Tom DiLorenzo posted the following quote by Ludwig Von Mises from a lecture he gave in 1952:

If there is credit expansion [by the central bank], it must necessarily lower the rate of interest. If the banks are to find borrowers for additional credit, they must lower the rate of interest or lower the credit qualifications of would-be borrowers. Because all those who wanted loans at the previous rate of interest had gotten them, the banks must either offer loans at a lower interest rate or include in the class of businesses to whom loans are granted at the previous rate less-promising businesses, people of lower credit quality.

Is it any wonder that Austrian economists saw this current crisis coming from a mile away?

I was prompted by recent discussions about Socialism, to take a closer look at that particular system, and to contrast it with free-market Capitalism. I want to address, specifically, the means by which resources are distributed within the economy of each system. Though Socialism comes in many forms, they all share the underlying concept that the “collective ownership and administration of the means of production and distribution of goods.” It is from this definition that I base my criticism.

In any economy, there is the problem of routing people into jobs where consumer demand needs to be met. This is accomplished, in a Capitalist system through the price mechanism. If a scarce resource is in high demand its scarcity rises as it is consumed at a higher rate than it is produced. A scarce good or service naturally rises in value — and hence price — as it becomes scarcer. Higher prices attract self-interested entrepreneurs and laborers into that particular market where a profit is being sought. As more competition enters a market, the price is driven down until a relatively stable balance is reached between production and consumption. People are compelled to voluntarily seek, and become skilled in jobs they would not otherwise accept, due to the incentive of larger profits, higher likelihood of finding employment, and job security. If a particular market has been saturated, there is a disincentive for people to seek that as their main source of income, for reasons contrary to those stated above.

Under a Socialist system, the price mechanism is absent; since resources would be distributed by a central governing body (I’ll refer to it as the government, though some may prefer another designation). The continually changing demands of consumers are determined by the government and must be relayed back to producers. When a shortage occurs, i.e. demand exceeds the current supply; additional production of that resource is desired by consumers. Since there is no price mechanism, there is no incentive for laborers to enter that production market. The mere knowledge of higher demand for a particular good or service is insufficient to entice laborers to produce it.

In fact, without the price mechanism, there is no incentive to work at all, since everyone is promised an equal share of the common pool of resources. An alternative method must be put in place to motivate people to work. The government may require proof of labor before redeeming public goods and services, but then we are faced with the problem of those who extract more than they produce. This might be resolved by creating a quota or “credit” system based on the amount of production one contributes to the common pool of resources. This initially seems like a plausible way to overcome the problem of providing laborers an incentive to work, while not extracting more than they put in, but there is a crucial element missing.

Aside from being extraordinarily inefficient, even a well run quota system lacks the price mechanism necessary to best distribute resources. The ability to assign a rational measurement of value is non-existent. One person may value a certain pair of shoes more than 8 hours of labor, while another person values the same shoes not more than 4 hours of the same labor. How are “credits” to be assigned to specific forms of labor without an accurate and concurrent report of demand and available supply? The value of goods and services, regardless of the economic system, are constantly changing, as surely as the needs and wants of the individuals within the economy change. The price mechanism reflects this fluctuation very accurately, and nearly in real-time. Assigning value by any other method is unsound, and fails to meet the demands of consumers, because the link between production and consumption is missing.

One might claim that this could be resolved through a system that allows consumers to request goods and services, which will then be supplied by producers; but again, without prices, there is no incentive for laborers to switch their focus to that market. Any attempts to artificially adjust the “credit” compensation based on inventory, will be arbitrary and very likely inaccurate. It is easy to see how this would lead to shortages of some goods and services, and excesses of others. The only tool available within a Socialist system that may marginally overcome this inadequacy is the use of coercion. Laborers would need to be forced into specific jobs in order to meet the demand for those products that are not produced abundantly enough through mean of voluntary employment. This is both morally unacceptable and a failure pragmatically.

Under Capitalism, fluctuations in prices act as an indicator to producers, and allow adjustments to be made before severe shortages or excesses are realized. In contrast, adjustments in a Socialist system are made in response to severe shortages and excess. Furthermore, the proposed solution under Socialism would likely lead to an exacerbation of the problem, by over or under compensation by the central planners.

Socialism is vulnerable to impedance and corruption due to its bureaucratic nature. The only processes available to Socialism, to monitor and relay information about shortages and excess, are through central planning. This means that the entire economy is run by a small group of people, who like every other human, are neither omniscient, nor exempt from the forces of self-interest and corruptibility. The capacity for a central planning board to predict or quickly react to the ever changing demands of consumers is severely inadequate. Capitalism best achieves the goal of distribution by prices, which are determined by, and continually fluctuating based on, the countless voluntary, mutually beneficial transactions that occur in an economy.

There has been a lot of discussion recently, about the prevalence of Socialism in the United States. While it’s true that Socialism, as defined above, does not exist in the US, significant steps have been taken to diminish the efficacy of the price system that we currently have in place. Subsidies, disproportionate and excessive taxation, interest rates manipulated by a central bank, regulation, and a plethora of other interventions into the market by the government, despite any good intentions, has resulted in the dissolution of the price mechanism. The link between production and consumption is being deteriorated by government policy. Misallocation of resources, poor investments, overconsumption, and artificially inflated prices are the result. Rising unemployment, economic uncertainty, inflation, loss of savings, and overall decline in the quality of living, are some of the associated symptoms.

The price mechanism is not a magical cure, capable of eliminating all society’s ills. It is however, the most efficient and just way of allocating resources and distributing goods and services. In a world comprised of self interested individuals, this our surest hope of achieving prosperity and peace. Through Capitalism and the price mechanism, the self interest of one individual becomes the reciprocal of another self interested individual.

For a more complete understanding of economic calculation problem, see Ludwig Von Mises’ “Economic Calculation in the Socialist Commonwealth.” Another excellent source is Friedrich Hayek, who demonstrated in his book “The Road to Serfdom,” that implementation of Socialist policies will gradually lead to an oppressive dictatorship, or totalitarian regime.