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Saturday, April 1, 2000

Toward an Austrian Critique of Governmental Economic Policy

Regulation Interferes with the Spontaneous Market Process

This is the fourth (and last) of a series of articles laying out some foundational elements of modern Austrian economics. Read the first article here, the second here, and the third here.

In preceding articles we outlined the way in which Austrian economists understand the entrepreneurial competitive market process that is responsible for the law of supply and demand. In the present article we pursue this understanding further, to permit us to see why government interventions in spontaneous market processes tend to frustrate and obstruct the coordinative tendencies that the market process generates. The most extreme sense in which such obstruction may occur is in the pure socialist economy (in which all productive activities are governed wholly by a central planning authority). Here the obstruction is total; market tendencies toward spontaneous coordination are completely paralyzed. But less extreme (less “total”) forms of government intervention, particularly so-called “mixed” systems, incorporating significant central regulation of market activity, will be seen to suffer from the same kind of difficulty—the frustration of market tendencies toward spontaneous coordination.

Mises on Socialism

It was in 1920 that renowned Austrian economist Ludwig von Mises enunciated his thesis that centralized socialist planning was, in a definite sense, simply impossible. What he meant by this provocative assertion has often been misinterpreted. Mises did not claim that a socialist system cannot exist; nor did he predict unequivocally that such a system cannot survive for many years. What Mises meant was that, with the best will in the world, with the most dedicated and incorruptible central planners in the world, it is simply impossible to plan centrally for an entire economy. The decisions made by the central authorities in an economy without a market for productive resources cannot possibly take into account all the alternatives that would, in principle, need to be taken into account in order for decisions to be able to be described as socially efficient. Without a market for productive resources (and thus without market prices reflecting the urgency with which consumers in other industries are demanding the services of these resources), central planners have no way of ensuring that resources flow to satisfy the more urgent, rather than the less urgent, demands among consumer preferences.

In a market economy the price of a resource expresses the priority with which consumers wish entrepreneurs to direct that resource for the satisfaction of their preferences; a high resource price means that entrepreneurs, somewhere, are aware of a productive employment for this resource that consumers value highly. For an entrepreneur to allocate this resource to any particular industry, he must, in the market competition for the resource, outbid other entrepreneurs; that is, he must be convinced that he has identified a use for it which consumers value more highly than consumers value alternative uses for that resource. Without themselves necessarily being aware of the nature and value of these alternative uses, the entrepreneurs are led, yes, as if by an invisible hand, to allocate resources in a way that takes account, in effect, of these alternative uses.

But for the central planners, operating as they must without market prices for resources (since there can, by definition, be no resource markets in the socialist economy), a decision made as to whether to allocate steel to the construction of a bridge or to the construction of an apartment building cannot be made on the basis of any measures of alternate urgencies of need; there simply are no such measures. The central authorities may decide to build the bridge, but their decision is not “rational” (in the sense of expressing a rational selection among alternatives). Central planning, in the ordinary sense of the term “to plan” (which expresses the idea of taking into account the need to balance conflicting objectives), is, as Mises showed, impossible.

The Myth of So-Called “Nonmarket” Prices

In the interwar debate that ensued as a result of Mises’s provocative assertion, one attempted socialist response stood out among the others. This was the suggestion, offered separately in the 1930s by two competent socialist economists, Oskar Lange and Abba R. Lerner, that socialist planning might be possible, provided decisions, to be made by socialist employees, could be guided by nonmarket “prices” for resources—that is, by prices promulgated by a central authority, without any resource market, but as based on regular reports to the authority of shortages or surpluses of each particular resource during the preceding production period. Space limitations do not permit us here to spell out the details of this suggestion. As we shall see, its central, damning weakness is the notion that resource “prices” can be promulgated without the spontaneous interplay of the bids and offers of profit-hungry competing entrepreneurs.

Remarkably, but in a sense disastrously, mainstream economics for some four decades ignored this weakness and pronounced the Lange-Lerner suggestion a valid and definitive solution to the problem identified by Mises. Only during the past two decades have economists finally conceded the power of Mises’s argument. In an outstanding 1985 revisionist work devoted to the socialist economic calculation debate—a work rooted in the Austrian understanding of the market process—Donald Lavoie effectively dissected the fallacies that underlay the mainstream illusion that Lange and Lerner had solved the Misesian dilemma.* The source of the illusion is the mainstream preoccupation with states of equilibrium, to the exclusion of any appreciation for the way in which the dynamically competitive ventures initiated by profit-seek-ing entrepreneurs are responsible for the calculative usefulness of real-world market prices. To imagine that a central planning bureaucracy might generate numbers in a manner that might remotely resemble the way in which prices are generated in the course of market competition is fundamentally to misunderstand the way markets work.

To put this in somewhat different terms: the mainstream’s willingness to accept the Lange-Lerner notion of nonmarket “prices” parallels precisely that mainstream’s enunciation of the “law of supply and demand” in strictly equilibrium, nonentrepreneurial terms. Mises’s (and also F. A. Hayek’s) refusal to acknowledge meaningfulness in such nonmarket “prices” parallels precisely the Austrian insistence on understanding the law of supply and demand as the manifestation of an entrepreneurial process.

*Donald Lavoie, Rivalry and Central Planning: The Socialist Calculation Debate Reconsidered (New York: Cambridge University Press, 1985).

The Economics of Government Intervention

Our articulation of the Austrian version of the law of supply and demand, and our corresponding understanding of the Austrian refusal to accept the Lange-Lerner solution (in terms of centrally promulgated nonmarket prices) to the socialist economic calculation problem first identified by Mises permits us to push the logic a little further. It seems reasonable to interpret Mises’s well-known general rejection of government intervention (not only for the socialist model, but more particularly for the “mixed” economy) as a consistent application of his insights into the impossibility of rational central planning in a socialist economy. Each and every act of government regulation constitutes, no matter what noble intentions for social betterment such regulation may reflect, an act of interference with the spontaneous market process generated by entrepreneurial competition.

No one claims that the results of this spontaneous market process are, at any given moment, those that would express perfect social efficiency as seen from a vantage point of imagined omniscience. What Austrians claim for the spontaneous market process is that it is the only procedure available to less-than-omniscient humans to move systematically in the direction of social efficiency, properly defined and understood. For government regulators to believe themselves able systematically and deliberately to improve on the results of the free-market competitive process is not only arrogantly to assume themselves able to approximate the omniscience needed to do so; it is also to fail to realize how their activities are inevitably destined to distort and/or paralyze that market process through which society grapples creatively and constructively with its lack of omniscience. It was Ludwig von Mises who, in his critique of the possibility of socialist planning, drew indirect attention to the central planner’s crippling lack of the knowledge necessary to plan centrally. It was Mises’s subtle understanding of the dynamics of the competitive market process that made him, more than all other twentieth-century economists, the complete skeptic regarding the social usefulness of government intervention in otherwise market economies.

We commenced this four-part series with an Austrian critique of the textbook version of the law of supply and demand. Consideration of the Austrian understanding of that law in terms of a competitive-entrepreneurial process of mutual discovery and coordination led us to a thoroughly negative perspective concerning well- meaning attempts to “maintain competition” through so-called antitrust policies. We have now concluded with brief attention to the manner in which the Austrian view leads, not only to a critique of the pure socialist economy, but also toward the critique of interventionism in all its forms.

  • Israel Kirzner is Emeritus Professor of Economics at New York University. He is widely published (some of his books include: The Economic Point of View, Market Theory and the Price System, An Essay on Capital, Competition and Entrepreneurship, Perception, Opportunity and Profit Studies in the Theory of Entrepreneurship, Discovery, Capitalism and Distributive Justice). Also, he has published many articles and edited both books and journals. He resides in New York. He is a member of the FEE Faculty Network.