SOCIALISM, as we have seen, accepts for the time being, at any rate, the capitalistic principle that

rewards should be related to contributions. The contributions of the nonhuman resources, however, are
to go to society as a whole. Only inequalities in wages are to be permitted. Wage differentials are to be
used as inducements, as incentives, and as guides to the proper allocation of the labor supply, very
much as under capitalism. The citizens are then to be allowed to spend their earned incomes as they see
fit. These two freedoms, it is argued, will suffice to guarantee fundamental human values and without
the need of accepting the inequalities which result from the institutions of private property and the right
of bequest. Accordingly we shall call the model to be examined in this chapter "liberal socialism" to
distinguish it from the authoritarian socialism of the avowed communist.

THE MISES INDICTMENT

In the early 1920s Professor Ludwig von Mises, then of Vienna, published an article 1 in which
he argued that the destruction of private property in land and capital makes impossible the
establishment of objective prices for the material means of production and hence deprives
society of the means of calculating costs. Lacking the necessary data, the socialist State has no
way of determining what constitutes the most effective use of its scarce material resources. The
State could, of course, assign arbitrary prices to every concrete instrument of production and
instruct the plant managers 1 The article was elaborated upon in his Die Gemeinwirtschaft (1921) which later appeared
in English under the title Socialism (1936). His argument and the replies to his critics are to be found in his Human Action, Yale
University Press, New Haven: 1949.
to act as though these were genuine prices. But these prices would not measure the real
economic significance of the instruments of production and hence would lead to faulty
production decisions. Furthermore the managers could not discharge the entrepreneurial function
which the private businessman discharges in a capitalistic society. The end result of socialism,
according to Mises, is stagnation, progressive impoverishment, tyranny, and war. The fiasco of
the first efforts of the Russian communists to set up an economy freed from the directives of
competitively determined factor prices forced socialist theorists to deal with Mises' charge. The
majority of them now recognize that Mises has raised an issue that will have to be met if they are
to continue to assert the feasibility of socialism. The model developed in this section represents
the efforts of honest and competent socialist theorists to meet Mises' criticisms. It attempts to
respect the consumer freedoms and the job freedoms which Mises held to be essential to the
maintenance of a free society. Curiously enough the outcome is a competitive price-directed
socialism which involves the very types of behavior that socialists decry in contemporary private
enterprise societies. Its successful performance requires both perfect markets and a perfect State.
It is highly unlikely that any socialist party would be willing to preserve so many features of the
capitalistic system as this model requires. Nonetheless the model exercises a tremendous
fascination on intellectuals and helps explain why so many people of genuinely liberal
convictions refuse to be disillusioned by recent socialistic experiments.

THE PLANNING BOARD AND THE PLANNING BUDGET

In the "liberal socialist" model the instruments of production are socially owned. The technical
tasks of production are assigned to Managers charged with the production and distribution of
vendable goods and services, and to Ministers charged with providing the services which are
either nonvendable or deliberately provided gratuitously. There is no longer any sharp distinction
between the public and the private sectors of the economy. The distinction now is between
activities for which a direct charge is made and activities provided gratuitously.
The Planning Board. A Planning Board is an essential feature of this model. It must work out a
Plan. The Plan, we are told, will be democratic in the sense that, in its broad outlines, it will have
been endorsed at the polls, and that, at intervals, the citizens will have an opportunity to vote out
of office those in power, and, if successful, to secure die appointment of a new Planning Board
charged with the formulation and execution of a new plan. But between elections the Planning
Board must be clothed with rather plenary powers. This does not preclude the possibility of
frequent small changes to meet technical shortcomings or popular dissatisfactions as registered in
the press and public discussions. But it does not exclude the possibility that the control of all jobs
will enable those in power to reduce elections to a farce. For the time being, however, we shall
assume that the citizens retain the power to elect representatives of their own choosing.
We shall examine this model first on the assumption that our socialist society has no trading
relations with other countries and then re-examine it on the assumption that it is part of a world
of independent and sovereign countries. The Planning Budget. The financial aspects of the Plan
are embodied in the National Budget. The Board sets up a gross national product figure in the
money of the country—dollars, for example. This over-all total is broken down into three sub-
budgets:
(1) The Public Services Budget: This budget contains the allocation for the gratuitous services
and the subsidies for any vendable services that are to be provided at less than cost.
(2) The Commercial Services Budget: This budget contains the sum allocated to industries
producing vendable goods and services.
(3) The Investment Budget: This budget contains the amount to be used for the maintenance and
the planned increase of the nation's capital goods, including housing. Each of these sub-budgets
is broken down into a large number of smaller budgets, one for each Industry 2 and each
Ministry. Control of current operations. The Planning Board opens up drawing accounts with
the National Bank for each Ministry and each Industry. (We reserve for later the handling of the
Investment Budget.) The Ministers and the Managers in turn allocate their credits to various
subordinate offices and plants. The Planning Board may determine the precise amounts to go to
these subordinate agencies, or it may give considerable discretion to the officials in charge of the
ministries and the industries. This is a detail, though an important one. The principle of
decentralization, which "liberal socialists" make much of, calls for a wide application of intra-
agency allocations. At the beginning of each new planning period every responsible operating
official will have a drawing account of a known amount with the National Bank. His task is to
use this money to produce as economically as possible the kind of things he can produce with his
existing physical facilities and to maximize his profits or minimize his losses. He is expected to
compete in the labor market and in the materials markets for the workers and the supplies he
requires. This competition is expected to produce prices that will clear these markets and
produce identical prices for labor and for materials of equal significance. In order to know
whether a particular plant is maximizing its profits or minimizing its losses, it is essential that the
Planning Board charge it for the use of the land, the buildings, and the very durable equipment
entrusted to it. The fixing of the amount of this charge is one of the thorniest problems
confronting the Planning Board. The charge should certainly be enough to cover the cost of
replacing equipment as it wears out. But this is not enough. An interest charge must also be
added. How is the interest rate to be determined? We shall deal with this problem in connection
with the Investment Budget. Here we shall simply assume that the appropriate rate has been set
and that each responsible operating official's performance is to be judged on the basis of his
ability to recover from his customers this expense as well as his current operating expenses. The
land is presumably indestructible. It is essential, however, that those assigned superior land
should be charged a sum equivalent to the rent item in capitalistic accounting. Otherwise there is
no way of comparing the relative efficiency of plant managers or the true costs of production.
The original acquisition price of land might serve for a time as the basis for determining the land
utilization charge, but with every passing year this figure would become more unrealistic.
Socialist theorists say that, since the demand for specific plots of land is derived from the
demand for the products made with the use of these plots, their values can be imputed. The
absence of a real market for land complicates the problem. It may very well prevent the Planning
Board from getting and keeping each plot of land in its highest and best use. So far the tasks
confronting the Ministers and the Industry Directors are the same. It is with respect to the size of
their operations that differences emerge. The Ministers are expected to spend all the money
allotted to them and to make the money go as far as possible. This is the problem of bureaucratic
efficiency that confronts private enterprise systems, which also have a fairly large public sector.
No issues of theoretical importance are involved. It is with respect to the vendable goods sector
that the problem of judging and securing efficiency becomes difficult. The problem involves
(1) the establishment of efficiency standards;
(2) the selection of the Industry Managers and the plant Directors; and
(3) the provision of incentives and disciplines for the managerial group.
Efficiency standards. Uncertainty necessarily prevails in this sector due to the fact that
consumers and workers alike have freedom of choice. Plant managers know what their drawing
accounts with the National Bank are, but they do not know what their expenses of production
and their revenues are going to be. As production proceeds and sales are made, some plants will
show profits and others will show losses. Efficiency requires that the firms showing surpluses
should expand outputs until their marginal revenues equal their marginal costs. The others should
contract until their marginal revenues and their marginal costs are equalized at levels below their
average costs. If the profits and losses persist, the Managers of the profitable industries must be
able to secure additional capital with a view to establishing new plants or enlarging existing
plants which have not yet reached optimum size. Conversely some of the capital attached to the
unprofitable industries must be withdrawn. These expansions and contractions do not involve net
capital formation. The proper procedure, therefore, is for the Planning Board to transfer an
appropriate part of the amortization payments of the unprofitable industries to the accounts of the
profitable industries and to direct the Managers involved to make the necessary internal
adjustments. In theory the adjustment of outputs and capacities in the several industries to
changing conditions of supply and demand is simple. It requires considerable optimism,
however, to believe that the adjustments will not be much slower than in private enterprise
systems where the profits and the losses fall directly on individuals and hence predispose them to
react promptly. The Managers of the unprofitable industries will not like to see their domains
contracted; they may be expected to argue that the situations confronting them are temporary and
that they have already taken remedial measures. The Planning Board cannot possibly possess the
detailed knowledge needed to evaluate the claims and the counterclaims of the Managers.
British socialist experience with the African ground-nut venture and with the coal mines shows
how difficult it is for a central authority to cut losses before they reach serious proportions.
Economic analysis shows that this problem of adjustment is solvable at the theoretical level, and
that is all that the economist, as economist, can say. But if the misgivings of the skeptics should
prove correct, then a considerable element of waste may be part of the social costs of "liberal
socialism." The selection of the managing personnel. In a private enterprise system the selection
of the managerial group is a relatively coldblooded affair. They must succeed or they are
displaced. Competition and, still more, potential competition—keeps them constantly on their
toes. Technically they are not innovators; yet, in fact, the managers of successful firms tend to be
innovators as well as routine administrators. Their very large salaries and bonuses are, in part,
rewards for innovation. They may not be risking their own capital when they propose radical
changes, but they risk their reputations and their jobs. Would a politically appointed Planning
Board be as successful as private business in the selection of its Industry Managers and the
hundreds of thousands of plant managers? No definite answer can be given to this question. The
writers personally doubt whether the method of political selection would be as effective as that
prevailing under capitalism—but it might be. Managerial rewards and disciplines. The socialist
method of rewarding the Industry Managers increases the likelihood that their performance will
be inferior to their performance in private enterprise economies. It can be taken for granted that
salaries would be fixed according to some administratively defensible standard, much as in the
civil services of all modern governments. Rewards according to contributions would be but
imperfectly realized for this small but highly strategic group. It is probable that the routine
administrative functions would be reasonably well performed. But the overcoming of
administrative lethargy, on the one hand, and the curbing of overambitious Managers, on the
other, would prove difficult. The Investment Budget. Two problems are involved in the
management of the Investment Budget. The first has to do with the determination of the
proportion of the planned gross national product to be devoted to net capital formation. The
second has to do with the allocation of the investment fund between the Industry and the Public
Services sectors, and within the Industry and Service sectors. The savings-investment decision. In
a private enterprise economy the rate of capital formation is determined not entirely, but to a
considerable extent, by the time-preferences of resource owners. Can the Planning Board allow
the time preferences of the socialist citizens to play the same role? Theoretically, yes. But note
the dilemma facing the authorities if they attempt to respect this aspect of consumer sovereignty.
Reliance on voluntary savings produces a "rentier" class, and, if the right of inheritance were
recognized, a greater degree of inequality would develop than that prevailing under capitalism.
Under capitalism, the inheritor must risk his inheritance in the market if he is to derive any
income from it. The inheritor in the socialist society could only invest in government bonds. He
would thus be guaranteed a completely riskless income. The "shirtsleeves to shirtsleeves"
justification for inheritance under capitalism would be gone. It may be taken for granted,
therefore, that the right of inheritance would be narrowly restricted. But, in that event, the
authorities are immediately confronted with another problem. Why should a person save more
than enough to provide for an occasional splurge or for a more comfortable living in his old age?
The socialist citizens, taken as a group, would make no net savings over their lifetime. The State
would be forced to assume full responsibility for the maintenance and accumulation of capital.
Abolition of the right of inheritance would involve a further complication. It would introduce a
direct incentive for persons with large earned incomes to spend as they earned. This would lead
to a more flagrant type of "conspicuous consumption" than that which Thorstein Veblen3 found
to be characteristic of private capitalism. If public opinion frowned upon this type of behavior—
and the egalitarian bias inherent in socialism makes it virtually certain that this would be the
casemen of ability would be tempted to save with a view to retiring as soon as they had
accumulated enough to live as well as it was safe to live without offending the socialist
mores. In either event, the end result would be waste—either wasteful consumption or a serious
loss of man power, and precisely the man power which the society could least afford to lose.
For all these reasons it seems probable that "liberal socialism" cannot leave to the citizens, in
their roles as consumers, the final decision as to the rate of capital formation. The Planning
Board must decide on the relative importance of the present and the future. Danger of
underinvestment. There are several reasons for believing that this collective decision would
result in a rate of capital formation substantially lower than that typical in either a healthy
private enterprise economy or an authoritarian and war-oriented socialism.
(1) The greater equality expected to prevail would automatically decrease the propensity to save,
to use a Keynesian expression. The liberal provisions for the aged, which are part of the socialist
promise, would further reduce the incentive to save for retirement. The destruction of the right of
bequest would, as already indicated, encourage the higher wage and salaried workers to live up
to their incomes and retire at an early age. In the absence of compulsions the "liberal socialist"
economy would be a very high consumption economy.
(2) The democratic processes, which "liberal socialism" would preserve and respect, would make
it politically dangerous for the Planning Board to call for any large, present sacrifices. Indeed, if
the Party came into power on the basis of roseate promises of an immediate improvement in the
lot of the "downtrodden proletariat/' the Planning Board might not be able to allocate enough to
the Investment Budget to offset the depreciation and depletion of existing resources. It would be
under great popular pressure to permit the people to live beyond their means while it was
consolidating its power. Recent European experience confirms the reality of this danger.4
(3) The third reason why investment is likely to be small is bound up with the problem of
innovation. This innovation problem will be discussed presently. Here it suffices to point out that
if innovation should be stifled the Planning Board would hesitate all the more to set aside very
much for net capital formation. The reason is fairly obvious. The tendency to diminishing returns
operates sharply when investment results simply in the provision of more of the same sorts of
tools and equipment. The future benefits to be expected from present sacrifices are thus, reduced.
Unless "liberal socialism" can produce an environment "favorable to innovation, popular
pressures will be against a large investment budget. The reasons for expecting a slowing down of
technological progress will be presented shortly. The allocation problem. So much for the
considerations which the Planning Board will have to take into consideration in fixing on a
figure for the Investment Budget. Some figure will have to be set and it will have to be arbitrary.
Let us assume that it is a positive one, i.e., one larger than the sums which the Managers are
required to pay back to the National Bank out of current earnings as amortization and depletion
charges on the resources for which they are responsible. How shall this sum be allocated as
between the Public Services and the Industries, on the one hand, and as between the
several Services and Industries? The major breakdown, as between the Services, on the one
hand, and the Industries on the other, is a straight political decision which involves no issues of
theoretical interest. The legislatures of all capitalistic countries have to decide how much to
devote to road building, new schools, post offices, courthouses, hospitals, and similar structures.
If housing is subsidized, the housing subsidy would appear in the Public Services Investment
Budget. All that can be said here is that the more the Planning Board allocates to this sector of
the Investment Budget, the less will be available for the type of capital formation on which a
long-time rise in the level of living primarily depends. The issue of theoretical interest arises in
connection with the allocation of the amount appropriated for the capital goods industries.
How shall this fund be divided as between Industries, and, within each Industry, as between
plants? The decision to operate the system on the basis of consumer sovereignty and freedom of
job choice requires that the Planning
INNOVATION
How is the innovation problem to be handled? Will "liberal socialism" provide an environment
as hospitable to innovation as does the capitalistic model? Innovation under Capitalism.
Innovation occurs when a man with a new idea is able to enlist the resources needed to try it out.
In a private enterprise economy the man with the new idea—the inventorseldom has the capital
needed to back up his idea. He must find men with imagination and judgment who have funds
and who are willing to risk them. Innovation always involves risks. If successful,
it destroys capital values in other parts of the economy and causes
unemployment there. The automobile destroyed the buggy industry.
The development of fuel oil hurts the coal mining industry. The
innovators are not concerned with these losses. If they had to
shoulder them, anticipated rewards would have to be much greater
than they actually are, and innumerable innovations would be
stifled, despite the fact that the direct and indirect benefits vastly
exceeded the indirect losses.
Innovation is further favored in a private enterprise economy by
the existence of literally millions of potential innovating centers.
664 ALTERNATIVES TO CAPITALISM
Every individual proprietor, every partner, and every corporate
Board of Directors is a court of appraisal of new ideas. Innumerable
innovations get financed out of the retained earnings of enterprises.
Today our great corporations are our principal innovating centers,
nurturing the ideas, screening them, and providing the capital.
Investment bankers are also sifters of new proposals. A single individual
may back a lone inventor.
The point to note here is that innovation flourishes in environments
in which contact is easily established between men with new
ideas and men who control liquid capital that can be diverted to the
exploitation of these ideas. At the same time the personal risks
involved lead to a meticulous scrutiny of new ideas and the prompt
cutting short of experiments which fail to meet the acid test of consumer
acceptance.
Innovation under "liberal socialism." In the socialist model each
plant manager might be instructed to incorporate in his periodic
statement of the amounts of savings he could profitably use at various
rates of interest a figure for investments of an innovating type
to be developed within his organization. This inclusion would shift
the demand schedule for savings to the right and result in a higher
rate of interest. Thereafter the allocation of planned savings to
Industries and to plants would follow as before, and innovating proposals
would get their due share of planned savings. The Planning
Board would not have to set itself up as a court of appraisal.
But is this a realistic solution? Could the Board divest itself of
the responsibility for weeding out the less promising proposals?
It must be remembered that men with new ideas are seldom the
best judges of their economic feasibility. They are enthusiasts—dedicated
men. Their schemes have to be tested by individuals possessing
a rare combination of daring, caution, and judgment. This phase
of the innovating process is at least as important as the idea phase.
In a private enterprise system it is in the hands of men of property
whose willingness to take risks is tempered by the knowledge that
it is their own property they are risking. The large net gains which
an innovating economy enjoys are due as much to the killing off of
impracticable ideas as to the successful maturing of fruitful ideas.
If the Planning Board divested itself of the responsibility of
screening the demands for capital for innovation, the inventors
would enjoy a field day. In that event, however, the proportion of
"screwball" ideas in the investment program would be so high that
the net gain from innovation would be small, or even negative.
It seems probable, therefore, that all innovating ideas that got
SOCIALISM 665
through the screening process at the Industry level would have to
go before the Planning Board, as a final court of appraisal. Furthermore
this final court, being responsible for the general welfare,
would have to consider in each case not only the probable gains but
also all of the probable indirect losses involved. These losses would
ordinarily fall in the first instance on other industries. The Managers
of these Industries would have to be given a hearing. They
may be expected to point out the problematical character of the
expected gains and the certainty of their own losses and of those of
the workers attached to their industries. It is difficult to escape the
conclusion that technological progress in most fields would be much
slower in a genuinely liberal and humane socialism than under a
dynamic, competitive enterprise system.
"LIBERAL SOCIALISM" AND THE BUSINESS CYCLE
One of the attractions of socialism is its alleged immunity to the
business cycle. If "liberal socialism" can abolish the business cycle
and with it the wastes and suffering that have gone with the severe
depressions of the past, its case is very strong. A slow but uninterrupted
rate of capital formation might lift levels of living more in a
generation than can private capitalism with its spasmodic investment
spurts. And living might be more secure and more satisfying.
The National Resources Committee estimated the loss of potential income
in the eight-year period, 1930-37, for the United States alone at $200 billion
dollars. (The Structure of the American Economy, Part I, p. 2 (June,
1938) ). At today's prices the loss would be at least twice as great.
An appraisal of this claim involves two issues: (1) the correctness
of the assumption that major recessions, such as that of the 1930s,
are inevitable under capitalism; and (2) the validity of the assumption
that "liberal socialism" could avoid wastes of comparable magnitude.
Capitalism and The Great Depression. For the reasons given in
Chapter 38 we do not regard The Great Depression of the 1930s as
typical. It was the delayed and exaggerated outcome of the First
World War and the improper and fettering governmental interventions
of the 1920s. If this is true, the socialist claim should be
judged not by the performance of "fettered capitalism," but by what
can be reasonably expected if governments confine their controls
to measures that are consistent with the operating requirements of
unfettered capitalism.
In one respect, however, the solution of the employment problem
666 ALTERNATIVES TO CAPITALISM
might prove easier. Unemployment is, to a considerable extent, the
price we pay for change.5 An innovating society is one in which the
rate of change is rapid. In such a society voluntary factor mobility
must be high if involuntary unemployment is to be avoided. One
way to simplify the problem is to stifle innovation. "Liberal socialism,"
as we have seen, may do precisely this. In a peaceful world
this might not be too high a price to pay for security, but, for the
time being, at any rate, it is a dangerously high price. National survival
today depends on strength, and strength, in turn, depends on
strong and progressive industries. The real choice today appears to
be between a dynamic, private capitalism and some form of authoritarian
and undemocratic socialism.
"Liberal socialism" and the danger of overinvestment. But even if
we rule out military considerations, it does not necessarily follow
that a "liberal" socialist regime would avoid wastes at least as serious
as those associated with the cyclical fluctuations of a dynamic and
responsible private enterprise economy. The Planning Board would
almost certainly be compelled by international competition to provide
considerable sums in the absolute sense for net capital formation.
Some of this money would be used to finance investments of
an innovating character. The chances are that the Board would not
be in a position to evaluate the innumerable little innovations that
are constantly being tried out in a regime based on private property.
Most of these would never get as far as the Board. Such time as the
Board could spare from its more routine duties would necessarily go
to the examination of large and ambitious schemes capable of capturing
the public imagination and promising early and dramatic
results.6
Once an innovating venture was launched, the reputation of the
Board members would be at stake. It is humanly understandable,
therefore, that they would insist upon pushing an ill-judged venture