1. The Socialist Calculation Problem

The problem with socialism, as Ludwig von Mises pointed out, is that there are no price signals with which to rationally allocate resources.

This is called the socialist calculation problem.

On the free market, Entrepreneurs can gauge whether the products and services they sell result in net social gain from whether they are earning profits or suffering losses.

The earning of profits indicates that consumers value the product more than the sum of its parts. Resources are being rationally allocated and this is resulting in consumers willingly purchasing goods and the entrepreneur earning profits.

On the other hand, if the entrepreneur is suffering losses, this indicates a waste or inefficient use of scarce resources. Consumers do not value the product offered more than the sum of its parts.

As profits earned by the entrepreneur strengthen his production power and losses diminish it, the market therefore, has a natural mechanism with which it weeds out inefficient production processes.

Losses are not sustainable in the long term, whereas profits can be reinvested in further value-added production processes.

Under socialism, by comparison, as there are no profit and loss signals, there is no way to know objectively, that the goods or services produced via the political process are resulting in a socially beneficial outcome. All decisions regarding allocations of resources are arbitrary, and more representative of the interests of the political class than of real social demand.

One reason why the environment under Soviet Russia was so badly destroyed was the fact that there were no price signals attributed to goods (along with no property rights) and therefore no rational way of extracting, conserving, and distributing them.

2. Preferences Not Exhibited Through Choice

The second reason that socialism fails, (or at least can be seen as having indeterminate results) is that preferences are not expressed through choice.

When people choose to exchange goods and services, it can be deduced that, at the time of exchange, each valued the good received more than the good given up. Their preferences have been exhibited through their choice made. The transaction is “win-win”.

Government goods and services, on the other hand, are paid for through coercive expropriation of wealth, either in the form of taxation or monetary inflation.

The argument that consumer preferences are expressed through the political process i.e. voting, must accept the fact that choice of political party is usually severely limited (compare it to the near infinite number of goods and services offered by the market), the policies are not always clearly defined at time of voting and are subject to change, and that even desirable public goods are usually part of a package deal included in which there may be several undesirable goods. Therefore, “choice” is severely limited in democracy and voter preferences can only be considered very loosely related to real consumer preferences. The market, by comparison, is a direct expression of them.

As the consumer of the publicly provided good does not directly choose to pay for them voluntarily, and therefore, does not express preferences through action, there is no way to know whether he really prefers the good to the wealth expropriated.

While voluntary exchange results in both sides of the exchange benefiting (i.e. net social gain), the same cannot be said for forced transactions, which are indeterminate.

3. The Role of the Entrepreneur

A third factor that is overlooked by those supporting collective production processes (such as co-operatives for example) is the role of the entrepreneur.

The entrepreneur serves two important functions:

Firstly, he exchanges present consumption for future consumption. While those employed are paid wages by the entrepreneur in the present, the goods that they are working to produce will not be ready for sale for some length of time. The entrepreneur is only paid once the product sells, hence, he has to delay consumption.

Secondly, wage earners are paid regardless of the success or failure of the final product. The entrepreneur, however, has to deal with uncertainty. If all goes well, he earns profits. If, on the other hand, he is wrong in his forecasting and decision-making, and this results in losses, it is up to the entrepreneur to bear them.

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