Not Just What, But How

The indispensability of free-market prices.


Filed Under : Socialism

There are a variety of ways to look at the fundamental problem that all economies must solve. One way is to talk about the responsiveness of producers to consumers. In this view, the problem the economy solves is figuring out what consumers want and then giving it to them. The challenge here is how producers are to know what consumers want. This view is embraced by some defenders of markets, who argue that they do the job quite well, and by many critics, who deny that proposition. But both groups generally agree that the problem is figuring out what to produce. Faced with stacks of potential inputs, what outputs should we produce that consumers want and value?

Although this perspective has much truth to it, it leaves aside an even more fundamental question that is frequently overlooked in discussions about the efficacy of market economies. Knowing what to produce is one problem, but figuring out how best to produce it is perhaps an even bigger one.

To Build a Bridge

Suppose we know that people would value a bridge over a nearby river. Suppose we even know the location they prefer (and suppose they’re unanimous about it). For some, the hard economic problem has been solved. But that leaves unanswered the question: How we are going to build that bridge? And by “how,” I mean not the engineering question, but the economic ones: With what inputs? How much of each? And are we going to build that bridge with the least valuable resources possible, leaving the most valuable ones for other wants?

We could perhaps build it out of wood, or stone, or steel. We could build it in a labor-intensive way, using lots of workers doing things by hand, or we could go more capital-intensive by using lots of heavy machinery and less labor. If we care at all about the economic well-being of our citizens, getting these questions right matters a great deal. If we could avoid it, we would not want to build the bridge with resources that had more highly valued alternative uses, since that would reduce the total wealth we were capable of creating. Ideally, we’d like to use the least valuable set of resources possible consistent with having a functioning bridge. How are we to figure that out?

Almost a hundred years ago, in one of the social sciences’ most important articles (“Economic Calculation in the Socialist Commonwealth”), Ludwig von Mises gave us the answer. He argued that such comparisons require a common standard of value and that the only standard that would permit rational resource allocation consists of prices generated by a genuinely free market in capital and labor. Market prices, Mises argued, require exchange against money, and exchange requires private property. Only in a free-market economy, characterized by the private ownership of capital, could we figure out not just what to produce, but how best to produce it.

“Groping in the Dark”

Imagine a dark room with stacks and stacks of potential inputs lying around and all kinds of potential consumers trying to find the outputs they want. Free-market prices provide us with a series of lights that allow us to navigate that room and begin to get a sense of how we might answer those questions. Profits and losses tell us after the fact whether or not we got it right. Hence Mises referred to socialism as just so much “groping in the dark.”

No matter how much we know about people’s desire to cross that river, or how much engineering knowledge we have, we cannot figure out the best way to build the bridge unless we can compare the values of the relevant inputs. That is why the prices that emerge from the exchange of privately owned of capital are an irreplaceable feature of an advanced society.



Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University and the author of Microfoundations and Macroeconomics: An Austrian Perspective, now in paperback.

comments powered by Disqus


* indicates required


December 2014

Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.
Download Free PDF




Essential Works from FEE

Economics in One Lesson (full text)


The full text of Hazlitt's famed primer on economic principles: read this first!


Frederic Bastiat's timeless defense of liberty for all. Once read and understood, nothing ever looks the same.


There can be little doubt that man owes some of his greatest suc­cesses in the past to the fact that he has not been able to control so­cial life.


Leonard Read took the lessons of entrepreneurship with him when he started his ideological venture.


No one knows how to make a pencil: Leonard Read's classic (Audio, HTML, and PDF)