer that he based on an elaboration of Menger's theory of value imputation.¹⁹

Menger had based his analysis of imputation on the premise that value is a quantity, or at any rate some sort of extensive entity. This assumption was necessary for his imputation theory, because if value did not have such an extended nature it would be unintelligible from what it was that was imputed to something else. It was also an assumption shared by the greatest authorities in German economics.²⁰ And it certainly did not contradict the dominant interpretation of the new marginalist approach, which thanks to the efforts of Wieser was commonly perceived to be a “psychological” approach dealing with feelings of satisfaction and levels of satiation. And these feelings can vary in strength and duration.

Wieser unquestioningly adopted Menger's premise that value is a quantity and added further speculations on the nature of value to the Mengerian fabric. In particular, he came up with two new claims about value that would prove to have great significance for the political implications of his own value theory, and which foreshadowed the way economic analysis would be practiced during the rest of the twentieth century.

First, Wieser advocated the use of the fiction that one could meaningfully speak of value without respect to the wealth or income of the acting person.²¹ The value that is independent of income and wealth is “natural value.” Of course the natural value of capital goods is derived from the natural value of consumers' goods. How the natural value of consumers' goods is imputed to capital goods is the subject matter of imputation theory.

Second, natural value is objective in the sense that it is the same for all persons. For example, Wieser claimed that an increase in the quantity of money entailed the same decrease of the value of money for every individual, and he therefore also held that the marginal value of any given amount of money is lower for a rich person than for a poor person. Thus, in spite of some statements in which he stressed that value was always related to an acting individual, in his theory of natural value Wieser completely dissociated the value of goods from any context of concrete human action.

This was the starting point for his theory of the shortcomings of capitalism and also for his policy recommendations. It is obvious that real-life monetary economies are not likely to bring about the same results as an economy in which natural value reigns. According to Wieser, only if all members of society are perfectly equal in their wealth and income position do the values of a monetary economy coincide with natural values. And since natural value is the economic ideal of all possible real economies, it follows that economic policy should make sure that all factors of production be treated according to their natural values. This might be achieved in a perfect communist state. But it might also be achieved through heavy government intervention in the market economy.²²

The practical nub of Wieser's theory, and his great innovation, was to turn upside-down the roles of value theory in production and distribution. In Mill's scheme, value theory played no role in production, but exclusively concerned distributive questions in the contingent framework of a market economy. In contrast, Wieser pointed out that, while the value of goods could be neglected in decisions about their distribution, the question of value was central to decisions of production, or a waste of resources would ensue. Modern marginal-value theory not only served to explain the value of all goods in all types of social organization, but could also be applied in all conceivable societies to solve the problem of evaluating and allocating factors of production. Contrary to Mill, therefore, value theory was a truly universal theory.²³ Capitalist calculation in terms of money prices was only one particular application—and a rather deficient one—of the general principles of value calculus.

By the end of World War I, Wieser's analytical framework had become orthodoxy.²⁴ It is true that the technical details of his imputation theory were challenged, and that it competed with Böhm-Bawerk's slightly different approach.²⁵ But the general postulates and distinctions on which value-imputation theory relied had not met with serious resistance from any major champion of theoretical economics. Most notably, Böhm-Bawerk had no substantial objections to offer. He was not enthusiastic about Wieser's emphasis on the use of fictions in economics, but he too adopted Menger's conception of value as an extended entity that can be imputed to other objects. Thus he compounded the confusion that Wieser had created among younger economic theorists.

The only theoretical challenge to the Wieserian orthodoxy came from a young Russian Marxist who for some time had been a member of Böhm-Bawerk's seminar and who later became Soviet Russia's top economist. In his Economic Theory of the Leisure Class, which was first published in Russian in 1917, Nikolai Bukharin presented an all-out attack on the new marginalist price theory, selecting as his prime target the Austrian School because “it is generally known that the most powerful opponent of Marxism is the Austrian School.”²⁶

One of Bukharin's main objectives was to explain why the Austrian pretensions to the universality of their value theory were untenable. He observed: “while Marx is concerned with the historically determined relations between men, Böhm-Bawerk presents universal forms of the relations between men and things.”²⁷ But, he went on, these universal forms are not sufficient to explain market prices because market prices result among other things from certain contingent features of the capitalist system, most notably private property and the production of commodities. Said Bukharin:

It is obvious that even the most fundamental phenomenon of political economy, that of value, cannot be explained on the basis of the circumstance common to all times and peoples, that commodities satisfy some human need; yet this is the “method” of the Austrian School.

We therefore reach the conclusion that the Austrian School is pursuing an absolutely erroneous methodological course in ignoring the peculiarities of capitalism.²⁸

Mises's socialist-calculation argument buried the old Wieserian approach, but it also overturned the doctrines of Mill and Marx as well.

First, Mises joined with Bukharin in his critique of the older Austrians by arguing that there can be no general principles of value calculation because there is no such thing as value calculation in the first place. There is only price calculation, and it comes into existence only at those times and places where the means of production are privately owned. The existence of economic calculation is a historically contingent event.

Second, Mises showed that this very historical contingency of the economic calculus played out against Marx and the Marxists. Rationality in economic affairs exists only to the extent that capital goods are privately owned. And the reverse holds true as well: the more socialist any given historical order was, the less rational it was. A rational economic order is not a fact of nature, but depends entirely on fragile institutions that need to be cultivated through a sustained cultural and political effort.

Third, Mises smashed Mill's dogma of the separate realms of production and distribution. Production in capitalism is guided by the individual businessmen's calculations. But these calculations are contingent on the existence of private property in the means of production. They cannot be performed in systems lacking such property rights. It follows that production does depend on distribution, and distribution on production. They cannot be separated.

Mises's case for the impossibility of socialist calculation relied on two insights of previous authors, which he had integrated into his brief exposition on value theory in chapter 2 of Theory of Money and Credit.

The first of these insights originated from the works of Georg Simmel and Joseph Schumpeter, who had characterized the essence of economic action as exchange; every human action “exchanges” a supposedly superior state of affairs against an inferior one (today one would of course say “choose” rather than “exchange,” but the point is the same).²⁹ As Mises later argued, this essential feature of human action is also the foundation of the phenomenon of value. In the few passages that he devotes to value theory in Theory of Money and Credit, Mises decisively elaborates on Menger's definition of value as “the importance that individual goods or quantities of goods attain for us because we are conscious of being dependent on command of them for the satisfaction of our needs.”³⁰

In Menger's definition of value—which contrasted somewhat with his actual analysis of value³¹—value was a characteristic feature of a single economic good. In contrast, Mises defined the value of one good in explicit context with the value of another good with which it was compared, and he stressed that this “comparison” was based on choice as it involved “acts of valuation.” In short, Mises agreed with Schumpeter that value had nothing to do with want satisfaction or any other feelings, and that therefore economists did not have to engage in psychological analysis. Value is ordinal; it is relative; it is a relation. It is not a quantity. Mises emphasized these heterodox observations, then went on to define value as being inextricably bound to human choices:

Every economic transaction presupposes a comparison of values. But the necessity for such a comparison, as well as the possibility of it, is due only to the circumstance that the person concerned has to choose between several commodities.³²

With these lines, Mises set the Austrian theory of value—the cornerstone of economic analysis—on a completely new trajectory. Carl Menger had resolutely rejected the notion that the phenomenon of value could somehow depend on human choices. He believed that any reference to free will in this context “would deny economics altogether the status of an exact science.”³³ Menger therefore stressed the will-independent factors determining the pricing process. Market prices resulted ultimately from individual needs that had to be satisfied with scarce means. He realized that human beings had to have “knowledge of this causal connection” between means and ends, but the Mengerian analysis of the pricing process paid scant attention to this subjective factor.³⁴ In Menger's account, the theory of value and prices was a subdivision of a Platonic theory of goods. With Mises, it became part of a reality-based theory of human action.

Second, Mises combined this choice-based theory of value with Franz Cuhel's insight that the values underlying individual decision-making cannot be measured. After reviewing the works in the field he was convinced that Franz Cuhel was correct in his emphasis of value as a purely ordinal relationship between economic goods, always tied to the context given by a concrete person at a concrete time and a concrete place.

Acts of valuation are not susceptible of any kind of measurement. It is true that everybody is able to say whether a certain piece of bread seems more valuable to him than a certain piece of iron or less valuable than a certain piece of meat. And it is therefore true that everybody is in a position to draw up an immense list of comparative values; a list which will hold good only for a given point of time, since it must assume a given combination of wants and commodities.... And economic activity has no other basis than the value scales thus constructed by individuals. An exchange will take place when two commodity units are placed in a different order on the value scales of two different persons. In a market, exchanges will continue until it is no longer possible for reciprocal surrender of commodities by any two individuals to result in their each acquiring commodities that stand higher on their value scales than those surrendered. If an individual wishes to make an exchange on an economic basis, he has merely to consider the comparative significance in his own judgment of the quantities of commodities in question. Such an estimate of relative values in no way involves the idea of measurement.³⁵

In these passages Mises almost anticipates his socialist-calculation argument. His 1920 essay on the calculation problem under socialism merely spelled out an important implication of his original revision of Carl Menger's value theory: one cannot calculate with values—only with market prices. But the dependence is mutual. The full scope of the socialist-calculation argument cannot be understood without first understanding that revised value theory.

In the early 1920s, almost nobody understood value the way Mises defined it. It was certainly not difficult to overlook a revision of value theory that was buried in a book on money. Moreover, most of his readers were only superficially acquainted with theoretical problems in the first place. Those with interests in monetary theory typically had only a thin background in general value theory, and economists interested in general value theory were unlikely to search for and ponder the value-theoretical disquisitions of a young monetary economist. As time went on, Mises's position became even more marginalized, with the result that the calculation argument was increasingly difficult to understand for the rising generation of professional economists.