Economic Calculation Problem

The economic calculation problem is a criticism of central economic planning. It was first proposed by Ludwig von Mises in 1920 and later expounded by Friedrich Hayek. The problem referred to is that of how to distribute resources rationally in an economy. The free market solution is the price mechanism, wherein people individually have the ability to decide how a good or service should be distributed based on their willingness to give money for it. The price conveys embedded information about the abundance of resources as well as their desirability which in turn allows, on the basis of individual consensual decisions, corrections that prevent shortages and surpluses; Mises and Hayek argued that this is the only possible solution, and without the information provided by market prices socialism lacks a method to rationally allocate resources. Those who agree with this criticism argue it is a refutation of non-market socialism and that it shows that a fully planned economy could never work. The debate raged in the 1920s and 1930s, and that specific period of the debate has come to be known by economic historians as The Socialist Calculation Debate.

Ludwig von Mises argued in Economic Calculation in the Socialist Commonwealth that the pricing systems in socialist economies were necessarily deficient because if a public entity owned all the means of production no rational prices could be obtained for capital goods as they were merely internal transfers of goods and not "objects of exchange," unlike final goods. Therefore, they were un-priced and hence the system would be necessarily inefficient since the central planners would not know how to allocate the available resources efficiently. This led him to declare "...that rational economic activity is impossible in a socialist commonwealth." Mises developed his critique of socialism more completely in his 1922 book Socialism, an Economic and Sociological Analysis.

Central planning has been criticized by socialists who advocated decentralized mechanisms of economic coordination, including Leon Trotsky and Peter Kropotkin before the Austrian school critique, and later by Janos Kornai and Alec Nove. Leon Trotsky argued that central planners would not be able to respond effectively to local changes in the economy because they operate without meaningful input and participation by the millions of economic actors in the economy, and would therefore be an ineffective mechanism for coordinating economic activity.