Friedrich August von Hayek, Pricing versus Rationing

Hayek’s magazine article, originally published in The Banker in September 1939 and supplied here in a 1997 republication, examines how a defence economy should allocate scarce productive resources. Its central claim is that wartime urgency strengthens, rather than removes, the need for economic calculation through relative prices. Against proposals for extensive government controls, Hayek distinguishes putting resources to work from combining them so that they produce the greatest possible result. He allows that rationing and government priorities may sometimes be necessary, but argues that their general extension would undermine the information needed to economize resources.

The argument begins with the displacement caused by rearmament. New military demands make particular materials, machinery, and skills unusually scarce. Other industries must release these resources, but their capacity to substitute alternatives varies. Classifying industries by national importance cannot establish where substitution entails the smallest sacrifice. A less essential industry might require enormous quantities of replacement materials, while an essential industry could relinquish the scarce input comparatively easily.

The required quantities of the urgently needed factor of production ought to be released from those uses in which they can be dispensed with at the least sacrifice of other necessary things.

This principle makes opportunity cost the article’s governing concept. Higher prices induce producers to release scarce inputs where replacing them consumes the fewest other resources. Those substitutes themselves have alternative uses, often directly or indirectly military. Consequently, the urgency of a particular demand cannot normally justify satisfying it regardless of cost: doing so may diminish the resources available for other defence needs. Hayek’s example of aluminum and magnesium shows why a priority assigned to one material cannot adequately represent the consequences of substituting another.

He then gives this argument a more formal structure through an exchange of tin and copper between two industries. If tin replaces more copper in one industry than in another, reallocating the metals can increase both industries’ output without increasing their total resources. The efficient adjustment continues until their marginal rates of substitution coincide. Competitive prices coordinate this process by giving producers a common basis for comparing inputs while each seeks to reduce costs.

In this way the existence of free markets secures that the 'rates of substitution' are made the same in all industries and thus that waste is avoided.

Prices therefore do more than suppress demand. Their movement also mobilizes dispersed efforts to find substitutes, economize consumption, release stocks, and recover scrap. Hayek concedes that commandeering may secure the maximum quantity of a material within a few days. His stronger claim concerns sustained supply with the least sacrifice of other production. In that setting, decentralized responses can exploit possibilities that a central authority cannot comprehensively identify. An important note specifies that this argument concerns changes in relative prices within a limited aggregate monetary demand, not inflation or a general rise in prices.

The second half contrasts this coordinating process with administrative quotas at artificially low prices. Under rationing, officials would allocate scarce materials according to classifications of national importance after satisfying direct government demand. Hayek argues that these allocations could preserve easily replaceable uses while forcing other industries into costly substitutions. Cheap access to a rationed input would no longer indicate that using it was economical for society.

Since prices of the factors no longer correspond to their relative productivities, they no longer tell us what we lose by using a particular factor in one place rather than another.

The criticism concerns the meaning of calculation, not simply the inconvenience of controls. A firm can still calculate expenditure at the prices it pays, but those figures cease to measure the productive alternatives sacrificed elsewhere. Nor can the rationing authority readily correct the resulting decisions. It would need to know alternative production methods and their costs across industries, effectively repeating and checking entrepreneurs’ calculations.

It must be specially emphasized that our argument in no way assumes that the rationing authority will act stupidly.

This qualification locates the difficulty in the authority’s informational task rather than its intelligence or intentions. Controlling scarce resources would also require controlling their substitutes, drawing officials toward detailed planning of production as a whole. Hayek’s immediate objection is to emergency planning that disables competitive coordination without providing an adequate replacement. Although he leaves the long-run feasibility of a fully planned system open here, he expects improvised wartime controls to reduce efficiency.

The conclusion extends the argument from industrial organization to strategy. When military requirements absorb much of national production, securing more of one military supply means sacrificing another. Decisions between tanks, aircraft, and ammunition therefore require comparative costs; economic calculation becomes a condition of military effectiveness. The article’s relevance lies in this connection between decentralized resource allocation and the practical pursuit of collective objectives.

Its scope nevertheless remains qualified. Hayek explicitly reserves questions of equity, exceptional profits, and government purchasing costs for later treatment, while a note exempts essential-food rationing from the automatic application of his critique. The editorial apparatus records that the promised third article never appeared. This essay thus establishes the efficiency case for flexible relative prices without resolving every distributive or fiscal objection to wartime markets.