All Commentary
Wednesday, January 1, 1997

Mises, Hayek, and the Market Process: An Introduction

How Are Market-Based Economies Cultivated and Maintained?

Ms. Cuckovic is research coordinator at the Institute for Development and International Relations in Zagreb, Croatia. Dr. Prychitko is associate professor of economics at SUNY-Oswego. This article is adapted from the introduction to the Croatian-language edition of Mises, Hayek, and the Market Process, to be published later this year in Zagreb.

Why Mises and Hayek?

After decades of self-managed socialism, Croatia has embarked upon a market-capitalist transition of historical proportions; yet it is still a country that struggles in search of sound economic foundations.

The collapse of the Yugoslav system has unleashed a new dialogue in Croatian scholarship over the promises and prospects of classical liberalism. The visions of Ludwig von Mises and F.A. Hayek, two leading figures of the Austrian School, have enjoyed a growing interest, although their work is often discussed solely in terms of the historical socialist calculation debate within the economics profession during the 1930s and 1940s. There are some exceptions, such as the largely neoclassical textbook of Djordje Pribicevic, which explores some later Austrian themes, including the notion of competition as a discovery procedure. Very little of Mises’ and Hayek’s work, however, has been translated into the Croatian language. We hope to make a small step forward with the publication of this slender volume.

The problem of central planning has been the distinguishing theme of the modern Austrian School through the twentieth century, nurtured through the concentrated efforts of Mises and Hayek. Both Mises and Hayek developed an epistemological case against comprehensive planning, and argued that modern society owes its preservation to private or separate ownership of the means of production and to market-exchange processes. The economic freedom stemming from private ownership and free markets becomes a necessary condition (though, emphatically, not sufficient: witness fascism) for an overarching political freedom.

Property Rights and the Market Order

But what is ownership? Scholars of the former Yugoslavia have asked this question for decades. Articles by Aleksandr Bajt (1968) and Eirik Furubotn and Svetozar Pejovich (1970) provided a pioneering critical analysis of the notion of social ownership, which would go a long way in establishing the property rights analysis within modern neoclassical economics (and its corresponding critique of self-managed socialism). More recently, Andrija Gams (1988) offered a comprehensive and important treatise on the subject, although the book (Svojina—ownership) is unknown to most Western economists.

The Austrian economists anticipated the development of modern property-rights economics and articulated a clear notion of ownership as early as 1881, with Eugen von Bohm-Bawerk’s short book Rechte und Verhaltnisse vom Standpunkte der volkswirtschaftlichen Guterlehre. Bohm-Bawerk is the first economist that we are aware of to distinguish between legal (de jure) ownership and factual (de facto) ownership of the means of production and by doing so maintain that economics must necessarily study de facto ownership and its corresponding social processes. Part I of our present collection addresses the implications of the Austrian study of ownership and the emergence of the market economy.

In the first essay, Ownership, Ludwig von Mises explores the full implications of these two kinds of categories of ownership rights. What matters for economic analysis is an exploration of who actually holds the power to use scarce economic goods, rather than simply focusing on the formal connections between those who enjoy the legal or juristic titles to economic goods. The juristic notion defines who, if anybody, should have the power to dispose of the means of production. In the 1974 Yugoslav Constitution, for example, the juristic notion of social ownership declared that society as a whole (and thereby nobody) owns the means of production. But the goal of the economist, according to Mises, is to pierce through the juristic network of formal ownership claims and uncover who, or what groups, are actually controlling society’s resources. The implications for the study of the factual workings of Yugoslav self-managed socialism are now obvious, but the seeds of the critique were actually planted, it seems to us, in this early essay by Mises.

Mises himself would embrace the idea that property rights emerged because people anticipated, in advance, the net benefits to be gained from such a social order, and he would continue to dismiss, as he does in this particular essay, the evolutionary explanation based on natural selection processes.

In the second essay, Our Moral Heritage, Hayek offers an alternative evolutionary explanation of the development of private property rights and other moral rules and codes that allowed small societies to thrive and eventually led to the extended order of the modern market-capitalist system. Hayek fully accepts the importance of the de jure/de facto distinction. Yet, he tries to explain how our overarching set of moral rules (those of contract, justice, trust, honesty, reputation, family, even private property itself) emerged over time, as largely an unintended and unanticipated consequence of individual cooperative and competitive behaviors.

Hayek argues that people did not accept the moral rules of property and family because they rationally understood the enormous social consequences that would emerge; instead, those small groups of people (Hayek is considering the earliest emergence of civilization here) who stumbled upon such unwritten, tacit codes of conduct tended to prosper, and their populations tended to multiply compared to those who had not. Later these would become codified into commandments, laws, and so forth. It was these de facto practices and customs that allowed people to prosper and civilization to emerge; only later would these customs reach de jure stature. The de jure codes of conduct did not create the extended market order, but rather helped reaffirm the embodied wisdom that had arisen through a complex process of selective, cultural evolution that emerged over the course of thousands of years.

The contemporary market order, then, is the product of a centuries-long unfolding of countless human actions, but it is certainly not the product of intentional human design. It is, in other words, a spontaneous order.

Hayek clearly discusses the distinction between organization—a fully planned or designed order—and unintended, unplanned, or spontaneous order in Kinds of Order in Society, the third essay in our book. Individual households and enterprises are generally goal-related organizations: their members cooperate to attain a common aim (for example, a family holiday, or university education for the children; higher productivity or increased sales for the firm). What emerges, however, is an integrated social division of labor and an overall market process that is at once more complex and informationally efficient than the participants could have ever intentionally engineered: the cooperative and competitive exchange processes and the system of commodity production at once harness knowledge from the level of individuals, households, and firms and, through changes in prices, interest rates, rents, incomes, profits, losses, and so on, also further inform them of the economic efficiency of their plans. In this way, the spontaneous ordering of the market process goes well beyond the epistemological limitations of individual human minds and plans.

The Knowledge Problem

The implications for socialist planning are enormous. Call it the knowledge problem, the subject of Part II.

The first article in this section, The Use of Knowledge in Society, provides Hayek’s most celebrated article in economic theory. Writing in response to the neoclassical market-socialist models of Oskar Lange, Abba Lerner, and Joseph Schumpeter, Hayek argues that models of socialism (advocating central planning or market socialism) assume away the central problem of economics: precisely how will planners gather the knowledge and information required to successfully design and coordinate a modern economy?

Most planning models demonstrate that planners could design a comprehensive and efficient plan if they possessed all the relevant information, including the preferences of millions of consumers and, even more incredibly, the availability and alternative uses of all scarce resources. The solution, then, is a mere unfolding of the logic of rational action, a task suitable indeed for neoclassical economics. But Hayek, as an Austrian economist, argues that these exercises in pure logic assume away the real economic problems that societies face: how can plans be integrated when people do not possess all the relevant information? Lange’s model went no further in addressing this question, since it assumed that consumer preferences, production functions, costs of production, and availability of resources are all given data, and the only knowledge that planners lack is that of the corresponding equilibrium prices. (Actually, Hayek’s criticism in this chapter can also be interpreted as a criticism of neoclassical economics in general. Whether the model is used, as Lange did, to defend market socialism, or whether it is used, as, say, Milton Friedman does, to defend capitalism, in either case it assumes too much for the planners or for the capitalist enterprises.)

How, then, does capitalism work? Building upon Mises’ path-breaking 1920 article, Die Wirtschaftsrechnung in sozialistischen Gemeinwesen (translated into English as Economic Calculation in the Socialist Commonwealth, and omitted here for lack of space[1]), Hayek argued that spontaneously generated market prices inform participants, after the fact, of the economic suitability and consistency of their individual plans. Enterprise organizations use past, present, and, especially, expected future prices to develop their ex ante plans, to make calculative business judgments and guesses about the future. They will learn whether their plans and calculations were worthwhile, however, by the actual unfolding of events that define the market process: ex post, the actualized market prices will inform enterprise owners of bottom-line profits or losses.

Both Mises and Hayek argue that the calculative or epistemological characteristics of the market pricing system cannot be limited to mere markets for consumer goods, but must also encompass higher-order capital goods and resources, including the means of production. Consumer-goods markets inform enterprise organizations of what to produce; but it takes a market process in the means of production to inform enterprises how to produce both consumers goods and higher-order goods.

By abolishing the market for means of production, through collectivization and nationalization, and by seeking, essentially, to turn all of society into a single, integrated organizational order, socialism must fail. Its complexity and ability to coordinate the millions of individual plans among households and enterprises and other suborganizations in society on the basis of an all-encompassing, comprehensive ex ante plan will be limited to the epistemological abilities of the central planning authorities. Lacking a market process and private or separate property in the means of production, and clinging to the goal of ex ante plan coordination, even decentralized or self-managed socialist planning schemes (such as Croatian economist Branko Horvat’s sophisticated attempt to answer Hayek) are equally vulnerable to the Austrian-School critique.

While Hayek’s article, written in 1945, was geared toward the economics profession, and considered a closing argument in the socialist calculation debate, Mises’ The Delusions of World Planning (the fifth chapter in this volume) appeared in 1944 as part of his observations of World War II in his book Omnipotent Government. Here Mises applies the Austrian arguments to immigration policies, foreign trade agreements, international monetary arrangements, and the planning of international capital transactions. Mises challenges the belief that a capitalistic market order can be rationally managed through broad-sweeping governmental (and intergovernmental) planning policies. Although his criticisms predated the post-Bretton Woods monetary order, they are applicable to today’s International Monetary Fund and the policies of the World Bank.

Hayek broadens the discussion of planners and their plans in chapter six, on The Pretense of Knowledge, his Nobel Memorial Lecture of 1974. For Hayek, the motivation to plan and intervene in spontaneous market order may largely be the result of scientism, or our over-fascination with positivistic science. People have placed too much faith in scientific expertise, as if science alone enjoys a monopoly on the generation of knowledge and truths, and the experts themselves have wrongly assumed that complex social phenomena can be managed and controlled much the same as natural phenomena. Scientism rests on the mistaken assumption that spontaneous social order can be rationally managed and scientifically engineered through state intervention and national economic planning. The cooperative and competitive behavior among individuals, households, and enterprises appears too haphazard and anarchic against scientism’s social-engineering ideal; better to rationally control those behaviors in order to facilitate an ever more efficient social outcome.

The pretense of science rests in the vain hope to predict and control social outcomes. We’ve recently learned, if chaos theory has any truth to it, that prediction is problematic even in the natural sciences. The social sciences differ from the natural in that they study phenomena of the highest complexity, not mere physical phenomena, but instead humans capable of imagining and forming expectations, and changing their expectations and plans on the basis of changes in socio-economic conditions (which can therefore unintentionally frustrate the carefully designed plans of the best social engineers). Hayek reminds us in the next chapter, on Competition as a Discovery Procedure, that neoclassical economics itself leans toward the scientistic ideal by its almost exclusive emphasis on general equilibrium and its welfare characteristics.

Recalling the central theme of his The Use of Knowledge in Society essay, here Hayek more clearly articulates that a real, rivalrous market process—in actual disequilibrium conditions—spontaneously discovers the data (the efficient ways to produce and distribute scarce goods and services) that are otherwise unexplained and already assumed in advance in the abstract fiction of a general economic equilibrium. Hayek discusses how, by its very nature as a process, rather than an already attained equilibrium, the results of a competitive discovery procedure cannot be predicted in advance.

On Economic and Political Freedom

These essays set the stage for Mises’ and Hayek’s confirmation of classical liberalism: economic freedom is a necessary condition for political freedom, the subject of Part III. Society seems to face a choice: Either we can allow millions of people to use property as they see fit (within a set of constitutional rules, of course) and engender a market-based discovery procedure, or we can abolish ownership and private initiative in favor of an increasingly centralized plan designed by expert authority and employing the latest scientific procedures.

In chapter eight—Interventionism—Mises argues that there is no third way between a market system and a planned economy. He states it bluntly and provocatively: either capitalism or socialism—there exists no middle way. State interventions into the market system (such as price controls) will unintentionally create distortions in other parts of the system (such as shortages or surpluses) which, in turn, will create more demands for intervention in order to solve those problems. Rational and partial interventions into the economy beget more interventions, which further choke the system’s discovery properties, generating further discoordination and inefficiencies which only promote louder cries for systemic and all-encompassing intervention. In this sense, capitalist economies might tend toward—but due to the knowledge problem—will never fully achieve, outright socialist planning.

What emerges is neither a more efficient capitalist economy nor greater political freedom. Instead, as Mises maintains in the next chapter, The Social and Political Implications of Bureaucratization, the piecemeal state interventions into capitalism create an ever-spreading and contradictory bureaucracy, a panoply of state bureaus and agencies with often conflicting and incompatible agendas that crowd out both the market process and civil society.

Chapter ten, on Why the Worst Get On Top, is taken from Hayek’s provocative book The Road to Serfdom. Here Hayek seems, on the surface, to affirm Mises’ dictatorship complex argument. Hayek argues that the interventions and creeping bureaucratization of society create a new kind of competitive selection mechanism—one that rewards totalitarian discipline and readiness to disregard society’s accepted morals in order to execute more rational plans and policies. The centralized, state-bureaucratic institutions reward precisely those individuals who can place the community in the abstract—but especially the institutions of the state itself—at a higher moral level than the millions of concrete individuals whom the democratic state was originally meant to serve; one who can confidently and without moral hesitation consider individuals—including those filling the bureaucracy—as the means to attain the collectivist goals of the state itself. The economic power of individuals (through private ownership of the means of production and labor mobility) becomes increasingly appropriated by the institutions of the state, reemerging as a tremendous instrument of political power that destroys political freedom—freedom of the press, of religion, of emigration, and so on. Those who despise such political freedoms are more likely to rise to the top as opposed to those who are indifferent to (let alone those who cherish) such freedoms.

Is Self-Managed Socialism the Answer?

What about democratizing the interventionist state? Or, recalling the writings of some members of the Praxis Group, such as Mihailo Markovic—which enjoyed critical international acclaim among disillusioned Marxists in the West—why not insist on a radically self-managed socialism as a corrective to the centralized socialist state? (Markovic himself argued that both the abolition of private ownership of the means of production and the abolition of politics as a profession are necessary conditions for true political freedom, which, when fully combined, amount to a sufficient condition.) Would this answer the Mises-Hayek objections?

Attempting to draw the Austrian critique to the Yugoslav model of self-managed socialism, one of the present editors has argued that self-managed socialism would face, even under some hypothetically ideal condition, the same set of knowledge problems and totalitarian problems as that of the centrally planned case.[2]

The maintenance, reproduction, and well-being of the self-managed socialist society still depends, absolutely, on a smoothly functioning, rational plan. But the planning board—democratically self-managed or not—would still face an immeasurable degree of complexity when it attempts to formulate a feasible plan of action. Without private ownership of the means of production, and thus a series of prices emerging from a spontaneous market process, the economy has no systemic discovery procedure to evaluate the relative scarcities of goods and services—especially that of the means of production. The planners would find that their task is constrained more by epistemological limitations than by moral principles. That is, although they may believe they possess objective, concrete guidelines regarding political-economic justice (whether traditional—to each according to his needs, from each according to his abilities, or more contemporary rules articulated by Markovic and others), the planners will soon face an enormous epistemological wall: they will inevitably lack useful criteria to help them acquire and transmit the detailed and relevant knowledge necessary to comprehensively coordinate and plan the entire economy. The relevant information surely will not be unearthed through the workers’ councils.

The planners, in a sincere effort to create a unified and comprehensive plan worthy of its name, will not allow—indeed, they cannot allow—everyone to participate in plan formulation. The organizational logic must be one whereby planning tasks must be delegated to experts—at the level of councils, enterprises, ministries, and the central organs of state power itself. In order to feed the people (let alone clothe, house, educate, safeguard, and enrich the masses) the planning board will find that it cannot place socially important technical problems into the hands of society as a whole. Rather, the planning board, in conjunction with other centralized bureaus of the state, will deem it necessary, if rationalized production, distribution, and consumption processes are ever to commence, to appropriate control over the means of production and pursue the social goals that it deems technically possible and economically and socially worthwhile. The knowledge problem inherent in socialist proposals—to the extent that socialism seeks to abolish private ownership by whatever method of planning (centralization, self-management, or market socialism of the Lange variety)—paves the way for the totalitarian problem, the logical tendencies behind Mises’ bureaucratization of the world or Hayek’s road to serfdom.

So what’s left? In chapter eleven—Economic Freedom and Representative Government—Hayek sketches what he considers the basic economic and political principles for a free, liberal society. How do we maintain or, in the case of the new regime in Croatia and other parts of Eastern Europe, cultivate, a market-based economy that fights the gradual erosion of political liberty and civil space—the tendencies to drift back toward statism and totalitarianism? Hayek argues that government must adopt a strict constitutionalist approach—a rule of law—that enforces general codes of just conduct equally applicable to all citizens. The details on the use of property, and so on, would be left to individual and group initiatives, to cooperative and competitive behavior among people and organizations, as long as they follow the broad rules articulated within the general constitution. (There is nothing prohibiting, for example, the emergence of cooperatives and other self-managed organizations, at least in principle, to compete alongside more traditional privately owned enterprise.)

This type of constitutional approach is of key importance for present-day Croatia. The editors do not, of course, pretend that Hayek should have the first or the last word on the subject. Rather, we offer this chapter in order to complete the Mises-Hayek analysis of the problems of socialism and interventionism, and the corresponding appeal for the establishment of a general rule of law as opposed to the rule of men.

1.   See F. A. Hayek, ed., Collectivist Economic Planning: Critical Studies on the Possibilities of Socialism (London: George Routledge and Sons, Ltd., 1935), pp. 87-130.

2.   David L. Prychitko, Marxism and Workers’ Self-Management: The Essential Tension (New York and London: Greenwood Press, 1991), pp. 45-55, 83-100.

Lessons for Lithuania

I think the West is still a good example of how to get rich or at least how to emerge out of poverty. But only as long and as much as there is a grain of capitalist spirit and practice there—only as much and no more. It would be a big mistake to copy socialist tendencies of Western socioeconomic life—tendencies that are contrary to capitalist spirit and practice. Unfortunately, it is these attributes of Western life that seem to have a particular fascination for some of us. As to Lithuania, the adoption of constructive capitalist elements that continue to glimmer in the West would mean two simple things: first, the necessity to continue privatization of all state domains and functions without exception, starting, say, with the monetary and credit systems and all the way through to education, health care, social security, pension insurance, and others; and second, the necessity to put an end to all sorts of government controls and regulations that restrain and stifle private initiative. This is inevitable as Lithuania continues to extend the scope and weight of the private sector by using private property in the most beneficial way for people and the most profitable way for the owner. I believe that such reform guidelines that will lead to a free-market capitalism will help us to build up a better and more decent life—based on our own ingenuity and reason rather than government favors. Government, after all, is not an almighty gracious God that works miracles.

—Audronis Raguotis

(Excerpted from The Free Market, a newsletter of the Lithuanian Free Market Institute.)

  • David Prychitko is professor of economics at Northern Michigan University, where his teaching interests include microeconomics, macroeconomics, and comparative political economy.