The political revolutions of 1989–91 in Central and Eastern Europe and the former Soviet Union have created a new historical conjuncture in which the very future of the socialist project has been called into question.footnote¹ Socialists of all varieties have been affected by a profound loss of confidence and lowering of sights, including those who had long rejected even the term ‘actually existing socialism’ as an acceptable description of the Soviet and East European experience. The underlying reason for this loss of confidence is that the historical conjuncture coincides with a deep-seated crisis of socialist theory, above all of the theory of a socialist economy.

The classical Marxist model of a socialist economy may be characterized in terms of a dichotomy between capitalism and socialism in the two dimensions of ownership and coordinating mechanism. Under socialism, capitalist private ownership of the means of production is replaced by social ownership; theoperation of market forces is replaced by socialist economic planning. Social ownership enables exploitation to be abolished; socialist economic planning enables the anarchy of production to be replaced by conscious social control of the economy. The two dimensions are connected in that market forces operate through the interaction of numerous separate decisions over the use of discrete parcels of society’s productive resources, which are therefore de facto privately owned whatever the de jure position, whereas economic planning involves a single set of coordinated decisions over the use of society’s productive resources as a whole, which necessarily precludes private ownership and fragmented decision making.footnote²

This classical Marxist model, interpreted as the centralized planning of all production decisions, has been discredited by the Soviet experience. At the same time, the revival in the 1980s of the socialist economic calculation debate that had first taken place in the 1920s and 1930s provided theoretical support for the proposition that central planning, indeed any society-wide economic planning, is necessarily inefficient and strictly speaking impossible. Any socialist economic model today must take account of the Soviet experience and, even more importantly, address the theoretical issues that have been identified in the revived calculation debate.footnote³ These theoretical issues in relation to the efficiency and/or possibility of socialism are part of the more general theoretical climate, associated with the rise of the neo-liberal Right, which challenges the desirability of any form of collective action and celebrates the superiority of ‘spontaneous order’ over conscious social action.footnote⁴

The debate on the possibility of rational economic calculation in a socialist economic system, defined as a system in which the means of production are publicly owned, was effectively initiated by Barone in 1908, gathered momentum in the German literature during the 1920s, continued in the English literature during the 1930s, and then died out in the 1940s, after the summing-up article by Bergson in 1948.footnote⁵ The two principal sides in the debate were economists from the Austrian school, who denied the possibility of rational calculation under socialism, and socialist economists arguing within the neoclassical paradigm, who defended such a possibility. Underlying the debate were not only different views on the desirability of capitalism and socialism, but also different epistemological and methodological approaches. These differences of approach were, however, largely implicit at the time and it has been argued that the distinctive Austrian position only crystallized as a result of the debate itself and subsequent reflection on it.footnote⁶ In the neoclassical paradigm, knowledge is conceptualized as being objective, with production possibilities, costs and revenues constituting knowable objective constraints given which economic agents make maximizing decisions. In the Austrian school, by contrast, knowledge is conceptualized as being subjective. Instead of being taken as given for the purpose of decision making, subjective—or ‘tacit’—knowledge must be discovered through action, through competitive entrepreneurial activity in the market. The emphasis on the centrality of the ‘discovery’ process is the hallmark of the modern Austrian school and the basis of its reworking of the debate on the possibility of rational calculation under socialism which gathered pace during the 1980s. It is the foundation of the modern Austrians’ claim that the impossibility of a rational socialist economic system has been established not just historically but, more significantly, also theoretically.

In the debate, the role of the market in making rational economic calculation possible has been discussed under three headings—calculation, motivation and discovery. In 1920 Mises argued that economic calculation is only possible in a free-market system, based on private property, which establishes the exchange value of all goods and services and thus provides economic agents with the necessary information, in the form of prices, for them to decide how to act.footnote⁷ It then emerged that Barone had already refuted Mises’s argument by demonstrating that a socialist economy could achieve the same level of efficiency as its capitalist counterpart by solving the set of simultaneous equations, based on production and utility functions, that describes the interdependent behaviour of the economic actors in the system.footnote⁸ Hayek’s 1935 contribution in response to this has historically been interpreted as arguing that, although Barone’s analytic solution is conceivable in theory, it is impossible in practice, given both the amount of information that would have to be collected centrally and the scale of the computation required to solve the simultaneous equations.footnote⁹ Lange responded to Hayek’s argument by producing his seminal model of market socialism, drawing on earlier decentralized models.footnote¹⁰

In this model the central-planning bureau announces an initial set of prices for producer goods; the managers of the state-owned firms take these prices as given (parametric) and follow the rule that they should seek to minimize costs and set price equal to marginal cost; firms hire labour supplied by workers in pursuit of utility maximization, sell goods to consumers who purchase them according to their utility-maximizing demands, and buy and sell producer goods from and to each other. On the basis of information supplied by the firms on increases or decreases in inventories of producer goods, reflecting excess supply or excess demand, the planning bureau announces a new set of producer goods’ prices and the process continues through a series of iterations until the supply and demand for all goods is equalized.footnote¹¹ Lange’s model incorporates real markets for labour and consumer goods and ‘pseudo-markets’ for producer goods. Since the state owns the means of production, there is no unearned income and ‘profits’ are distributed by the state in accordance with democratically determined criteria. The model combines the allocative efficiency of idealized, neoclassical, perfectly competitive capitalism with a socialist income distribution.

Although most of the discussion in the 1920s and 1930s was of the calculation problem, there was also some discussion of motivation. Hayek responded to Lange’s model by stressing the relationship between ownership, incentives and economic efficiency.footnote¹² However, his arguments did not make the impact he might have expected and by the early 1940s the ‘standard account’ of the debate was that the neoclassical socialist school had succeeded in refuting the Austrian challenge and establishing that a rational socialist economy was indeed possible.