Vladmir Lenin sent warm greetings in April 1919 to the social-ist revolutionaries who had just seized power in Munich and declared a Bavarian Soviet Republic. Drawing on his experience eighteen months ear-lier leading the Bolshevik Revolution that gave Russia a Soviet Socialist gov-ernment, he asked them about a checklist of concrete measures they might take, urging their “most urgent and most extensive implementation”:
[H]ave councils of workers and servants been formed in the different sec-tions of the city; have the workers been armed; have the bourgeoisie been disarmed; has use been made of the stocks of clothing and other items for immediate and extensive aid to the workers, and especially to the farm labour-ers and small peasants; have the capitalist factories and wealth in Munich and the capitalist farms in its environs been confiscated; have mortgage and rent payments by small peasants been cancelled; have the wages of farm labourers and unskilled workers been doubled or trebled; have all paper stocks and all printing-presses been confiscated so as to enable popular leaflets and news-papers to be printed for the masses; has the six-hour working day with two or three-hour instruction in state administration been introduced; have the bourgeoisie in Munich been made to give up surplus housing so that workers may be immediately moved into comfortable flats; have you taken over all the banks; have you taken hostages from the ranks of the bourgeoisie; have you introduced higher rations for the workers than for the bourgeoisie; have all the workers been mobilised for defence and for ideological propaganda in the neighbouring villages?1
The list concisely summarizes Lenin’s immediate agenda for consolidat-ing power by winnconsolidat-ing over the workers. The absence of any suggestions for longer-range economic strategy hints at the problem Lenin himself faced in
1 V. I. Lenin, “Message of Greetings to the Bavarian Soviet Republic,” in Collected Works, 4th English ed., vol. 29 (Moscow: Progress, 1972), pp. 325–6. Available online at http://www.
marxists.org/archive/lenin/works/1919/apr/27.htm.
Moscow: because there were no concrete guidelines from Marx and Engels, economic policy had to be improvised.
THE BoLSHEVIkS MAkE EConoMIC PoLICy
Lenin imagined that in the communism of the ultimate future, the state would wither away. In the socialist transition between capitalism and com-munism, however, far-reaching state control of the economy would be nec-essary to advance the interests of the workers. As Lenin’s contemporary the Russian agricultural economist Boris Brutzkus noted, the Bolsheviks found in Marx’s critique of capitalism a rejection of the capitalist system of regu-lating production through market prices and the suggestion of replacing it with “a unitary state plan.”2
After taking power, the Bolsheviks quickly established a central planning agency known as the Supreme Economic Council. The Council national-ized the banking system in December 1917, putting all banks under the control of the State Bank left over from the tsarist regime. The Soviet gov-ernment nationalized large industrial firms and put worker committees in control of the factories. In the spring of 1918 foreign trade became a state monopoly. By fall, the government had nationalized even small businesses.
It completely outlawed private trade, private hiring, and private leasing of land. There was even an attempt to do away with money. An August 1918 decree, as described by Peter Boettke in his economic history of the period,
“declared that all transactions had to be carried out by accounting opera-tions without using money.”3 All goods were to be distributed by govern-ment rationing. In agriculture, the Soviet governgovern-ment confiscated all food grown by peasant farmers (beyond what the farmers were allowed for their own consumption) for distribution in the cities. It was, as the economist Jack Hirshleifer put it, “the most extreme effort in modern times to do away with the system of private property and voluntary exchange.”4
The results were disastrous. Without a price system to coordinate eco-nomic plans, in Leon Trotsky’s apt metaphor, “Each factory resembled a telephone whose wires had been cut.”5 By 1920 Russia’s industrial output
2 As quoted by Peter J. Boettke, The Political Economy of Soviet Socialism: The Formative Years, 1918–1928 (Boston: kluwer Academic, 1990), p. 31.
3 Ibid., p. 65.
4 Jack Hirshliefer, Economic Behavior in Adversity (Chicago: University of Chicago Press, 1987), p. 15.
5 As quoted by Paul Gregory, Before Command: An Economic History of Russia from Emancipation to the First Five-year Plan (Princeton, nJ: Princeton University Press, 1994), p. 99.
had plummeted to less than one-fifth of its 1916 level. In the countryside, peasants rebelled against the crop confiscations. They began to grow less and to hide what they did grow. In the cities, shortages of food and other goods were so severe that many people fled to the countryside to avoid star-vation. Famine and mass exodus halved the populations of Petrograd and Moscow in the two years following the Bolshevik takeover. Workers began protest strikes. Hungry soldiers and sailors rebelled.6
In 1921, Lenin retreated from the policies that he now called “war communism” and characterized as mere emergency measures necessitated by the civil war of the Reds against counterrevolutionary White resistance.
Lenin’s relabeling masked the fact that the policies had not been driven entirely by expediency or necessity. The Bolsheviks had been seriously try-ing to implement a marketless economy. The market-abolishtry-ing measures continued to multiply, eliminating the last pockets of private enterprise, even after the resistance had been defeated in 1920. The complete collapse of the economy followed the elimination of these pockets that had previ-ously escaped control.
With starvation the alternative, Lenin’s “new Economic Policy” of 1921 readmitted market exchange, allowing peasants to sell their produce and substituting a lower percentage tax for the previous confiscations. Small businesses and services were denationalized, and private trading was once again allowed. With his government still in control of banking, large indus-try, and foreign trade, Lenin described the nEP as a strategic retreat to the
“commanding heights of the economy.” The Russian economy improved.
The nEP would later be abandoned in 1928 with Stalin’s attacks on private traders, the “nepmen,”7 and his introduction of Five-year Plans for indus-trialization. Two years later Stalin would collectivize agriculture.
VIEnnA 1920
Marxist-Leninist ideas were not confined to Russia in the years following the First World War. They also captured minds and governments in central Europe. Bolsheviks held power in Budapest from March 1919 to August 1919, declaring the country a Hungarian Soviet Republic. As noted, com-munists seized power in Munich in April 1919 and proclaimed a Bavarian
6 For overviews of the period see Boettke, The Political Economy of Soviet Socialism, pp. 63–111, and Hirshliefer, Economic Behavior in Adversity, pp. 15–23.
7 on the nEP period see Alan M. Ball, Russia’s Last Capitalists: The Nepmen, 1921–1929 (Berkeley: University of California Press, 1990).
Soviet Republic. It lasted for about a month before the German army inter-vened. Marxists dominated local government in “Red Vienna.” Among the new city-owned housing projects was the Karl Marx Hof. Vienna was impoverished not only by the War and by the dissolution of the Austro-Hungarian Empire, but also by its own price controls on food and fuel. In Austria as a whole, the Social Democrats finished first in the 1919 elec-tions and formed a coalition government. Its Socialization Commission called for the nationalization of coal, iron, steel, and later other sectors of the economy. The head of the Commission, otto Bauer, advocated “guild”
socialism.8 The Viennese philosopher and economist otto neurath, who was involved in making economic policy for the Bavarian Soviet Republic in 1919, published a book in the same year proposing that the centralized allocation or “war socialism” of the First World War could serve as the first step toward a moneyless “natural” economy.9
Ludwig von Mises stepped forward as the leading critic of socialist ideas in Vienna. Provoked especially by neurath’s argument, Mises in 1920 pub-lished a soon-to-be famous article on “Economic Calculation in the Socialist Commonwealth,” followed two years later by his book Socialism (1922).10 Mises’s book shook Hayek out of his early inclination toward socialist ideas.
In a 1978 foreword to a reprint of Mises’s 1922 book, Hayek wrote that when Socialism first appeared, its impact was profound. It gradually but fun-damentally altered the outlook of many of the young idealists returning to their university studies after World War I. I know, for I was one of them. . . . We were determined to build a better world, and it was this desire to recon-struct society that led many of us to the study of economics. Socialism prom-ised to fulfill our hopes for a more rational, more just world. And then came this book. our hopes were dashed. Socialism told us that we had been look-ing for improvement in the wrong direction.11
LUDWIG Von MISES
Ludwig von Mises (1881–1973) received his doctorate in 1906 from the University of Vienna, where he had attended Eugen von Böhm-Bawerk’s
8 kari Polanyi-Levitt and Marguerite Mendell, “The origins of Market Fetishism – Critique of Friedrich Hayek’s Economic Theory,” Monthly Review 41 (June 1989), pp. 11–32.
9 See Bruce Caldwell, Hayek’s Challenge (Chicago: University of Chicago Press, 2004), p. 116.
10 Ludwig von Mises, “Economic Calculation in the Socialist Commonwealth” [1920], trans.
S. Adler, in F. A. Hayek, ed., Collectivist Economic Planning (London: Routledge, 1935), pp.
87–130; Mises, Socialism: An Economic and Sociological Analysis [1922], trans. J. kahane [1936] (Indianapolis: Liberty Fund, 1981).
11 F. A. Hayek, “Foreword,” in Mises, Socialism, p. xix.
seminar. He became the chief economist for the Austrian Chamber of Commerce in the following year. The first of his many noteworthy books was The Theory of Money and Credit, published in 1912. After serving in the First World War, Mises returned to the Chamber, where he was an official adviser to the Austrian government. He was also an unpaid external lec-turer (privatdozent) at the University of Vienna. From 1920 to 1934 he ran a private seminar that was Vienna’s leading discussion venue for advanced economics.12 Hayek joined the Mises Circle in 1924, after taking a job in a temporary postwar government office headed by Mises. Mises and the other members of Circle developed the “Austrian” approach to econom-ics that had been pioneered by Carl Menger and then advanced by Eugen Böhm-Bawerk and Friedrich Wieser at the University of Vienna.13 In eco-nomic policy, Mises argued strongly for free markets based on their bene-ficial practical results.
Mises founded the Austrian Institute for Business Cycle Research in 1927, giving Hayek the job of running it. Seven years later, endangered by his outspokenness and Jewish ancestry, Mises left the country ahead of nazi Germany’s takeover of Austria, and became a professor in Geneva, Switzerland. In 1940 at the age of 59, concerned about the nazi threat to Geneva, he and his wife fled to new york (they had married in 1938, soon after his mother had died). He finished out his long career as a visiting pro-fessor at new york University from 1945 to 1969. His best known work, the wide-ranging treatise Human Action, was published in 1949. 14
MISES’S CRITIqUE oF THE SoCIALIST EConoMy
Mises issued a forceful challenge to socialist thinking in his 1920 arti-cle. The socialists, he said, had not addressed a basic problem imposed by
12 on the basis of the importance of his books and articles, Mises was an obvious candidate for appointment to the chair in economics at the university when it became vacant in 1922. Hayek, in Hayek on Hayek: An Autobiographical Dialogue, ed. Stephen kresge and Leif Wenar (Chicago: University of Chicago Press, 1994), p. 59, attributes Mises’s nonap-pointment principally to his being an antisocialist when most faculty were socialists.
13 For more on Menger, see Chapter 8.
14 For a brief overview of Mises’s thought see David Hart, “Ludwig von Mises, Money, and the Fall and Rise of Classical Liberalism in the 20th Century,” Literature of Liberty 5 (Autumn 1982), pp. 3-6, available online at http://www.econlib.org/library/Essays/LtrLbrty/msEd-Bib1.html. For a detailed account of the interwar period in Mises’s career, see Richard M. Ebeling, “The Economist as the Historian of Decline: Ludwig von Mises and Austria between the Two World Wars,” in Richard M. Ebeling, ed., Globalization: Will Freedom or World Government Dominate the International Marketplace? (Hillsdale, Mich.: Hillsdale College Press, 2002), pp. 1–68. For a comprehensive biography see Jörg Guido Hülsmann, Mises: The Last Knight of Liberalism (Auburn, AL: Mises Institute, 2007).
scarcity: choosing how to produce. Having abolished markets and thereby prices for the means of production, the directors of a socialist economy would not know how to combine resources to produce goods economically.
Unable to calculate profit and loss, they would be at sea without a compass.
Socialism would generate waste and privation, not prosperity. Socialist economists naturally tried to answer Mises, and the “socialist calculation debate” ensued.15
The defining feature of a socialist economy, for both Mises and the social-ists of the day, was the abolition of private property in the means of pro-duction (labor, land, raw materials, machines, factory buildings). For Mises any economy with a stock market, where controlling shares in firms (which themselves own and hire means of production) are freely exchanged among private investors, is not a socialist economy. By this definition, Sweden today (for example) does not count as a socialist economy. It is a market economy with high taxes and a large welfare state.16 Mises wrote: “Production goods in a socialist commonwealth are exclusively communal; they are an inalien-able property of the community, and thus res extra commercium [things outside the market].”17 The socialist economist oskar Lange (discussed later in this chapter) accepted the same definition, contrasting a “socialist econ-omy” to “any system with private ownership of the means of production.”
With government rather than private owners or capitalist investors respon-sible for directing the farms and factories, any coordination of production planning among the factories and farms would fall to a central planning board.
Mises argued that a centrally planned socialist economy, like the new Soviet Russian economy (he was writing before Lenin had conceded the need to reintroduce markets), was bound to run poorly. To abolish private property in the means of production is to abolish competitive bidding by capitalists, the market process by which cost-revealing prices for inputs are formed. How do we know, for example, the economic cost – the value of its
15 For a book-length review of the debate see Don Lavoie, Rivalry and Central Planning:
The Socialist Calculation Debate Reconsidered (Cambridge: Cambridge University Press, 1985); for a shorter overview, see David M. Levy and Sandra J. Peart, “Socialist Calculation Debate,” in Steven n. Durlauf and Lawrence E. Blume, eds., New Palgrave Dictionary of Economics, 2nd ed. (new york: Palgrave Macmillan, 2008).
16 During the period spanning 1980 to 2007 Sweden’s composite ranking varied between 18th and 40th of 140-plus nations in the Economic Freedom of the World Index. It ranked higher in legal structure and security of property rights, sound money, and freedom to trade, but lower in size of government and regulation. James Gwartney, Robert Lawson, et al., Economic Freedom of the World: 2009 Annual Report (Economic Freedom network, 2009), p. 171. Available online at http://www.freetheworld.com/release.html.
17 Mises, “Economic Calculation,” p. 91.
next-best alternative use – of using a particular plot of land (or a particu-lar tractor) to grow yellow corn? only by seeing what profit-seeking soy-bean farmers (and others) will bid for its use in growing soysoy-beans (or other crops) that grow in the same season.
SoVIET SHoRTAGES
For the sake of argument, Mises was willing to grant that a socialist econ-omy could have free markets for consumer goods. Consumer goods, once produced, could be sold on markets. on these markets, accurate relative prices for consumer goods could in principle arise even in a socialist econ-omy. We should note, however, that the Soviet Union in practice failed to get consumer goods prices right. Historian Sheila Fitzpatrick has described how Russian life in the 1930s suffered from the failure to accurately price (and to allow markets to supply) food, clothing, and housing:
With the transition to a centrally planned economy at the end of the 1920s, goods shortages became endemic in the Soviet economy. . . . A worker from the Urals wrote that to get bread in his town you had to stand in line from 1 or 2 o’clock at night, sometimes earlier, and wait for almost 12 hours. . . . Bread was not the only thing in short supply. The situation was no better with other basic foodstuffs like meat, milk, butter, and vegetables, not to mention necessities like salt, soap, kerosene, and matches. Fish disappeared too, even from regions with substantial fishing industries. . . . Clothing, shoes, and all kinds of consumer goods were in even shorter supply than basic foodstuffs, often being completely unobtainable. . . . Meanwhile, people lived in com-munal apartments, usually one family to a room, and in dormitories and barracks. . . . So acute was the housing crisis in Moscow and Leningrad that even the best connections and official status often failed to secure a separate apartment.18
David Levy has importantly pointed out that it was not in the interest of a Soviet official or store manager, in charge of pricing and allocating a par-ticular good, to seek its market-clearing price when she did not personally benefit from greater store sales. Instead, by setting prices so low as to create shortages in the stores, and by having the de facto right to allocate goods in short supply before they reached retail shelves, she could unofficially trade the favor of access to an otherwise-unavailable good in exchange for the favor of access to otherwise-unavailable goods of other sorts. The Soviet humor magazine Krokodil illustrated the system at the retail level by imag-ining the following announcement in a department store: “Dear customer,
18 Sheila Fitzpatrick, Everyday Stalinism (oxford: oxford University Press, 1999), pp. 42–7.
in the leather goods department of our store, a shipment of 500 imported women’s purses has been received. Four hundred and fifty of them have been bought by employees of the store. Forty-nine are under the counter and have been ordered in advance for friends. one purse is in the display window. We invite you to visit the leather department to buy this purse.” other diversions took place earlier in the supply chain. Thus when Mises and Hayek assumed for the sake of argument that the socialist economy’s price-setters would be disinterested, they diverted attention from a key problem.19
THE nEED FoR InPUT PRICES
Even if central planners sincerely and disinterestedly wanted to meet consumer demands, and even if socialist factory managers could consult genuine consumer prices to know what mix of goods consumers were demanding, Mises argued, they would still need guidance from market prices in producer goods to know how best to produce consumer goods.
Suppose that output Z can be produced by various quantities and com-binations of the inputs {U, W, X, y}. Which of the many possible recipes minimizes the cost of Z (avoids waste)? When a lumber yard manager faces the simple decision of whether to use plastic or canvas tarpaulins, his is not purely an engineering problem. The relative prices of the two materials matter. When a farmer decides how much of each type of fertilizer to use
Suppose that output Z can be produced by various quantities and com-binations of the inputs {U, W, X, y}. Which of the many possible recipes minimizes the cost of Z (avoids waste)? When a lumber yard manager faces the simple decision of whether to use plastic or canvas tarpaulins, his is not purely an engineering problem. The relative prices of the two materials matter. When a farmer decides how much of each type of fertilizer to use