Subjectivism: Recent Episodes
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Subjectivism includes the principle that value is not an objective phenomenon but is determined by the preferences of individuals in the economic system.
This concept of economic calculation is really the foundation of all economic theory, and price theory is the cornerstone of economic calculation.
Download lectures slides at Mises.org/MU23_PPT_04.
Recorded at the Mises Institute in Auburn, Alabama, on 24 July 2022.
Menger discovered much more than the principle of marginal utility—he created an entire system of economics based on subjective value and individual choice.
Download lecture slides at Mises.org/MU23_PPT_03.
Recorded at the Mises Institute in Auburn, Alabama, on 24 July 2022.
The latest from the world of social media is the role of "influencers." There is a perfectly good economic explanation for their popularity.
Original Article: "Influencers and Subjective Value: They Have Something to Teach Us"
This Audio Mises Wire is generously sponsored by Christopher Condon.
The Need to Be Whole: Patriotism and the History of Prejudiceby Wendell BerryShoemaker and Company, 2022; x + 513 pp.
Wendell Berry, a poet, novelist, and philosopher well known for his protests against mechanized agriculture and for his defense of the “land ethic,” is not a thinker one would immediately associate with Ludwig von Mises, and indeed, in economic theory the two are far apart. But there is nevertheless a passage in Mises’s Socialism that is central to Berry’s concerns.
The passage I have in mind is this:
When society’s existence is threatened, each individual must risk his best to avoid destruction. Even the prospect of perishing in the attempt can no longer deter him. For there is then no choice between either living on as one formerly lived or sacrificing oneself for one’s country, for society, or for one’s convictions. Rather, must the certainty of death, servitude, or insufferable poverty be set against the chance of returning victorious from the struggle. War carried on pro aris et focis [for hearth and home] demands no sacrifice from the individual. One does not engage in it merely to reap benefits for others, but to preserve one’s own existence.
Berry uses a similar idea to explain and defend the South’s standpoint in the Civil War, but he does not do so in the way one might expect. Far from extolling the virtues of antebellum slavery, he condemns it as a grievous sin. In this connection, he makes an interesting criticism of John C. Calhoun, who deemed manual labor beneath the dignity of gentlemen, fit only for slaves. Berry argues that it was in part the unwillingness of elements among the Southern planter elite to acknowledge the virtue of work that led them to turn away from the Jeffersonian position that slavery is a great evil. In this connection, Berry quotes John Quincy Adams, a great opponent of slavery whom he admires: “I told Calhoun I could not see things in the same light—It is in truth all perverted sentiment—mistaking labor for slavery, and dominion for Freedom” (Adams, quoted on p. 298).
If slavery was wrong, why, then, does Berry defend the South’s position in the Civil War? His answer is that the great bulk of those who fought for the South did so not to entrench slavery but rather to protect their land and homes from invasion: “But from the point of view of the Confederate soldiers, the great fact of the war, once it had begun, was that their country had been, and was going to be invaded. They shared with [Robert E.] Lee a settled determination to defend their homelands and their people” (p. 203).
In arguing in this way, Berry agrees with Murray Rothbard, another thinker not usually coupled with him. Like Berry, Rothbard argues that the Southerners were defending their lands from invasion:
In 1861, the Southern states, believing correctly that their cherished institutions were under grave threat and assault from the federal government, decided to exercise their natural, contractual, and constitutional right to withdraw, to “secede” from that Union. The separate Southern states then exercised their contractual right as sovereign republics to come together in another confederation, the Confederate States of America. If the American Revolutionary War was just, then it follows as the night the day that the Southern cause, the War for Southern Independence, was just, and for the same reason: casting off the “political bonds” that connected the two peoples. In neither case was this decision made for “light or transient causes.” And in both cases, the courageous seceders pledged to each other “their lives, their fortunes, and their sacred honor.”
If it is objected that without the war, the end of slavery might have been indefinitely postponed, Berry admits that he has no easy answer but that he does know that the violence of war exacts tremendous costs. He reminds us that the “crusade” mentality led to later disasters:
[The Civil War] remains popularly credited as the solution, entirely good, of our worst national problem. So successful were we at solving our own great problem that we have generously undertaken to solve international problems and the problems of other nations also by force of war and with the same assurance of our goodness in doing so. If we have a sort of notion of preventability, we are not long detained by it. We appear never to bother with the question of net good. We went to war in Iraq and Afghanistan as if such questions could not be asked, as if no useless war had ever been fought, and in a nationalist confusion of pride, fear, moral certainty, and (never dismissible) the allure of profits in the war industries. (p. 85)
In condemning the stern moralism of the Northern aggressors, Berry again finds himself at one with Rothbard.
The Civil War seems to me to have been, to an extent sufficiently noticeable, a conflict of patriotism, which is to say love for one’s actual country or the land under one’s feet, against nationalism, which is to say allegiance just short of worship to a political idea or ideal and to a government. The difference is well illustrated by the anthems of the two sides: the jaunty “Dixie,” which celebrates the “land where I was born,” versus “The Battle Hymn of the Republic,” a hymn sure enough of a sanctified nationalism, in which the misfortunate Jesus once again shows up in uniform. (p. 250)
In like fashion, Rothbard says:
The Northern war against slavery partook of fanatical millennialist fervor, of a cheerful willingness to uproot institutions, to commit mayhem and mass murder, to plunder and loot and destroy, all in the name of high moral principle and the birth of a perfect world. The Yankee fanatics were veritable [Isabel] Patersonian humanitarians with the guillotine: the Anabaptists, the Jacobins, the Bolsheviks of their era. This fanatical spirit of Northern aggression for an allegedly redeeming cause is summed up in the pseudo-Biblical and truly blasphemous verses of that quintessential Yankee Julia Ward Howe, in her so-called “Battle Hymn of the Republic.”
We have much to learn from Berry’s profound defense of the local and particular against militarism and fanaticism.
The roots of Austrian economics go back to the great theologian Thomas Aquinas, whose view of what constitutes a good was a prototype of Menger's pathbreaking theory of the good.
Original Article: "Defining a Good: The Intersection of St. Thomas Aquinas and Carl Menger"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Mainstream economists claim that Austrian economics is "discredited" because Austrians use deductive reasoning instead of employing complicated calculus and statistics. The irony is that Austrian analysis is better at explaining real-world economic phenomena.
Original Article: "A Commonsense Approach to the Austrian-Mainstream Methodenstreit"
This Audio Mises Wire is generously sponsored by Christopher Condon. '
This concept of economic calculation is really the foundation of all economic theory, and price theory is the cornerstone of economic calculation.
Download lectures slides at Mises.org/MU22_PPT_02.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2022.
Menger discovered much more than the principle of marginal utility—he created an entire system of economics based on subjective value and individual choice.
Download lecture slides at Mises.org/MU22_PPT_01.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2022.
Recorded at the 2022 Austrian Economics Research Conference hosted at the Mises Institute in Auburn, Alabama, March 18–19, 2022.
The Lou Church Memorial Lecture, sponsored by The Lou Church Foundation. Includes audience question and answer period.
The Austrian Economics Research Conference is the international, interdisciplinary meeting of the Austrian School, bringing together leading scholars doing research in this vibrant and influential intellectual tradition. The conference is hosted by the Mises Institute at its campus in Auburn, Alabama, and is directed by Joseph Salerno, professor of economics at Pace University and academic vice president of the Mises Institute.
In the past few weeks, I’ve been involved in an email exchange about the differences in methodology between the Austrian school and the Chicago school. The correspondence has revealed some surprising misunderstandings of a key Austrian view, demonstrated preference, and what I hope to do in this week’s article is to give an account of that view and some of the misunderstandings about it.
The best account of demonstrated preference is in Murray Rothbard’s essay “Towards a Reconstruction of Utility and Welfare Economics” (1956). Essentially, the doctrine is this. When you make a choice, it’s usually among a few options. The choice is an action, and the action demonstrates, or reveals, that the option, or preference, that you choose ranks higher than the competing options. As Rothbard puts it,
Human action is the use of means to arrive at preferred ends. Such action contrasts to the observed behavior of stones and planets, for it implies purpose on the part of the actor. Action implies choice among alternatives. Man has means, or resources, which he uses to arrive at various ends; these resources may be time, money, labor energy, land, capital goods, and so on. He uses these resources to attain his most preferred ends. From his action, we can deduce that he has acted so as to satisfy his most highly valued desires or preferences.
The concept of demonstrated preference is simply this: that actual choice reveals, or demonstrates, a man’s preferences; that is, that his preferences are deducible from what he has chosen in action. Thus, if a man chooses to spend an hour at a concert rather than a movie, we deduce that the former was preferred, or ranked higher on his value scale. Similarly, if a man spends five dollars on a shirt we deduce that he preferred purchasing the shirt to any other uses he could have found for the money. This concept of preference, rooted in real choices, forms the keystone of the logical structure of economic analysis, and particularly of utility and welfare analysis.
When we talk about “preferences” or “options” here, what is meant are the alternatives that an actor has in mind when he decides what to do. We aren’t assuming that these preferences remain constant over a substantial period of time, much less that the actor has “in his mind” a list of all possible actions he could take in all possible worlds and that this list also remains the same for a long period. Because we don’t assume these things, we also don’t assume “transitivity of preferences.” If you prefer A to B, B to C, and A to C, then your preferences are transitive; but if your preferences are A over B, B over C, and C over A, they are intransitive. Many people think that intransitive preferences are irrational, for reasons we won’t go into here.
In the Austrian view, this issue doesn’t arise, because we’re concerned only with someone’s choice at a particular time. If the actor now has to choose between A and B, we don’t assume that he considers how to choose in situations that involve other options, nor do we assume that his preference for A over B remains constant. As Rothbard puts it, “The prime error here is the assumption that the preference scale remains constant over time. There is no reason whatever for making any such assumption. All we can say is that an action, at a specific point of time, reveals part of a man’s preference scale at that time. There is no warrant for assuming that it remains constant from one point of time to another.”As Rothbard points out, there is a difference between constancy and consistency, and the former isn’t a requirement of reason.
[C]onstancy and consistency are two entirely different things. Consistency means that a person maintains a transitive order of rank on his preference scale (if A is preferred to B and B is preferred to C, then A is preferred to C). But the revealed preference procedure does not rest on this assumption so much as on an assumption of constancy —that an individual maintains the same value scale over time. While the former might be called irrational, there is certainly nothing irrational about someone’s value scales changing through time. Hence, no valid theory can be built on a constancy assumption.
One of the participants in the email exchange raised this objection:
It [demonstrated preference] at most reveals his higher preference, his preference between two alternatives he is free to choose between…. Consider a prude who is made unhappy by other people’s consumption of pornography. In the free market society he doesn’t have the option of forbidding it, even though his highest preference might be an otherwise free market plus a ban on pornography. If there were only two other people in the society he could offer to pay them to agree not to consume pornography, but in a society of millions transaction costs plus the public good problem—the ban is a public good from the standpoint of all the other prudes—make that impractical.
The mistake here is that demonstrated preference concerns only choices that face an actor at a time. It isn’t about how he ranks possible states of affairs. I’d “prefer,” in one sense of that word, a world in which everyone held the correct view (mine, of course) of how society should be organized, but that sense of preference isn’t relevant to Austrian economics.
Another comment about demonstrated preference didn’t aim to undermine it directly, but rather to show that the doctrine brought with it baggage Austrians wouldn’t welcome. Austrians are against logical positivism, but, the commenter said,
[t]here is actually something like logical positivism in Austrian economics. I mean the idea that one can’t make interpersonal utility comparisons, as well as the more fundamental idea that “preference” must mean “revealed preference”. This is very reminiscent of the positivistic idea that all meaningful statements must be testable by sensory observation. Good rationalists reject this assumption.
Maybe they do, but “demonstrated preference,” as Austrians use this concept, means that choice reveals the chooser’s highest preference. It isn’t a claim about the meaning of “preference.”
This objection, one must say, doesn’t “demonstrate” much acquaintance with Austrian economics. It’s good to have it anyway. As W.V.O. Quine once said, “Every knock a boost.
This concept of economic calculation is really the foundation of all economic theory, and price theory is the cornerstone of economic calculation. Download lectures slides at Mises.org/MU21_PPT_03.
Recorded at the Mises Institute in Auburn, Alabama, on 19 July 2021.
Menger discovered much more than the principle of marginal utility—he created an entire system of economics based on subjective value and individual choice.
Download lecture slides at Mises.org/MU21_PPT_01.
Recorded at the Mises Institute in Auburn, Alabama, on 19 July 2021.
According to Marxists, the subjective theory of value is just bourgeois apologetics. By using the subjective theory, economists conceal the fact that the proletariat under capitalism is exploited. The labor theory of value shows that labor is the source of all surplus commodity value not accounted for by the cost of production of a commodity.
The refutation of the labor theory of value isn’t our task today. Also, while it’s true that even if the subjective theory of value is, as the Marxists say, capitalist apologetics, that wouldn’t show that it’s false. That also isn’t our topic today.
Rather, what I want to discuss is a point Mises makes in Human Action that I haven’t seen elsewhere in the literature. When the subjective theory was formulated in the 1870s by Carl Menger, William Stanley Jevons, and Léon Walras, it suffered from a defect. This defect gave socialists help in making their case. It wasn’t until Mises himself that this defect was remedied; this took place after World War I, when Mises developed his famous calculation argument against socialism. The fact that the subjective theory was around for fifty years while it retained the help it gave socialism is strong evidence that the theory wasn’t devised as a defense of capitalism. A possible counterargument is that even if the subjective theory aided socialism, this feature is outweighed by other aspects of the theory that disguised exploitation; but this doesn’t seem a plausible path to take.
The way that the subjective theory helped socialism is that one of the main antisocialist arguments is along these lines: Even if the capitalist system has all sorts of defects, this doesn’t make the case for socialism. We have little reason to think that a socialist system could be put into practice. But the subjectivist theory gives us grounds to think a socialist system might work.
Mises explains the issue in this way.
Socialists, Institutionalists and the Historical School have blamed economists for having employed the imaginary construction of an isolated individual's thinking and acting. This Robinson Crusoe pattern, it is asserted, is of no use for the study of the conditions of a market economy. The rebuke is somewhat justified. Imaginary constructions of an isolated individual and of a planned economy without market exchange become utilizable only through the implication of the fictitious assumption, self-contradictory in thought and contrary to reality, that economic calculation is possible also within a system without a market for the means of production.
It was certainly a serious blunder that economists did not become aware of this difference between the conditions of a market economy and a nonmarket economy. Yet the socialists had little reason for criticizing this fault. For it consisted precisely in the fact that the economists tacitly implied the assumption that a socialist order of society could also resort to economic calculation and that they thus asserted the possibility of the realization of the socialist plans. (Human Action, p. 206)
The way that the early subjective theorists made this mistake is that they wrongly thought that economic calculation can take place without the use of money prices. A socialist system is by definition centrally planned, and a centrally planned system doesn’t allocate resources by using money prices. But if utility calculation is possible without money, then maybe the calculation problem can be overcome.
Mises explains the prosocialist argument in this way:
It was unpardonable for the modern economists to have failed to recognize the problems involved.
Wieser was right when he once declared that many economists have unwittingly dealt with the value theory of communism and have on that account neglected to elaborate that of the present state of society. It is tragic that he himself did not avoid this failure.
The illusion that a rational order of economic management is possible in a society based on public ownership of the means of production owed its origin to the value theory of the classical economists and its tenacity to the failure of many modern economists to think through consistently to its ultimate conclusions the fundamental theorem of the subjectivist theory. Thus the socialist utopias were generated and preserved by the shortcomings of those schools of thought which the Marxians reject as “an ideological disguise of the selfish class interest of the exploiting bourgeoisie.” In truth it was the errors of these schools that made the socialist ideas thrive. This fact clearly demonstrates the emptiness of the Marxian teachings concerning “ideologies” and its modern offshoot, the sociology of knowledge. (207)
Mises made a major advance in the subjective theory by bringing out the full implications of the fact that preferences are purely ordinal. You can prefer vanilla to chocolate ice cream, for example; but you can’t say how much you prefer one to the other. Intensive magnitudes can’t be measured. Calculation can only take place using money prices, and without calculation, there is no means of telling whether production goods with alternative uses are being allocated in a way that best satisfies the consumers. Further, without economic calculation, you could not
show how much one is free to consume without impairing the future capacity to produce. It is with regard to this problem that the fundamental notions of economic calculation—capital and income, profit and loss, spending and saving, cost and yield—are developed. The practical employment of these notions and of all notions derived from them is inseparably linked with the operation of a market in which goods and services of all orders are exchanged against a universally used medium of exchange, viz., money. They would be merely academic, without any relevance for acting within a world with a different structure of action. (212)
The Marxists might try to reply to Mises that his claim about the necessity of money prices for economic calculation is itself ideological. But this would carry more conviction if they could show that economic calculation without money prices is possible, and this they conspicuously failed to do.
In Human Action, Mises suggests that opposition to economic theory intensified as the theory developed. When the subjectivist school showed that economics isn’t limited to a separate sphere, but rather that all human action can be studied scientifically, the opposition went so far as to challenge reason itself.
Before economic theory got started, philosophers studied political and economic affairs from a normative standpoint. They tried to say how society should be organized, in the same way that they devised accounts of how human beings ought to act.
They looked at human things from the viewpoint of government. They were intent upon establishing rules of political action, a technique, as it were, of government and statesmanship. Speculative minds drew ambitious plans for a thorough reform and reconstruction of society. The more modest were satisfied with a collection and systematization of the data of historical experience. But all were fully convinced that there was in the course of social events no such regularity and invariance of phenomena as had already been found in the operation of human reasoning and in the sequence of natural phenomena. They did not search for the laws of social cooperation because they thought that man could organize society as he pleased. If social conditions did not fulfill the wishes of the reformers, if their utopias proved unrealizable, the fault was seen in the moral failure of man. Social problems were considered ethical problems. What was needed in order to construct the ideal society, they thought, were good princes and virtuous citizens. With righteous men any utopia might be realized. (p. 605)
What does Mises mean? Suppose that you think, as many do, that employers should pay their workers a “living wage,” enabling them to support a family on one income. If the employers do not do so, they are denounced as greedy. The presupposition here is that whether to offer a wage of this kind is entirely up to the employers. In what sense might it not be? Surely, an employer is free to make an offer, and the employee to accept or reject it. But according to economic theory, workers earn the discounted marginal value product of their labor. In brief, workers earn what their labor contributes to the value of what they make. If a firm pays a “living wage” above this, it will lose money and will tend to be supplanted by other firms. If a law requires that firms pay a living wage, the economy will be disrupted. There are, then, regularities that limit what political action can achieve. If political actors disregard these laws, they will be unable to get what they want.
The statists could not answer the arguments of the economists but instead challenged their motives. This challenge took two forms. First, it was claimed that the economists were not impartial scholars but were in the pay of the capitalists, who want to pay workers as little as they can get away with. (Such accusations are far from ended: the accusation is a principal theme of Nancy MacLane’s Democracy in Chains [2017].) Second, detractors of economics maintained that there is no such thing as objective reason. All human reasoning is biased, with class and race most often declared to be the source of this bias.
Marxism asserts that a man's thinking is determined by his class affiliation. Every social class has a logic of its own. The product of thought cannot be anything else than an “ideological disguise” of the selfish class interests of the thinker. It is the task of a “sociology of knowledge” to unmask philosophies and scientific theories and to expose their “ideological” emptiness. Economics is a “bourgeois” makeshift, the economists are “sycophants” of capital. Only the classless society of the socialist utopia will substitute truth for “ideological” lies. (p. 606; the “sociology of knowledge” refers to the work of Karl Mannheim and Max Scheler)
Mises is careful to avoid a counterattack. If he is trying to discredit the opponents of economics by calling attention to their motives, i.e., their wish to promote statist panaceas, can’t he also be accused of doing the same thing as the statists? They said that the economists are biased; he says the critics are biased. What is the difference?
He answers that he is not claiming to refute the opponents of economics by calling attention to their bias. Their arguments need to be answered on their own terms. But this does not preclude inquiry into the motives of those who advance these arguments.
It is not permissible to dispose of these objections merely on the ground of the political motives which inspired them. No scientist is entitled to assume beforehand that a disapprobation of his theories must be unfounded because his critics are imbued by passion and party bias. He is bound to reply to every censure without any regard to its underlying motives or its background. (p. 607)
Before the rise of the subjectivist school in the 1870s, opponents of economics could say that even if there are binding laws of economics, these apply only to one part of human behavior, the pursuit of material wealth. The laws of economics, according to this position, do not apply to nonmaterial goals, and this offers ample scope for state action. After the 1870s, this response collapsed. There is a general science that establishes truth about all human actions. This more sweeping claim has elicited more strident attacks on economics.
For a long time men failed to realize that the transition from the classical theory of value to the subjective theory of value was much more than the substitution of a more satisfactory theory of market exchange for a less satisfactory one…. It is much more than merely a theory of the “economic side” of human endeavors and of man’s striving for commodities and an improvement in his material well-being. It is the science of every kind of human action. (p. 605)
Mises says that the
radicalism of this wholesale condemnation of economics was very soon surpassed by a still more universal nihilism. From time immemorial men in thinking, speaking, and acting had taken the uniformity and immutability of the logical structure of the human mind as an unquestionable fact. All scientific inquiry was based on this assumption. In the discussions about the epistemological character of economics, writers, for the first time in human history, denied this proposition too. (p. 605)
The assertion that “tax-financed public goods can make us all better off” is just that: an assertion. As Rothbard showed, there is no reason to just assume consumers would pay for these amenities were they not forced to through taxation.
Original Article: "Rothbard's Underappreciated Contributions to Public Goods Analysis"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Abstract: New institutional economics (NIE) and Austrian economics (AE) both emphasize the role that institutions play in facilitating or impeding entrepreneurship and hence economic growth. In this paper, we discuss the complementarities between AE and NIE for advancing our understanding of the relationship between institutions and entrepreneurship. We argue that a subjectivist view of institutions, entrepreneurial microfoundations, and capital heterogeneity can enrich our understanding of within-country variation in entrepreneurial strategies, institutional evolution, and the relationship between institutions and production processes. We hope our discussion serves as an invitation both for further theoretical collaboration between the two camps and as a spur to applied research at the intersection of institutions and entrepreneurship.
JEL Classification: H35, L5, M13, 031, P14 Scott Burns (scott.burns@selu.edu) is assistant professor of economics at Southeastern Louisiana University. Caleb S. Fuller is assistant professor of economics at Grove City College.
We thank Ennio Piano, David Lucas, Jeff Herbener, Rosolino Candela, and Chris Coyne for helpful commentary. We are also grateful to two anonymous referees and the editor for insightful remarks. The standard disclaimer applies. Both authors shared equally in the writing of this paper.
INTRODUCTION New institutional economics (NIE) has made important contributions to our understanding of the relationship between institutions and entrepreneurship.The term institutional economics is probably now more commonly used than is NIE, but we prefer NIE nomenclature to distinguish from old institutionalism. Eggertsson (1990) draws a distinction between neoinstitutional economics and new institutional economics, with the latter rejecting more of the “hard core” of neoclassical economics. While recognizing the differences between many contemporary institutional thinkers, we do not draw that distinction. NIE scholars stress the critical function that institutions—society’s “rules of the game”—play in constraining and enabling entrepreneurial action (North 1986; Baumol 1990; Murphy et al. 1991; Williamson 2000). Austrian scholars have also written extensively about institutions and entrepreneurship, work that predates the mid-twentieth-century advent of NIE. Beginning with Carl Menger’s ([1871] 2007; 1883) analysis of the spontaneous emergence of social orders, as well as Ludwig von Mises’s ([1920] 1990) and F. A. Hayek’s (1945; 1948) comparative analyses in the socialist calculation debate, Austrians have always been concerned with how choice generates institutions and how these institutions influence social outcomes in turn (Lavoie 1985; Langlois 1986, 1992, 165; Foss 1997; Garrouste 2008). Especially in the twentieth century, Austrians have also stressed the central role that entrepreneurs play as the “driving force” of the market process (Mises [1949] 1998; Hayek 1968; Kirzner 1973; Klein and Bylund 2014; Bylund 2019).
Given these overlapping themes, it is unsurprising that there has been some collaboration between the traditions. At the same time, it is also surprising that this exchange of ideas has not been more thoroughgoing. Numerous authors have suggested that there are gains from trade to be had from merging aspects of each tradition (see Langlois 1986, 1992; Boettke 1989; Foss 1994, 1997; Boettke and Coyne 2003, 2009; Sima 2004; Foss and Klein 2009; Manne 2014; Bylund and McCaffrey 2017; McCaffrey 2018; Piano and Rouanet 2020). These contributions represent promising movements in the direction of integration; nevertheless; we believe that there remain unseized profit opportunities from further integrating the two traditions to improve our understanding of the institutions- entrepreneurship link.
This paper identifies three areas where NIE literature on entrepreneurship may benefit from more thoroughly incorporating Austrian insights. The first deals with a recent puzzle in NIE literature: explaining within-institution variations in entrepreneurial strategy––that is, why some entrepreneurs abide by existing rules while others seek to alter or evade them. The second deals with a subject that prominent NIE scholars such as Douglass C. North (1994) contend has not been satisfactorily resolved: explaining why and how institutions evolve over time. The third area addresses an even less well-established but promising research stream: the interaction between institutions, capital heterogeneity, and entrepreneurial action.
Suggesting how long-established Austrian insights can enrich NIE thinking on entrepreneurship is not to imply that the influence should be unidirectional. As this paper will demonstrate, Austrians can also incorporate NIE ideas in several areas. These include extending well-developed Austrian notions of entrepreneurship beyond “productive activity” and the adoption of new approaches which emphasize the distinction between “economic” and “legal” property rights.
This article achieves three tasks. First, it demonstrates the overarching complementarity between Austrian economics and NIE, particularly for furthering understanding of the institutions-entrepreneurship “black box.” Second, it highlights existing work that points in the direction of synthesis. Third, it proposes future research avenues based on our proposed integration of the traditions. The objective here is not to provide a comprehensive overview of the ways that these traditions can benefit from each other, nor is it to provide a final word on the proposed research ideas. However, the hope is that this article will spur further collaboration between the two traditions that will help resolve ongoing puzzles in the entrepreneurship literature.
The article proceeds as follows. First, the elements of both Austrian economic (AE) and NIE that are crucial for better understanding institutions and entrepreneurship are reviewed. A discussion of the prior interaction between the two traditions follows, and some ways in which they can complement each other are suggested. The final section builds on that synthesis to identify concrete ways that Austrian ideas can inform our approach to questions at the intersection of institutions and entrepreneurship. In doing so, it also raises several questions which will hopefully inspire future research. The article concludes with implications.
AUSTRIAN ECONOMICS AND THE NIE–KEY THEMES FOR ENTREPRENEURSHIP Austrian Economics
Austrian economics is marked by its subjectivist foundations. Of course, all contemporary economic traditions recognize the subjective nature of value, though the Austrian emphasis is the most thoroughgoing (Stringham 2010).Hayek (1955, 52) famously quipped, “it is probably no exaggeration to say that every important advance in economic theory during the last hundred years was a further step in the consistent application of subjectivism.” A key aspect, though, of the Austrians’ encompassing subjectivism has been to show that each person evinces not merely different preferences, but also divergent knowledge and expectations. Unsurprisingly, then, Austrians have been the most systematic exponents of subjectivism within economics, an emphasis that extends to Austrian theorizing on entrepreneurship and management (Klein et al. 2008, 4).
The subjective nature of knowledge is likely the most widely recognized aspect of Austrian subjectivism. In his much-cited 1945 paper, Hayek argued that prices serve as knowledge surrogates since “local knowledge” is not given in its totality to any single mind; rather, it is dispersed throughout society in the minds of individuals.Salerno (1990) initiated a debate, centered on the calculation literature, regarding the similarities and differences between Mises and Hayek. Specifically, Salerno (1990, 1993, 1994), Rothbard (1991), Herbener (1996), and Hülsmann (1997) argue that Mises’ emphasis on monetary calculation was substantively different from Hayek’s emphasis on knowledge dispersion. Although conceding some points advanced by the “dehomogenizers,” such as the renewed emphasis given to forward-looking appraisement, Yeager (1994), Kirzner (1996), Boettke (1998), and Horwitz (1998, 2004) argue that such a position rests on the tenuous (in their view) idea that Hayek treats prices as “sufficient statistics” in the neoclassical sense (also see Stalebrink 2004). Although these differences in interpretation are worth noting, any further adjudication of this debate is beyond the scope of this paper, as we see both sides as likely being amenable to the insights offered here. As Hayek emphasized, this knowledge “of the particular circumstances of time and place” can only be discovered in the context of a market economy.
Although Austrians have consistently integrated subjectivism with their theories of value, knowledge, expectations, and even capital (described below), they arguably have not applied it as thoroughly to institutions. This gap is puzzling given that many of the most seminal Austrian contributions (i.e., the emergence of money and law, the socialist calculation debate) either explained the origins of institutions or engaged in comparative institutional analysis (Menger [1871] 2007; 1883; Mises [1920] 1990, [1949] 1998; Hayek 1945, 1948). These contributions were deeply rooted in subjectivism, as they sought to explain real-world institutions in terms of the personal values and knowledge of the relevant actors. (The way that further application of subjectivism to institutions can provide answers and generate new research directions at the interchange of institutions and entrepreneurship is described below.)
The Austrian tradition is also widely recognized for its pioneering work on entrepreneurship and the central role accorded to entrepreneurs in driving the competitive market process (Mises [1949] 1998; Kirzner 1973; Boettke and Coyne 2003; Foss et al. 2008; Klein and Bylund 2014).A formalistic approach to entrepreneurship has gained traction in the mainstream economics profession. For example, Lazear (2004) offers a formal model of entrepreneurship with the primary prediction being that “generalists,” rather than “specialists,” will become entrepreneurs. Austrians eschew static general equilibrium models, with their assumptions of perfect information, which dominate neoclassical economics.The Austrian conception of the “evenly rotating economy” is an analogue to “general equilibrium,” though Austrians do not derive welfare implications from this construct, nor is it held as being attainable in the real world. Still, Cowen and Fink (1985) have criticized this construct. Instead, they favor a dynamic, processoriented approach—one that emphasizes how entrepreneurs utilize their unique knowledge while responding to continuous profit and loss feedback. Mises ([1949] 1998, 249) famously described the entrepreneur as the “driving force” of this process, the catalyst of change who drives the dynamism of the market economy. Whereas the defining feature of long-run equilibrium in the neoclassical approach is zero economic profits, Austrians place the ceaseless earning of profit and loss at the forefront of the dynamic market process (Mises [1922] 1951).
Austrians have advanced somewhat differing perspectives on the so-called market process. For Israel M. Kirzner (1973, 1996, 1997, 2009), the market process describes entrepreneurs’ ceaseless attempt to seize profits, which via arbitrage, continually drive disequilibrium states toward equilibrium. Continuous learning is key to this framework. Joseph T. Salerno (1993, 1994) argues for a narrower conception of market process that emphasizes how those less skilled at forecasting the future are continuously and systematically weeded from the marketplace. Arguably, both of these ideas find textual justification in Mises ([1949] 1998, [1922] 1951), but what these varying conceptions share in common is that entrepreneurs, responding to profit and loss, are the primary drivers of this competitive process, once more standing in sharp contrast to general equilibrium models, where, based on the assumptions, the entrepreneur has no role to play.
A corollary of market process analysis is that entrepreneurial decision- making cannot be characterized by stochastic models, where outcomes are unknown but which are drawn from a known probability distribution. Instead, it is better characterized by the uncertainty described by Frank Knight (1921),Klein (2010) discusses the overlap between Knight’s and Mises’s approaches to entrepreneurship and uncertainty. where the distribution of possible outcomes is itself unknown. Entrepreneurs therefore act under conditions of uncertainty, drawing on their subjective knowledge to anticipate opportunities, a function eliminated by static equilibrium models that assume perfect information and thus preclude genuine uncertainty (Mises [1949] 1998, 249–56).
The speculative function of entrepreneurship is a universal human function, not a job title or characteristic of a subset of individuals (Klein 2008). This universal speculative element owes to the fact that action is future oriented, that the future is uncertain, and that all actions therefore confer either psychic profits or losses. At the same time, the Austrian tradition also designates a specific set of economic actors as “entrepreneurs,” in contrast to wage earners, landowners, or consumers. In the Austrian framework, entrepreneurship is the element which organizes and arranges the factors of production but is not a factor of production itself.
This basic conception of the entrepreneur has generated a flurry of literature attempting to demonstrate that “innovation” (Schumpeter 1934), “alertness” (Kirzner 1973; Sautet 2018), “judgement” (Foss and Klein 2012), or “creativity” (Alvarez and Barney 2007) is the essence of the entrepreneurial function. These debates have important implications for market theory and for integrating entrepreneurship with organizational economics, but they have less direct bearing on the interface between institutions and entrepreneurship that is central to NIE literature. We concur with Matthew McCaffrey (2018, 190) that “a major advantage of [William J.] Baumol’s argument is that its value does not depend on any particular theory of entrepreneurship.” To that end, entrepreneurship is here defined as “profit seeking”—a “big tent” description broad enough to capture all major conceptions. Additionally, the phrase “entrepreneurial action” is often used, because “discovery,” “judgment,” and “creation” all require subsequent action for there to be any real-world impact.
Austrians have also long stressed the heterogeneity of capital, an emphasis that begins with Menger’s ([1871] 2007) development of an intricate capital—or production—structure. At least until the emergence of certain NIE concepts, Austrians were unique in stressing that capital is heterogeneous not only in form but also in function (Lachmann [1956] 1978; Lewin 1998; Garrison 2001). As Ludwig M. Lachmann ([1956] 1978, 2) argued, heterogeneity in function, or “use,” refers to the multiple specificity of capital goods, meaning that “each capital good can be used for a limited number of purposes.” Capital goods also vary according to their complementarity with other capital goods, a point that is implicit in Hayek’s (1945) argument. Knowledge of the “particular circumstances of time and place” includes the degree to which capital goods (and labor) are substitutable for one another.
As with subjectivism, capital heterogeneity and entrepreneurship are inextricably linked. Entrepreneurs must continuously allocate capital goods to what they perceive is their most profitable use, which requires that they judge their complementarity (Mises [1949] 1998, 252-254; Lachmann [1956] 1978; Foss 2012).Mises (1949, p253) emphasizes this point, noting that “the various complementary factors of production cannot come together spontaneously. They need to be combined by the purposive efforts of [entrepreneurs].” The heterogeneous attributes of capital goods must first be subjectively perceived and interpreted by entrepreneurs before they can be integrated into their production plans (Kirzner 1966). A key aspect of entrepreneurship, then, is exercising judgment over how to best combine and utilize heterogeneous capital goods (Foss et al. 2007). As Lachmann ([1956] 1978, 16) notes, “As long as we disregard the heterogeneity of capital, the true function of the entrepreneur must also remain hidden.”
New Institutional Economics NIE arose in the latter half of the twentieth century as an effort to revive core elements of classical political economy and to return institutions to the forefront of economic analysis. Rooted in Ronald H. Coase’s seminal contributions (1937, 1960), the term new institutional economics was coined by Oliver E. Williamson in 1975. NIE, which came to represent an amalgam of transaction cost, property rights, law and economics, public choice, and agency theorizing, blossomed around the time the Austrian tradition was experiencing its own revival, sparked by seminal publications (Rothbard [1962, 1970] 2009; Kirzner 1973), the famed South Royalton conference in 1974, and Hayek’s Nobel Prize in 1974. NIE scholars frequently addressed institutional issues that, with a few notable exceptions, were not systematically examined by Austrians in the decades between the Keynesian Revolution and the Austrian revival (Foss and Klein 2009). Coase and Williamson devised transaction cost theories of the firm and other organizations. Armen A. Alchian and Harold Demsetz (1972), Steven N. S. Cheung (1983), and Yoram Barzel (1997) offered somewhat differentiated transaction cost theories of the firm, while also seeking to explain how alternative property rights arrangements affect and are affected by economic activity.Just as in the case of the Austrians, these contributions are not monolithic and scholars continue to debate their commensurability. For example, Coase (1937) focused primarily on the transaction costs associated with discovering market prices, whereas Williamson focused on the transaction costs stemming from the ex post appropriation of quasi rents (Bylund, forthcoming). Similarly, Williamson (1991) argued that Alchian and Demsetz (and, by extension, Cheung) were mistaken to downplay the hierarchical nature of the firm. North and Baumol examined the role that society-wide institutions play in providing a framework for economic activity.
What unites these various strands of research is their focus on the role that institutions—the “humanly devised constraints that structure human interaction”—play in providing guideposts for human activity (North 1994, 360; Foss and Garzarelli 2007). Naturally, NIE’s emphasis on how institutions structure incentives has had an important influence on the emerging economics of entrepreneurship. This focus on the guiding role of institutions for entrepreneurial actors was most famously noted by Baumol (1990), who argues that what differs between nations is not the supply of entrepreneurial talent but its allocation between productive (e.g., innovation), unproductive (e.g., rent seeking), and destructive (e.g., crime) activities. This allocation is determined by the relative payoffs that a society offers to such activities, and these payoffs are determined by the prevailing institutions (Baumol 1990; Boettke and Coyne 2003; Boettke and Piano 2016; Lucas and Fuller 2017; McCaffrey 2018). The primary conclusion is that entrepreneurship is a proximate cause of growth but institutions are the fundamental cause.
Baumol’s classic 1990 paper has sparked a research program spanning both NIE and the “mainstream” entrepreneurship literature, with scholars deploying his framework to explain variation in the allocation of entrepreneurial activity across different nations—that is, why some nations have high rates of productive entrepreneurship while others have a larger share of unproductive activity (see, for instance, Coyne and Leeson 2004; Acs 2008; Aidis, Estrin, and Mickiewicz 2008; Sobel 2008; Bjørnskov and Foss 2008, 2016; Minniti 2008; Estrin et al. 2013; Stenholm et al. 2013). Furthermore, Baumol’s work opened the door to extending entrepreneurship beyond the application to “productive activity” found in the works of Mises, Murray N. Rothbard, and Kirzner. At the same time, his framework stands to be enriched by further incorporation of subjectivism, process, and heterogeneity––a project that is advanced in the final section of this article.McCaffrey (2018) notes that Baumol’s account also overlooks uncertainty.
FINDING COMMON GROUND: SYNTHESIZING AUSTRIAN AND NIE SCHOLARSHIP Institutional Environments
What might a synthesis between the Austrian and NIE approach look like, specifically for furthering our understanding of the institutions-entrepreneurship nexus? To answer this question, one first must ask whether a synthesis is possible given the methodological differences between the two traditions. Certain strands of NIE are, indeed, deeply rooted in neoclassical economics, though it is generally seen as a relaxation of the stricter, more unrealistic assumptions of the neoclassical framework (Eggertsson 1990). Given that Austrians came to understand their unique identity in a sharp critique of core aspects of the emerging “neoclassical synthesis” during the socialist calculation debate, some may question whether such an integration is possible.For this reason, Palermo (1999, 277–78) argues that the Austrian and NIE traditions are “methodologically incompatible.” NIE analysis dating back to Coase, he argues, is “explicitly developed within a neoclassical context.” Its goal, according to Williamson (1985), is to explain all capitalist institutions by means of neoclassical tools and assumptions. Palermo therefore concludes that any attempt to reconcile the two traditions is “fundamentally misguided.” We disagree strongly with this conclusion. It is worth noting, for instance, that both traditions have leveled critiques of Walrasian general equilibrium (Mises [1949] 1998; Kirzner 1997; North 1990; Barzel 1997).
To provide an overview of the Austrian assessment of NIE, we find it useful to follow Lance Edwin Davis and North (1971) in distinguishing between the “institutional environment” (society- wide rules that often arise spontaneously) and “institutional arrangements” (organizations that are usually the consequence of conscious design).See Klein (2000) for a discussion of the distinction between the “institutional environment” and “institutional arrangements.” This bears a striking semblance to Menger’s distinction between “organic” and “pragmatic” institutions and Hayek’s distinction between “cosmos” and “taxis,” or planned versus spontaneous orders. Sometimes the distinction is described as being between “institutions” and “organizations,” though admittedly, this line is not always easy to draw and some have challenged its existence altogether (see, for example, Cheung 1983).
Most Austrian criticism of NIE has focused on institutions, specifically Coase (1960), the locus classicus of what, under Stigler’s influence, came to be known as the “Coase theorem.” Austrian scholars advanced the idea that Coase was hostile to private property rights because his work can be read as suggesting that courts could reallocate rights on the basis of perceived willingness to pay when transaction costs are prohibitive (Block 1977, 1995; Rothbard 1979, 1982; Lewin 1982; Cordato 2004; Hülsmann 2004). Additionally, Austrians have argued that courts striving for Kaldor-Hicks efficiency encounter insuperable difficulties, namely that subjective costs cannot be aggregated and that assigning property rights encounters the calculation problem (Rizzo 1980; Lewin 1982; Stringham 2001). Given the “Posnerian” wealth maximization appropriation of Coase, such criticisms are justifiable, yet they may also explain why there has been more synthesis of Austrian ideas with NIE thinking on “organizations,” rather than with “institutions” proper.
Institutional Arrangements
With a few notable exceptions, Austrian assessment of NIE contributions to organizations has been largely positive, beginning with Rothbard ([1962, 1970] 2009) and including Nicolai J. Foss and Peter G. Klein (2012). The first noteworthy exception is Donald J. Boudreaux and Randall G. Holcombe (1989), who argue that the Coasian equilibrium framework is in tension with Austrian concerns for disequilibrium, and the second is Per Bylund (2014), who argues that Coase (1937) was attempting to provide justification for central planning. In contrast to these misgivings, Klein and Foss develop a theory of the firm—a subject that has been the primary NIE focus from its beginning—by incorporating Austrian insights into a framework that is grounded in Coase (1937; Klein 1999; Foss and Klein 2009, 2012). Foss and Klein (2012) see the Austrian emphasis on the entrepreneur as necessary for a robust theory of organization, arguing that entrepreneurs establish firms because the judgment they exercise is noncontractible and can thus only be expressed by forming a firm.The emphasis on firm formation as a way for entrepreneurs to express the noncontractible element of the entrepreneurial function is also present in Manne’s (2014) argument that entrepreneurship should be viewed as idea generation. It is also closely related to Barzel’s (1987, 1997) notion that the residual claimant will be the party whose contribution to production is costliest to measure. Note that the Kirznerian (1973) concept of “alertness” is also noncontractible.
More recently, Ennio E. Piano and Louis Rouanet (2020) have argued that NIE scholars should incorporate insights bequeathed by the calculation debate. For their part, Austrian scholars ought to adopt a greater appreciation for the fact that private property rights are costly to establish and the corollary that, even in unhampered markets, not every asset will be privately owned due to the existence of transaction costs (Barzel 1997; Allen 2000; Piano and Rouanet 2020).the party whose contribution to production is costliest to measure. Note that the Kirznerian (1973) concept of “alertness” is also noncontractible. Furthermore, Piano and Rouanet (2020) maintain that economic calculation over which property rights to establish can only occur in an institutional environment where some prices already exist and are free to arise. However, like Foss and Klein (2012), Piano and Rouanet (2020) develop their arguments in the context of organizational economics. Thus, one irony given the Austrians’ Mengerian origins is that in the last thirty years Austrian work in “institutions and organizations” has tended to shift toward “institutional arrangements” and away from the “institutional environment.” Yet, although the focus of their own argument is on organizational issues, Piano and Rouanet (2020, 16) hope their work “will build a bridge” between NIE and AE “with respect to…interventionism, entrepreneurship, and the economic analysis of law.”
A Path Forward
A call for integration between the two traditions is supported both implicitly by NIE thinkers who have developed similar concepts to those in the Austrian tradition and explicitly by other scholars who have developed direct arguments in favor of synthesis. Implicit support for integration can be found in the mutual emphasis on (some form of) certain concepts ignored in the sterile general equilibrium approach. These concepts include a shared focus on (some form of) capital heterogeneity, exemplified in Williamson’s “asset specificity” or Barzel’s “attributes” (Lachmann [1956] 1978; Williamson, 1975, 1985; Barzel, 1982, 1997). Additional Austrian themes can be found in other aspects of Williamson’s transaction cost economics, such as his frequent citations of Hayek on the nature of knowledge and adaptive learning (cf. Williamson 1985, 8). Similarly, North credits Hayek’s work on how knowledge is generated and transmitted through time, specifically highlighting his idea of “collective knowledge,” socially useful learning that is embodied in institutions as they evolve (North 1994, 364).Also note the heavy citations of Hayek by North in his work on institutional change (North 2005).
Of course, drawing a direct line of influence between Austrian themes and the development of NIE thought is fraught with difficulty.See Bylund (2014) for one such attempt which draws this conclusion. Still, these overlapping themes are worth noting, especially as explicit calls for integration have been sounded by scholars such as Richard N. Langlois (1992, 165), who was among the first to outline points of tangency between the two traditions. Like the NIE tradition, he argues, “the Austrian school of economics is and has been fundamentally concerned with the theory of social institutions.”
This concern can be seen in Mises, who combined institutional analysis with a processual perspective by endogenizing institutions all while conducting institutional analysis using choice theoretic tools, methods that later became a staple of the NIE approach (Foss 1997). That Mises consistently rooted his institutional analysis in a market process approach is best exemplified in the socialist calculation debate. As he famously remarked, “the problem of economic calculation is of economic dynamics: it is no problem of economic statics” (Mises [1922] 1951, 139). Unlike the general equilibrium approach, Mises’s analysis was not constrained by unrealistic assumptions of perfect knowledge or static equilibrium, and unlike old institutionalists, his analysis of institutions was not beholden to excessive historical details or atheoretical descriptions. The institutional analysis practiced by Mises therefore occupied a middle ground between formalism and old institutionalism (Lavoie 1985).Nonetheless, the institutional context was so front and center in Mises’s analysis that Lange accused him of being an old institutionalist for his emphasis on the importance of private property (Boettke 2018). As Foss (1997, 77) argues, Mises was “much more than a precursor” to NIE; he, in fact, managed to “blend institutional and process analysis in a way that is still yet to be achieved by modern neo-institutionalists.”
Hearkening back to one of the key Menger-Mises themes, more recent scholarship has renewed the call to explain the origins and evolution of institutions using the tools of economics (Leeson 2012).This view is in stark contrast to Coase and Kirzner, who preferred to take institutions as exogenous with the task of the economist being to examine the economic activity occurring within those rules (Coase 1977; High 2009; Leeson 2012; Boettke 2014). As Menger himself asked, “How can it be that institutions which serve the common welfare and are extremely significant for its development come into being without a common will directed toward establishing them?” (1883, 146). The following section shows that in the same way that Austrian insights have enriched NIE understanding of organizations, AE-NIE integration can also enhance our understanding of the institutions-entrepreneurship “black box.”
TOWARD AN INTEGRATED RESEARCH PROGRAM IN INSTITUTIONS AND ENTREPRENEURSHIP Institutions and Subjectivism
Within-Institution Entrepreneurial Variation
Although the literature inspired by Baumol (1990) can be described as an “empirical success story” in explaining variation in entrepreneurial activity between nations, it has generated fewer answers regarding what causes entrepreneurs within a given nation to respond to the same institutional rules in vastly different ways. As Christopher J. Boudreaux, Boris N. Nikolaev, and Peter Klein (2019, 1202) describe Baumol’s approach, “incentives are clear and unambiguous and do not need to be interpreted.” In other words, once institutions are exogenously determined, “Baumolian” entrepreneurs seemingly respond to the institutional environment by solving an objectively given maximization problem, that is, by directing their energies toward “productive,” “unproductive,” or “destructive” efforts (McCaffrey 2018). This approach renders the Baumolian “entrepreneur” little different from the “entrepreneur” (really, manager) of neoclassical producer theory, who “chooses” (really, reacts) to a given constellation of prices. The Baumol framework is certainly valuable for explaining differences in the overall allocation of entrepreneurial talent between nations, where the rules may vary considerably from one society to the next. To put it another way, this approach is helpful in generating an “average treatment effect” of the institutional environment. However, this framework has had less success explaining why entrepreneurs within the same country (and even producing similar products) often interpret and respond to the same rule in different ways.
Until recently, this question has received little attention. Preliminary attempts at addressing this puzzle can be seen in the emerging literature that examines the range of potential entrepreneurial responses to various institutional rules. This work expands on Baumol (1990) by demonstrating that entrepreneurial response, like entrepreneurial outcome, may also be divided into three broad categories: entrepreneurial actors may abide by, alter, or altogether evade the rules of the game (Coyne and Leeson 2004; Li, Feng, and Jiang 2006; Henrekson and Sanandaji 2011; Elert and Henrekson 2016). An abiding strategy refers to entrepreneurial action that complies with the institutional status quo; an altering strategy occurs when entrepreneurs lobby rule makers for change; an evasive strategy seeks to circumvent the rules entirely (Henrekson and Sanandaji 2011; Elert and Henrekson 2017).
Although this taxonomy of entrepreneurial response to the institutional context has expanded Baumol’s taxonomy, additional research ought to explore the factors that influence an entrepreneur’s decision to abide, alter, or evade. Perhaps one reason why NIE scholars have not made more progress on this question is because the standard neoclassical toolkit has limitations that render it difficult to open this black box. For instance, many, though certainly not all, NIE scholars have treated the formal institutional rules that govern a society as not only objectively given to entrepreneurs, but also uniformly interpreted by them.Leeson’s (2012) distinction between the “Coasian” and “Posnerian” approach to institutions is apropos. The former approach takes institutions as both exogenous and beyond the reach of economics to explain. Within economics, Allen (2011) and Leeson (2017) are excellent examples of endogenizing a wide range of social institutions to the choices of individuals who solve problem situations by devising new institutional constraints.
Incorporating Austrian insights may shed light on the question of why entrepreneurs adopt different strategies by further “disaggregating” the relationship between entrepreneurship and institutions. Entrepreneurs possess not only different values and preferences, but also different knowledge and expectations of the future. Institutions are therefore perceived as they are filtered through the subjective lens of each economic actor. This implies that all entrepreneurs face differing and subjectively determined costs and benefits associated with alternative ways of interacting with the institutional environment. They also possess different propensities for noticing perceived profit opportunities.
Imagine two rock climbers attempting to surmount the same wall at a rock-climbing gym. In this case, the constraint of geography is undoubtedly “real,” but the perception of it must still be filtered through the climbers’ minds. An unnuanced reading of Baumol (1990) may tempt some economists to assume that each climber’s (i.e., entrepreneur’s) approach to this challenge will be identical because the challenge they face is identical—they are both trying to summit the same (objective) rock formation. But the “institutional entrepreneurship” literature has highlighted that such an assumption is likely misleading (Henrekson and Sanandaji 2011; Elert and Henrekson 2020).
Consider the following reasons for why one of the climbers may attempt a different approach to ascending the rock wall. Suppose one climber has already scaled that particular wall or was able to learn from observing the successes and failures of other climbers (in other words, he is more experienced). To explore another possibility, suppose a climber is being radioed by his friend who works at the gym and who is able to describe a pass that remains hidden to the climbers from their current vantage point. In either of these cases, both climbers seemingly face the same objective constraint. Yet one has unique (i.e., subjective) knowledge about a superior route that may not be visible to the other climber from their current vantage point. In Hayek’s words, one climber’s superior knowledge of the “particular circumstances of time and place” may lead him to adopt a different route.
The analogy is somewhat crude. Nevertheless, it conveys the point about how two actors may adopt different strategies based on their subjective perceptions of what is seemingly the same objective constraint. In this example, one climber not only perceives the costs and benefits of a route differently than his counterpart, but he may also be aware of a route that is hidden to his friend. This analogy suggests two important avenues of research. The first possibility, that each climber simply assesses the costs and benefits of alternative routes differently, demonstrates that “judgment” is required in all contexts (Boudreaux, Nikolaev, and Klein 2019). A subjectivist perspective emphasizes that, even when placed in identical environments with identical knowledge, not all entrepreneurs will form the same conjectures about the future, perhaps due to differing sociocognitive traits or other factors that lie beyond the realm of economics and in the domain of thymology (Boudreaux, Nikolaev, and Klein 2019).
The second possibility, that entrepreneurs may possess differential knowledge, suggests that more remains to be understood about the use of institutional knowledge in society. Austrians are known for their concern with the epistemic properties of institutions, but to the extent that they have developed this research agenda, they have tended to focus on how different institutional environments influence entrepreneurial learning in market settings, such as how alternative contract regimes facilitate or impede the market process (Wonnell 1985). Although an important line of inquiry, understanding how market actors acquire knowledge of their institutional environment is another promising topic.
Knowledge of institutions includes awareness of “institutional contradictions,” such as when the costs of regulation are prohibitively high. Levying noncompliance fines on AirBnB hosts in New York City is one example, as the costs of monitoring by regulators are prohibitive in this case, allowing for a profitable opening (Elert and Henrekson 2016). It also includes knowledge of the institutional players themselves, of their ideologies, experiences, and what they can do for market-based entrepreneurs in particular contexts. Unsurprisingly, the importance of these considerations grows when the agency in question wields discretionary powers (Newman 2019).
A way for Austrians to build on these insights is in developing a concept that parallels the so-called knowledge filter of mainstream entrepreneurship literature. The knowledge filter either facilitates or impedes the diffusion of technical knowledge (Acs et al. 2004). Factors such as the university innovation system and the structure of intellectual property rights comprise the “filter,” determining how much technological knowledge disseminates to others who then deploy it in new entrepreneurial ventures. Yet, in many circumstances, knowledge pertaining to the institutional environment can be just as important for profit seekers as is technological know-how. This is particularly true in environments with a large divergence between de facto and de jure rules.
A concrete example of the importance of institutional knowledge is the informal blat system of graft that enabled superior navigation of the commercial realm during the post-Soviet transition years (Ledeneva 2009). Being “embedded” in this informal and corrupt network proved a key determinant of entrepreneurial success in this environment (Aidis, Estrin, and Mickiewicz 2008). Social embeddedness was critical for understanding which rules would be enforced and which officials were susceptible to bribery. Given their historic strength in examining “organic” institutions, Austrians might turn their attention to exploring the emergence and roles played by such “meso-level” institutions as informal or black market networks (Kim, Wennberg, and Croidieu 2016). “Meso” institutions, the informal network of ties that exists “between” formal institutions and spontaneously arising norms, may thus enable some entrepreneurial action even in contexts subject to regime uncertainty, but the extent of it is not yet well understood (cf. Bylund and McCaffrey 2017).
More obvious in transition economies, the divergence between de facto and de jure is important in less corrupt environments too, suggesting a list of questions that Austrians are poised to address (Colombatto 2003). Is institutional knowledge diffused through meso-level networks? Are such networks an emergent response to weak formal rules? Are entrepreneurs without political or informal connections more likely to engage in evasive entrepreneurship due to their unfamiliarity with the rules and rule makers? Most importantly, can attention to institutional knowledge help scholars understand within-country entrepreneurial variation and therefore within-country economic development? To provide concrete answers for this variation, scholars should conduct intensive research that takes subjectivism seriously by allowing for a looser link between “given” institutions and entrepreneurial response.
Economic vs. Legal Property Rights
Applying subjectivism to institutions helps to avoid the pitfalls in the seemingly harmless assumption that there is no ambiguity, contradictions, or gaps in a society’s formal rules, nor in the interstices formed by imperfect alignment between formal and informal rules (Boettke, Coyne, and Leeson 2008). One notable NIE scholar sidesteps this pitfall by offering what might be considered an idiosyncratic definition of property rights but one which bears marked similarities to the way that Mises understood property rights. Barzel (1994, 394) defines a property right as “an individual’s net valuation, in expected terms, of the ability to directly consume the services of an asset, or to consume it indirectly through exchange.” He adds: “A key word is ability: The definition is concerned not with what people are legally entitled to do but with what they believe they can do,” (ibid. 1994, 394). Meanwhile, Mises ([1949] 1998, 678) defines a property right as “full control of the services that can be derived from a good.” Kirsten Foss and Nicolai J. Foss (2002) argue that Barzel’s conception of a property right, by placing the emphasis on individuals’ beliefs, is highly consistent with the subjectivism of the Austrian tradition.Both Barzel (1994, 1997) and Mises (1949) identify control as the locus of ownership. However, Barzel’s definition is arguably rooted in “expected utility,” a framework which Mises rejected for its failure to incorporate true uncertainty. Substituting the word belief for expectations, as the second part of Barzel’s definition does, certainly bring the two conceptions closer together.
In his landmark 1997 text, Barzel describes how this definition leads naturally to a distinction between “economic” and “legal” property rights, where the former are what a person can actually do (de facto), while the latter are what the legal apparatus, usually the state, permits (de jure). Despite the subtle differences in these definitions of property rights, this foregoing distinction can also be found in Mises ([1922] 1951), who emphasizes the distinction between “having” something and legal ownership, stating: “Economically, however, the natural having alone is relevant, and the economic significance of the legal should have lies only in the support it lends to the acquisition, the maintenance, and the regaining of the natural having,” (p. 37, emphasis in original). We concur with Foss and Foss (2002) and Piano and Rouanet (2020) that this Mises-Barzel distinction is more than mere theoretical curiosity. Indeed, it has already been deployed in Austrian work on organizational economics. In similar fashion, incorporating this subjectivist understanding of property rights into the analysis of society-wide institutions also has important implications for how scholars might conduct research at the institutions-entrepreneurship interface.
Take the work on legal origins by Andrei Shleifer and various colleagues, which is among the most cited economics research of the last three decades. This research seeks to illuminate the influence of legal institutions, such as shareholder rights, on commercial activity and economic growth.See Glaeser and Shleifer (2002) and La Porta, Lopez-de-Silanes, and Shleifer (2008) for overviews of this literature. Some scholars have even argued that this body of work represents a “missed opportunity” for those in the Austrian tradition because it essentially turns Hayek’s arguments on law into an empirically testable research agenda (Subrick and Beaulier 2004).Arguably, another missed opportunity for Austrians is the “new economics of management” literature, which examines the connection between labor regulations and management practices worldwide (Bloom and Van Reenen 2010; Bloom et al. 2019). It can be interpreted as empirical support for Mises’s argument that “bureaucratization” of business is a result of government intervention (Mises 1944; Klein 1999, 36).
The work of Shleifer (and coauthors) might be faulted for relying too heavily on de facto measures of institutional quality. Though having missed the opportunity of generating this literature, Austrians still have the opportunity of sidestepping these criticisms of overreliance on de facto measures by embracing the Mises- Barzel definition of property rights in their empirical work. To do this, scholars might conduct surveys of entrepreneurs to ascertain their perceptions—their “expectations,” in Barzel’s terminology—of the institutional environment. Such an approach is particularly important because Austrian work in the theory of institutions has emphasized that formal institutions only “stick” when they exhibit strong correspondence with the underlying, informal norms of a society (Boettke, Coyne, and Leeson 2008; Williamson 2009). Some preliminary work in this direction has already been conducted by mainstream scholars, such as Simon Johnson, John McMillan, and Christopher Woodruff (2002), who survey entrepreneurs about the institutional environment in transition economies and reject the hypothesis that liquidity constraints are responsible for low reinvestment rates.Shleifer and Fyre (1997) have employed a survey method to investigate entrepreneurs’ perceptions of government quality in transition economies. Public predation is the culprit.
This subjectivist approach to institutions accounts for “what people think and believe” (Hayek 1943), their expectations about the “institutional environment,” and thus helps to open the “black box” of de facto measures. By incorporating the Misesian (and NIE) distinction between “legal” and “economic” property rights, scholars can better build on the empirical forays into the institutions-entrepreneurship relationship (Bowen and DeClerq 2008; Bjørnskov and Foss 2008; Sobel 2008). A subjectivist approach naturally suggests that scholars investigate the moderating and mediating interactions of formal and informal institutions (which may be measured via survey) for entrepreneurial outcomes. How important are “productive” formal institutions if the underlying informal institutions are sound (and vice versa)? This approach also suggests the development and use of more fine-grained measures of the informal institutional environment, such as asking entrepreneurs questions about their commercial interactions with others, as a substitute for the typical reliance on society-wide measures of “trust.”
Institutions and Process
Intended Institutional Change
NIE scholars have criticized general equilibrium models that assume perfect information and zero transaction costs and are thus poorly suited to explain why and how economies and their institutions evolve. Indeed, as has been widely noted, such models are ill equipped to explain the very existence of institutions at all. In his Nobel Prize address, North (1994, 359) pinpointed these shortcomings. “Neoclassical theory,” he argued, “is simply an inappropriate tool to analyze and prescribe policies that will induce development.” North even acknowledges that one of the goals of economic historians working in the NIE tradition is to “not only shed new light on the economic past, but also to contribute to economic theory by providing an analytical framework that will enable us to understand economic change” (359). He concluded that economists studying institutions need to shift from general equilibrium models that posit a “static and frictionless world” and toward a dynamic framework “capable of increasing our understanding of the historical evolution of economies over time”––one that takes seriously how “the learning process of human beings shapes the way institutions evolve” (360).
North’s plea for scholars of institutions to discard static equilibrium models in favor of a dynamic framework invites those who embrace the compositive method adopted by Austrians dating back to Menger in his pioneering analysis of the origins of money. As Langlois (1992, 170) notes, this causal-genetic approach explains how social institutions evolve over time by “tracing out a sequence of events rather than merely constructing the conditions for an equilibrium.” This approach to institutional analysis relies on “invisible hand explanations” built on the foundations of subjectivism and methodological individualism, allowing it to explain social phenomena as emerging in bottom-up fashion from the purposive actions of individuals.
For Austrians, entrepreneurial action is the driving force behind this institutional evolution. Identifying the entrepreneur as the catalyst of change has allowed Austrians to avoid the puzzle posed by Kenneth J. Arrow (1959), who pondered who is responsible for changing prices in a general equilibrium world. However, similar quandaries may be generated by viewing institutions as merely exogenous constraints to which entrepreneurs helplessly react. Adopting such a perspective would import a version of the bloodless price-taking “entrepreneur” (really, producer) who populates the static world of general equilibrium models.
By contrast, incorporating an entrepreneurial agent who drives institutional change is important, because, by NIE scholars’ own admission, institutional dynamics are largely treated as a “black box.” Perhaps nothing better illustrates this claim than the Demsetz (1967) analysis of the transition from common to private property. In this landmark account, changes in the relative costs and benefits of private property are translated seamlessly into a change in the property regime. To paraphrase Garrison (1995), “it’s ‘costs and benefits’ the whole way down.” Because of their focus on process over equilibrium states and their emphasis on entrepreneurs as catalysts of change, Austrians are well positioned to contribute to theories of institutional evolution (Leeson and Suarez 2015). To be sure, repeating the phrase “entrepreneurs matter” as an explanation for institutional change is no better than repeating the mantra that “institutions matter” to explain economic outcomes. What is needed are “entrepreneurial microfoundations” that illuminate the mechanisms by which entrepreneurs spur institutional change.
Jack High (2009) offers one such account in which new institutions emerge as a result of entrepreneurial actors attempting to realize “gains” (not necessarily money profits). In this story, an alert entrepreneurial actor introduces an “institutional innovation,” such as indirect exchange. The second step in this sequence also requires an act of entrepreneurship. As High argues, a second adopter of the new institutional innovation must recognize it and then decide upon adoption. He notes: “Observation requires alertness of the kind emphasized by Kirzner; deciding whether or not to adopt the new practice requires judgment in the face of uncertainty, as emphasized by Mises” (High 2009, 8). That economic activity takes place in close social proximity provides opportunity for “observation and communication” (8). People are convinced to adopt the institution via “imitation” (emphasized by Menger) and persuasion (not explicit in Menger’s story). High deploys this framework to examine the emergence of money, the division of labor, accounting, and the transition from common to private property.
High’s analysis is fruitful because it raises a host of research questions that Austrians are positioned to integrate with existing thinking on institutional change. For example, appealing to Williamson’s (2000) hierarchical approach to analyzing institutional structures, Bylund and McCaffrey (2017) describe how entrepreneurs shift activity between institutional “levels” when government policy reduces the profitability of acting on one level relative to others. The highest level in Williamson’s hierarchy— L1—consists of informal norms and rules (i.e., religious beliefs, customs, etc.), and Williamson contends that L1 changes only slowly, usually on the scale of a century to a millennium. Bylund and McCaffrey (2017, 461, 465) likewise argue that “entrepreneurs can experience extreme difficulty when trying to act in L1,” because the “social embeddedness level (L1) is far less amenable to direct and frequent change.”
However, Robert C. Ellickson (2001) advances a theory of “norm entrepreneurs,” while North (1990) sketches the concept of “ideological entrepreneurs,” developed further by Virgil Henry Storr (2011). These change agents aim at shifting society’s slowest moving, most spontaneous rules. Austrians will appreciate the general thrust of Ellickson’s theorizing because of his explicit emphasis on purposive action but will also find ways to improve and extend his analysis. For example, Ellickson’s (2001) entrepreneurial actor is someone who simply adjusts conditions to changes in the relative prices imposed by changing constraints, rather than acting as an agent who might also introduce relative price changes. Secondly, Ellickson’s analysis focuses on individuals who introduce norm changes to gain social applause, but what of entrepreneurs who introduce “L1” changes in anticipation of money profits because a combination of government intervention and existing norms would otherwise curtail their ability to do so? To what extent, and when, do market entrepreneurs undertake “norm entrepreneurship” as a means of augmenting their profitability? Because such pursuits have society-wide implications, are they often pursued collectively by profit seekers, and if so, what institutional innovations do entrepreneurs implement to monitor and enforce contribution to this “public good” (Dorobantu, Kaul, and Zelner 2017)?
Regardless of one’s stance on the alterability of L1 rules, research on intentional institutional change by entrepreneurs, even that occurring at a lower level of Williamson’s hierarchy, raises a host of questions that Austrians are poised to address. The first question has to do with the nature of the feedback guiding an actor like High’s “institutional entrepreneur” (our term, not his). Entrepreneurial activity within the context of private property yields money prices, profits, and losses, which facilitate monetary calculation. Does entrepreneurial activity over the rules of the game also generate high-quality feedback (Boettke and Coyne 2009, 192–95)? What substitutes for money profits and losses when entrepreneurship is occurring over the institutional prerequisites to profit-and-loss accounting?
Second, Austrians might deploy this step-by-step approach to better understand entrepreneurial solutions to the “grand challenges” that societies face, such as the private provision of goods with “publicness” characteristics, the prevention of war, the mitigation of diseases, development, immigration, aging populations, or the supplying of “missing” institutions.See George et al. (2016) for a discussion of how management scholars are tackling “grand challenges.” On this last topic, Boettke and Peter T. Leeson (2009) show that, especially for the underdeveloped world, the traditional view of entrepreneurs acting within a given institutional framework is highly deficient.This point is also applicable to many “pockets” of underdeveloped institutions in the developed world. See, for example, David Skarbek (2014) on prison gang governance. In underdeveloped nations, formal institutions of property and contract enforcement are often severely lacking (Rajan 2004). Because there is gain to be had in supplying this missing framework, entrepreneurs work to directly supply these institutions. Once again, though, questions of feedback arise. There are also questions about the antecedents to success; for instance, how weak must public governance be for entrepreneurs to successfully provide and enforce the overarching legal framework?
Third, some Austrians have argued that market entrepreneurship yields a “multiplier effect” whereby entrepreneurial action generates subsequent profit opportunities (Holcombe 1998; Coyne, Sobel, and Dove 2010).Hülsmann (1999) disputes this mechanism by arguing that it is impossible to know whether an act of entrepreneurship, on net, creates additional opportunities for subsequent entrepreneurship. He also objects to what he sees as a passive conception of entrepreneurship in Holcombe’s argument. Holcombe (1999) responds by granting that it is impossible to know the counterfactual pertaining to additional acts of entrepreneurship. However, he makes the subtler point that the new opportunities are better suited to satisfying consumer preferences. The mechanism by which this occurs has been spelled out for market entrepreneurship within a set of institutional rules. Austrians might contribute to the entrepreneurship literature by examining whether similar mechanisms are at work in the case of institutional entrepreneurship. Lastly, the High (2009) account is focused on institutions which arise out of purely voluntary interactions, so what must be modified to understand the evolution of institutions, such as slavery, which are undergirded by violent actions?
Unintended Institutional Change
Although the High (2009) analysis suggests that institutional change results from an entrepreneurial actor who explicitly attempts to alter the existing institutional framework, this is not always the case. Entrepreneurs may (unintentionally) reinforce the status quo through abiding entrepreneurship or (unintentionally) alter that status quo through evasive entrepreneurship, even when institutional alteration is not their explicit aim (Elert and Henrekson 2016, 2020). As an illustration, David S. Lucas and Caleb S. Fuller (2018) explore the “market-making” activities of entrepreneurs in the face of interventionist policies. Certain interventions—such as bounties—“commodify” products which did not previously possess “goods-character” in the Mengerian sense. For example, they describe how entrepreneurs increased the supply of pests for which public authorities had set a bounty. In the cases they examine, entrepreneurship undermined the stated rationale of the intervention, leading to its eventual repeal. Institutional alteration was the outcome, though not the intention, of the market-making entrepreneurs who responded to the intervention.
Similarly, Niklas Elert and Magnus Henrekson (2016) describe how evasive entrepreneurship may also foster formal institutional change, despite that not being any entrepreneurial actor’s explicit intent. Consider the following examples that they provide: the success of Chinese farmers’ (illegal) experiments with private property subsequently undergirded arguments that facilitated China’s move in the 1990s toward agricultural privatization; a private network of TV stations in Italy undermined the public telecommunications monopolies; and the rise of Uber caused taxi monopolies to implement “surge pricing” to compete with their new rivals.
These examples are preliminary attempts at opening the “black box” that conceals the mechanisms by which entrepreneurs generate institutional change; much more work is yet to be done. For example, is institutional change usually a result of intentional action by entrepreneurs, as in the case of “altering” activity (Elert and Henrekson 2017), or is institutional evolution more commonly an unintentional by-product of entrepreneurial behavior, as in the cases described by Lucas and Fuller (2018)? Furthermore, evasive entrepreneurship clearly does not always precipitate formal institutional change. Uber’s evasive activity vis-á-vis taxicab monopolies has eroded the latter’s rents and forced pricing adjustments, but has not yet generated wholesale repudiation of transportation licensure.
Additionally, when evasive entrepreneurship does generate institutional change, the mechanisms driving that change are also largely unclear. For example, some instances of evasive entrepreneurship might render a public monopoly unprofitable, whereas others might bring public pressure to bear on existing institutions. In yet other cases, evasive entrepreneurship might simply serve as the template for public entrepreneurs attempting to implement reforms (Klein et al. 2010).Cf. DiLorenzo (1988). Future research might explore the conditions under which evasive entrepreneurship tends to result in explicit institutional change while also better enumerating the mechanisms by which evasive entrepreneurial activity translates into institutional change.
Institutions and Heterogeneous Capital
Another hallmark of the Austrian tradition is its emphasis on capital as a network of interconnected, heterogeneous, and multispecific produced factors of production (Mises [1949] 1998; Lachmann [1956] 1978; Rothbard [1962, 1970] 2009; Kirzner 1966; Lewin 1998; Powell 2010; Burns 2018a). This stands in marked contrast to mainstream economic theorizing going back to Knight that treats capital as an undifferentiated blob of “shmoo” (Foss and Klein 2012, 105–07). Historically, the Austrian emphasis on capital heterogeneity has played an important role in macroeconomic or systemwide analyses, specifically trade cycles and the calculation debate.Famously, it was Mises’s emphasis on capital heterogeneity that led Frank Knight to pan Human Action. Capital heterogeneity featured prominently in the calculation debate, because if capital goods are costlessly interchangeable between production processes, the calculation problem becomes much less severe even if not altogether irrelevant.There is ambivalence on whether perfect capital homogeneity would eliminate calculation problems. Horwitz (1998, 438) states: “If all capital goods are perfectly substitutable, no calculation is necessary….If all capital goods are perfectly specific, such choices are also not necessary.” Foss (2012, 152–53) argues: “In fact, even if capital were homogeneous, there would still be calculation problems left (how much homogeneous capital to devote to production now versus later).” Foss and Klein (2012) cite Mises ([1949] 1998) saying that only “trivial calculation” problems exist in a world of “shmoo” capital. It was also a centerpiece of early twentieth-century Austrian development of the trade cycle. This emphasis continues to this day, particularly as mainstream macro continues to deploy homogenizing assumptions about capital that obscure the ways that monetary policy generates booms and busts (Garrison 2000; Boettke and Piano 2019).
Given these historical foci, there is promise in examining the more strictly microeconomic implications of capital heterogeneity, especially those which pertain to institutions and entrepreneurship. In fact, several NIE scholars have also relaxed the capital homogeneity assumption to generate explanations of microeconomic phenomena. Williamson (1975, 1985), for instance, leans heavily on his notion of “asset specificity”—investments that have transaction- specific characteristics which reduce their value in alternative lines of production—to explain the wide array of institutional arrangements that firms devise, including “arm’s length” contracts, vertical integration, and in-between hybrids.For Williamson, the other determinants of contractual form include transaction frequency and uncertainty, but he has argued that asset specificity is the most determining. Another notable example is Barzel’s (1982, 1997, 2005) contention that capital assets are best characterized as bundles of “attributes,” arguing that it is costly to completely and perfectly define property rights over each of an asset’s attributes. He deploys these insights to explain why some attributes are left in the “public domain” (that is, are not privately owned) and also reexamines classic questions pertaining to the widespread variation in contractual forms.
Arguably, Barzel’s notion of asset attributes is inherently more amenable to Austrian theorizing—it maps almost perfectly onto Lachmann’s ([1956] 1978, 2–5) notion of multiple specificity—than is Williamson’s concept of asset specificity, since the latter has specific users rather than specific uses in mind (Klein 2009). There are still ways, however, that Austrian concepts can further enrich and build on the framework provided by the attributes concept. To begin, Barzel’s conception of heterogeneous goods implicitly assumes that all attributes have been discovered but that it is prohibitively costly to define property rights over each of them (Foss and Foss 2002). Kirzner (1966), however, argues that a capital good’s multispecific uses (“attributes” in the Barzelian terminology) must be subjectively perceived by entrepreneurial actors who integrate them into a production plan. This point has been used to explain firm and asset ownership (Foss and Foss 2001), but we see room for more work that links entrepreneurs’ discovery of valuable assets to society-wide institutions.
Clearly, not all institutional environments are equally conducive to the perception of asset attributes nor how they can be profitably deployed. Kirzner (1985), for instance, recognizes that government intervention alters the market process by stifling some discoveries and in generating superfluous avenues for profit making (i.e., rent seeking). This logic might be extended to explore how the institutional environment facilitates or impedes discovery of asset attributes under an entrepreneur’s control. Alternatively, interventionist institutions may generate discovery of attributes which prove useful in evasive entrepreneurship but which may not have been discovered absent the intervention.
Cell phones provide a useful illustration of both cases. As Burns (2018b) documents, permissive regulatory environments in Sub-Saharan Africa facilitated the discovery of cell phone attributes which would allow them to serve as a platform for a banking system. Yet a laissez-faire environment is not the only context under which valuable attributes may be discovered. For example, that smartphones could coordinate a ride-sharing platform was only discovered when it was due to the existence of interventionist institutions. Of course, to note this is to say nothing of the welfare implications in either case. More research is needed to understand the conditions which facilitate the first or second outcome.
Other research demonstrates that the “elasticity of substitution” between capital goods is endogenous to the institutional environment (Bjørnskov and Foss 2016). Such reasoning naturally generates a host of follow-up questions. How do entrepreneurs structure contracts (e.g., duration, asset ownership, etc.) to protect their assets’ most valuable attributes in the face of known interventionist institutions? Furthermore, how do contractual arrangements change when entrepreneurs confront institutional uncertainty regarding intervention (Higgs 1997; Terrell 2013; Baker, Bloom, and Davis 2016; Bylund and McCaffrey 2017)? Relatedly, do entrepreneurs who command highly specialized assets devote more resources to the political process to better secure their rents? Entrepreneurs in these contexts are presumably more “exposed” by the thin markets in which they operate, suggesting higher payoffs from political activity.
CONCLUSION The Austrian and new institutional economics traditions both place an emphasis on the vital role that institutions play in guiding human affairs. They also acknowledge the central role of the entrepreneur in the economy. This article contributes to prior efforts at bridging the gap between the two traditions by identifying some unrealized gains from trade: a more thoroughgoing subjectivism, an emphasis on process, and an incorporation of capital heterogeneity will open new areas of inquiry for the project of examining the relationship between institutions and entrepreneurship.
Scholars might shrink remaining gaps between AE and NIE by viewing transaction costs as the by-product of choice rather than objective, unalterable, exogenously given constraints (Robbins 1934; Buchanan 1969; DiLorenzo 1990). Indeed, North’s thinking evolved in this very direction over the course of his career (Candela, forthcoming). One implication is that scholars might turn their attention to entrepreneurial activity that is aimed explicitly at reducing transaction costs (Candela and Geloso 2019). Transaction costs, the costs of establishing property rights (Allen 2000), may arise out of either private opportunism or public predation. Although Austrian economics has emphasized the rivalrous striving by entrepreneurs to satisfy consumer preferences by discovering least-cost production techniques (Hayek 1948), these insights can be profitably extended to entrepreneurial action whose aim is to reduce transaction costs specifically. This research program will identify a host of institutional constraints that are devised to address the problem situations that consumers and producers confront. It will also reveal the entrepreneur as not only the driving force of change within a given institutional context, but also as the driver of institutional change itself. As has been argued, simply positing the existence of a change agent is insufficient. The antecedents, mechanisms, and feedback for institutional change should be elaborated.
This article is not intended to provide a comprehensive overview of all the ways that the Austrian and NIE traditions can learn from one another. Nevertheless, the hope is that this preliminary theoretical sketch will open up profitable new avenues for institutional research that incorporate important insights from both traditions. If this goal has been achieved, future scholarship on institutions and entrepreneurship will be grounded in Austrian insights and yield fruitful empirical findings.
Abstract: Many scholars have pointed to Austrian subjectivism as an appropriate framework for understanding and studying entrepreneurship. Yet very few empirical studies in the field of entrepreneurship have applied a subjectivist lens. This research article responds to calls for more subjectivist entrepreneurship research by theoretically refining and empirically extending the subjectivist approach to team entrepreneurship. The findings presented in this study, which are based on data from 124 high-tech start-ups founded in Norway, suggest that positive internal and external team dynamics contribute to team effectiveness, as measured by the lead entrepreneur’s subjective assessment of his or her team. Implications for theory and practice are discussed.
JEL Classification: B53, D80, L26 Daniel Leunbach (daniel.leunbach@sfe.uio.no) is a lecturer at the University of Oslo. Truls Erikson (trulser@ifi.ulo.no) is a professor at the University of Oslo. Ekaterina S. Bjornali (ekaterina.bjornali@ntnu.no) is an associate professor at the Norwegian University of Science and Technology.
The authors would like to thank Professor Bylund and the two anonymous reviewers for their helpful comments.
INTRODUCTION One of the defining characteristics of the Austrian school is its commitment to subjectivism (Boettke, Lavoie, and Storr 2004; Horwitz 1994; Lavoie 1991; Storr 2010).The term subjectivism is difficult to pin down, as it is used differently in different contexts. In the context of Austrian economics, subjectivism refers to the explicit recognition “that the actions of individuals are to be understood only by reference to the knowledge, beliefs, perception and expectations of these individuals” (Kirzner 2002, 64). More broadly, subjectivism refers to “the pre-supposition that the contents of the human mind, and hence decision making, are not rigidly determined by external events.” (O’Driscoll and Rizzo 2014, 68). This is not to say that mainstream economics completely ignores that individuals hold different preferences, beliefs, and expectations, only that Austrians are far more consistent and thoroughgoing in their application of subjectivism (Foss, Klein, and McCaffrey 2019). Within the Austrian tradition, for example, “it is not merely the ends toward which actions are directed that are subjectively determined, but the means as well” (Dempster 1999, 76; see also Garello 1996).
Whereas subjectivism is a defining aspect of Austrian thought, most entrepreneurship scholars, by contrast, tend to adopt an “objectivist” or “functionalist” metatheoretic approach (Jennings, Perren, and Carter 2005; Grant and Perren 2002; Packard 2017). Stated differently, the predominant approach to understanding and explaining entrepreneurial action and outcomes in the field of entrepreneurship is one characterized by a realist ontology, a positivist epistemology, a deterministic view of human agents, and a nomothetic methodology (Grant and Perren 2002; Burrell and Morgan 1979).Notable exceptions include effectuation theory (Sarasvathy 2001) and the theory of entrepreneurial bricolage (Baker and Nelson 2005). Effectuation theory is partly grounded in American pragmatism (Steyaert 2007) and entrepreneurial bricolage draws on social constructivism, and more specifically on Penrose’s (1959) subjectivist distinction between the resources in a firm’s environment and the firm-specific services derived from those resources (Fischer 2012).
The tendency of Austrian economists and entrepreneurship scholars to adopt divergent starting assumptions may discourage or hamper intellectual exchange between these two knowledge domains (MacLeod 2018). Of particular importance to our explanations of social reality is how much agency we are willing to afford the human subject (see Bevir and Blakely 2018; Hacker 2001). If, for instance, we adopt a mechanistic/deterministic image of the human actor as “nothing more than some sort of piano key or organ stop;… so that everything he does is not at all done by his will but by itself, according to the laws of nature” (Dostoevsky 1864, qtd. in Frank 2010, 423), then this will undoubtedly shape our language and our explanations of economic life (Boettke, Coyne, and Leeson 2003). Likewise, if we adopt an image of the human actor as a self-determining and autonomous being, in absolute command of his or her beliefs and actions, then our explanations and our language will look accordingly different. Scholars who adopt polar opposite assumptions about human agency may therefore find themselves divided by “a gulf of mutual incomprehension” (Snow 1959, 4).
Philosophical differences notwithstanding, this article is written in the belief that mutual learning between the Austrian school of economics and the field of entrepreneurship is both possible and desirable. In fact, there is already a vibrant ongoing dialogue between these two areas of knowledge (Berglund 2009; Chiles, Vultee, et al. 2010; Chiles, Tuggle, et al. 2010; Foss, Klein, and McCaffrey 2019; Foss and Klein 2012; Foss et al. 2008; Kor, Mahoney, and Michael 2007; Korsgaard, Berglund, et al. 2016; Mahoney and Michael 2005). Moreover, many recent contributions have pointed specifically to subjectivism (or interpretivism) as a useful alternative framework for understanding and studying entrepreneurship (e.g., Chiles, Tuggle, et al. 2010; Chiles, Vultee, et al. 2010; Foss et al. 2008; Gilbert-Saad, Siedlok, and McNaughton 2018; Leitch, Hill, and Harrison 2010; Jennings, Perren and Carter. 2005; Kor, Mahoney, and Michael 2007; Mahoney and Michael 2005; Packard 2017; Pittaway 2005). Despite these praiseworthy efforts to articulate the potential relevance and value of subjectivism for the field of entrepreneurship, there are still very few examples of empirical studies in the field built on explicit subjectivist foundations (see Chiles, Vultee, et al. 2010). This is both surprising and unfortunate given the subjectivist emphasis on creative agency and imagination—human elements that seem central to any comprehensive understanding of entrepreneurship (Chiles, Vultee, et al. 2010; Gilbert-Saad, Siedlok, and McNaughton 2018; Kier and McMullen 2018; Kor, Mahoney, and Michael 2007; Packard 2017).
This paper responds to calls for more subjectivist entrepreneurship research (see, e.g., Jennings et al. 2005) by empirically extending the subjectivist approach to team entrepreneurship (henceforth, SATE; Bjornali et al. 2017; Foss et al. 2008; Leunbach, Erikson, and Rapp-Ricciardi 2019; Kor, Mahoney, and Michael 2007; Mahoney and Michael 2005; Penrose 1959). Briefly put, SATE is a distinctive approach to studying and understanding entrepreneurial teams—first outlined by Nicolai J. Foss, Peter G. Klein, Yasemin Y. Kor, and Joseph T. Mahoney (2008)—that brings together methodological insights and assumptions from Austrian economics, Edith Penrose’s (1959) subjectivist resources approach, and the modern resource-based view. It will be useful, for the sake of clarity, to provide some additional theoretical context before developing this study’s hypotheses. The next section therefore offers a condensed overview of SATE and briefly explains how SATE differs from the standard objectivist approach that tends to dominate the study of entrepreneurial teams.In this article, the terms entrepreneurial team and new venture team (these are used interchangeably in the literature) are defined as “the group of individuals that is chiefly responsible for the strategic decision making and ongoing operations of a new venture” (Klotz, et al. 2014, 227).
The Subjectivist Approach to Team Entrepreneurship Unlike classical accounts of entrepreneurship, which tend to portray entrepreneurship as a solitary undertaking (e.g., Cantillion [1755] 1931; Kirzner 1973 Knight 1921; Say 1814), SATE embraces the team as the key unit of analysis. At first glance, it may seem incoherent that an approach that purports to be subjectivist would embrace the team as a focal object of inquiry. As Foss et al. (2008) carefully explain, however, SATE is consistent with subjectivism in that it is cognizant of individual heterogeneity and takes as its starting point that entrepreneurial teams are comprised of individuals with different experiences, interests, interpretations, personality traits, skills, knowledge, expectations, and so on. Moreover, SATE is also consistent with methodological individualism in that it recognizes that we cannot meaningfully ascribe psychological predicates, such as beliefs and intentions, to the team itself, as if it were a kind of agent in its own right (Quinton 1975). In other words, SATE is consistent with the view that “[o]nly individuals have ends and can act to attain them” (Rothbard [1962, 1970] 2009, 2). Yet it is also the case, almost by definition, that there must be more homogeneity in purposes and intentions among the members of an entrepreneurial team than there is between members of different entrepreneurial teams (Elster 1989, 248–49). As King, Felin, and Wetten (2010, 297) explain:
Pursuing “all” heterogeneous goals or preferences simply is not feasible for an organization not only because of costs and identity violations but also because of the limits of organizational attention (Ocasio 1997). In this sense “organization by firm is variety reducing.” (Kogut 2000, 408, emphasis added)
Thus, a primary assumption of SATE is that entrepreneurial team members join forces for a strategic purpose and that their association is predicated on the achievement of that shared purpose (Penrose 1959).
Of course, the adoption of a “team perspective” on entrepreneurship is not unique to SATE in itself. In recent years, entrepreneurship researchers have become increasingly interested in entrepreneurial teams (Klotz et al. 2014). As Anna Brattström, Frédéric Delmar, Alan R. Johnson and Karl Wennberg (2020) and many others have explained, however, entrepreneurial team researchers have predominately focused on examining the relationships between team characteristics (e.g., size, demographic diversity) and various types of outcomes while often downplaying or ignoring how team members work together to achieve meaningful outcomes (see also Bjornali et al. 2017; Lechler 2001; Leunbach et al. 2019). SATE, by contrast, focuses explicitly on the ways in which team members with heterogeneous mental models act and interact in subjective and intersubjective processes of “discovery, creativity and learning” (Bjornali et al. 2017, 319) to achieve their shared purposes (Gilbert-Saad, Siedlok, and McNaughton 2018; Packard 2017).
Finally, SATE also differs from standard approaches to studying entrepreneurial teams in that it takes seriously the proposition from Austrian economics “that the future is not merely unknown, but unknowable” (Kor, Mahoney, and Michael 2007, 1188). This proposition follows quite naturally from Austrian assumptions about individual agency, imagination, and choice (see Beckert 2016; Bronk 2009, 215–16; Buchanan and Vanberg 1991; Shackle 1979).As Robert Jackson (2000, 72) has put it in another context: “Human behaviour cannot be predicted scientifically because humans have minds, and because they can make up their minds and change their minds concerning the basic question of how they wish to live. They can be quite unpredictable in doing that. They have fertile imaginations.” As Gerald P. O’Driscoll Jr. and Mario Rizzo (2014, 69, emphasis in original) point out:
A world in which there is autonomous or creative decision-making is one in which the future is not merely unknown, but unknowable. There is nothing in the present state of the world that enables us to predict the future state because the latter is underdetermined by the former…. Subjectivism and action under uncertainty are thus inseparable ideas.
By taking uncertainty seriously, SATE allows us to ask different questions, questions that are not being sufficiently addressed in the entrepreneurial team literature. For instance, if the modern capitalist economy is characterized by persistent “novelty, surprise, and instability” (Chiles, Vultee, et al. 2010, 138), and thus exhibits Knightian uncertainty (as opposed to measurable risk), then how can entrepreneurial teams overcome paralysis and make the decision to act, how can they form shared expectations, and how can they convince, communicate, and collaborate with external actors who may be needed in the commercialization effort (see also Beckert 2016; Beckert and Bronk 2018; Bronk 2009; Tuckett 2018)?
Although we still lack satisfactory answers to these questions, any subjectivist answer to them is likely to include some reference to our human capacity for imagination. As Jens Beckert and Richard Bronk (2018, 3) have put it, “imagination is not only the root cause of uncertain futures; it is also one of our principal tools for coping with them.” In Foss et al.’s (2008) subjectivist framework, for example, the creative imagination also takes center stage. Specifically, Foss et al. (2008, 88, emphasis original) portray entrepreneurship “as a creative team act, where heterogeneous managerial mental models interact in a process that produces a collective output, which is creatively superior to individual entrepreneurship.”
Although Foss et al.’s (2008) original formulation of SATE is theoretically rich and built on sound Austrian foundations, it arguably lacks the specificity needed for empirical research. Moreover, Foss et al.’s (2008) framework focuses almost exclusively on the social and cognitive interactions within the entrepreneurial team, thereby discounting the interface between the focal entrepreneurial team and other important constituents whose contributions may also be critical to the successful development of the venture (e.g., investors, pilot customers, alliance partners, suppliers, external advisors, government agencies; see Elert and Henrekson 2019; Garnsey and Heffernan 2005).
This article attempts to overcome these limitations by developing and testing a conceptual model that includes two key constructs, positive internal dynamics (Foss et al. 2008) and positive external dynamics, to explain team effectiveness. After developing and presenting said model, the research design is described and the findings, based on self-reported data from 124 high-tech start-ups founded in Norway, are presented. The article concludes with a discussion of the theoretical and practical implications.
HYPOTHESES DEVELOPMENT Positive External Dynamics and Entrepreneurial Team Effectiveness
For innovation-based start-ups, a basic challenge is how to successfully communicate and collaborate with external actors whose complementary capabilities and resources are required in order for the venture to survive and grow (Clough et al. 2019; Elert and Henrekson 2019; Gans and Stern 2003; Villanueva, Van de Ven, and Sapienza, 2012). Examples of externally held resources that entrepreneurs need to attract to build their ventures include financial resources (e.g., venture capital financing or bank loans), human capital (e.g., skills from employees, advisors, board members, and business partners), and social capital (e.g., information from customers, suppliers, or other social contacts; see Clough et al. 2019 for an excellent review of the research on entrepreneurial resource mobilization).
Resource mobilization becomes particularly challenging in an Austrian world of dispersed knowledge and heterogeneous expectations (Dew, Velamuri, and Venkataraman 2004; Zander 2007). That is, subjectively held knowledge and heterogeneous expectations imply that it can be prohibitively difficult or costly for entrepreneurs to articulate and communicate their ideas and plans in such a way that relevant others will be able to understand, assess, and accept them (Zander 2007). If the venture is based on complex and highly specialized knowledge, as is often the case with science-based ventures, the likelihood of communication difficulties increases (Miozzo and DiVito 2018). In such a context, an entrepreneurial team’s deep knowledge of a particular technological domain may paradoxically limit the team’s ability to communicate effectively with potential resource providers, a phenomenon known as “the curse of knowledge” (Froyd and Layne 2008; Leunbach et al. 2019). Indeed, the history of science is replete with examples that illustrate just how excruciatingly difficult it can be to champion new ideas based on specialized knowledge of “the particular circumstances of time and place” (Hayek 1945, 521), even when the ideas have clear advantages over existing alternatives (see, e.g., Rogers 2003; Weintraub 2010). The reasons for such communication difficulties include not only nonoverlapping mental models between an idea’s champions and potential supporters (Foss and Grandori 2020), but also cognitive biases against novelty (Mueller, Melwani, and Goncalo 2012). To gain acceptance for their ideas, entrepreneurs and innovators may have to frame and present their novel ideas with reference to existing and familiar activities. For example, Kathleen Eisenhardt (2003, ix), describes how managers and engineers at Amazon.com used familiar metaphors such as “shopping cart” and “checkout” to disguise their novel internet technology and overcome resistance.
Of course, many entrepreneurial teams try to circumvent aspects of the resource mobilization process by making creative use of the resources at hand (Baker and Nelson 2005; Penrose 1959) or by using their own personal funds to purchase the inputs they need to exploit an entrepreneurial opportunity (Shane 2003, 167–71). However, most entrepreneurial teams sooner or later have to confront the problem of mobilizing external stakeholder support if they want to realize their plans, even those teams that self-finance and engage in entrepreneurial bricolage (Zott and Huy 2007; Elert and Henrekson 2019).
Research suggests that resource mobilization is an inherently social process, involving communication activities such as persuasion, explanation, sharing of stories, interpretations, and so on (Martens, Jennings, and Jennings 2007; Zott and Huy 2007). In particular, to communicate effectively with a potential stakeholder, an entrepreneurial team must have a reasonably accurate understanding of what the potential stakeholder knows (Nickerson 1999).
The above considerations highlight the central importance of empathic accuracy for mobilizing stakeholders in support of a venture. Empathic accuracy can be defined as the “the ability to accurately infer the specific content of another person’s thought and feelings” (Ickes 1993, 588). Some people display a remarkable talent for understanding the states of others. It has been said of the philosopher and historian of ideas Isaiah Berlin, for example, that he had “the gift of self-identification with the outlook of holders of widely different, sometimes incompatible points of view—to a degree unique among philosophers.” (Magee 2009, 43). Similarly, the bestselling novelist James Patterson attributes his own success to a “golden gut—an ability to sense what’s going to appeal to a lot of people” (qtd. in Belsky 2010, 28). Although people differ in their basic skills of empathy and social understanding (Mar, Oatley, and Peterson 2009), it is reasonable to assume that most entrepreneurs can make a deliberate effort to successfully place themselves in the shoes of potential stakeholdersEntrepreneurs who fall on the autistic spectrum are a possible exception (see Currie and Ravenscroft 2002). and that such social imaginative efforts can translate into distinct advantages, including, for example, improved communication with relevant parties outside the focal team and improved venture ideation (Kier and McMullen 2018; McMullen 2015; Nickerson 1999). For example, an entrepreneurial team that strives to inform itself of a potential financier’s values, goals, and strategies before delivering a pitch will be more likely to secure financing for their project (all else being equal), than an entrepreneurial team that conducts no such research. Similarly, an entrepreneurial team that goes to great lengths to learn about the values, goals, and everyday concerns of potential customers will be more likely to detect relevant market problems than an entrepreneurial team which places less emphasis on such perspective- taking efforts—an informational advantage that should translate into improved venture ideation (Kier and McMullen 2018; McMullen 2010). The success of the Norwegian web series Skam, for example, has been attributed to a four-month preproduction period during which the series’s creators conducted about “50 in-depth 3-hour interviews and 200 school class ‘speed interviews’ with Norwegian 16-year-old girls and boys” to learn about their everyday concerns and dreams (Redvall 2018, 151).
To summarize, entrepreneurial teams that comprise members who value and engage in positive external dynamics will be more effective than entrepreneurial teams composed of members whotalent for understanding the states of others. It has been said of the philosopher and historian of ideas Isaiah Berlin, for example, that he had “the gift of self-identification with the outlook of holders of widely different, sometimes incompatible points of view—to a degree unique among philosophers.” (Magee 2009, 43). Similarly, the bestselling novelist James Patterson attributes his own success to a “golden gut—an ability to sense what’s going to appeal to a lot of people” (qtd. in Belsky 2010, 28).
Although people differ in their basic skills of empathy and social understanding (Mar, Oatley, and Peterson 2009), it is reasonable to assume that most entrepreneurs can make a deliberate effort to successfully place themselves in the shoes of potential stakeholders5 and that such social imaginative efforts can translate into distinct advantages, including, for example, improved communication with relevant parties outside the focal team and improved venture ideation (Kier and McMullen 2018; McMullen 2015; Nickerson 1999). For example, an entrepreneurial team that strives to inform itself of a potential financier’s values, goals, and strategies before delivering a pitch will be more likely to secure financing for their project (all else being equal), than an entrepreneurial team that conducts no such research. Similarly, an entrepreneurial team that goes to great lengths to learn about the values, goals, and everyday concerns of potential customers will be more likely to detect relevant market problems than an entrepreneurial team which places less emphasis on such perspective- taking efforts—an informational advantage that should translate into improved venture ideation (Kier and McMullen 2018; McMullen 2010). The success of the Norwegian web series Skam, for example, has been attributed to a four-month preproduction period during which the series’s creators conducted about “50 in-depth 3-hour interviews and 200 school class ‘speed interviews’ with Norwegian 16-year-old girls and boys” to learn about their everyday concerns and dreams (Redvall 2018, 151).
To summarize, entrepreneurial teams that comprise members who value and engage in positive external dynamics will be more effective than entrepreneurial teams composed of members who place less emphasis on engaging in positive external dynamics. Positive external dynamics are social and cognitive interactions between an entrepreneurial team and actors outside of the team (e.g., funders, suppliers, and customers) involving: 1) perspective taking, which helps ensure effective communication between the parties, and 2) a balancing of self- and other interest, which helps facilitate intersubjective agreement between the entrepreneurial team and external actors (McMullen 2010; Nickerson 1999; Galinski et al. 2008). Thus, this study’s first hypothesis is: positive external dynamics are associated with venture team effectiveness.
Positive Internal Dynamics
In explaining team effectiveness, positive external dynamics have been highlighted; however, the social interaction within the team is no less important (Lechler 2001). A key ingredient in Foss et al.’s (2008) original formulation of SATE is the “positive team dynamics” which enable team members to continually (re)combine their knowledge-based assets. Positive team dynamics, according to Foss et al. (2008, 84), “involves a healthy mix of debating, which stimulates members to think differently and consider new insights, as well as a shared sense of respect, support, and care for members.”
Foss et al. (2008) mainly stress the beneficial role that positive team dynamics play in enabling the team to imagine and create “a collective output that is creatively superior to individual output” (Foss et al. 2008, 73). However, teams that display positive internal dynamics are likely to enjoy a host of other advantages as well, including, for example, improved task coordination, fewer information processing failures, and increased action propensity (Leunbach, Erikson, and Rapp-Ricciardi 2019). Indeed, it is difficult to imagine how a shared sense of identity and purpose can be sustained in the team without mutually supportive interactions within it (see, also, Hambrick 2007).
The discussion above can be summarized in the following hypothesis: positive internal team dynamics will moderate the relationship between positive external team dynamics and the effectiveness of the venturing teams.
RESEARCH METHODS Research Design and Data Collection
This study is based on survey data collected between 2015 and 2018. The sample was collected in Norway from a population of all the high-tech start-ups satisfying the high-tech NACE categories. A criterion for selection was that the businesses had to fit two main NACE categories: “high-tech knowledge-intensive service” or “high-technology.” From an initial sample of around nine hundred firms, a total of 761 firms were contacted, and 149 firms completed the survey, generating a response rate of 20 percent. However, there is complete data for only 124 firms. The survey questionnaires targeted the CEOs of these firms.
Measurements
This study is based on carefully selected validated items from previous team studies. All measures, with the exception of firm age and team size, were collected using a seven-point scale.
Team Effectiveness
Although scholars have tried to develop overall measures of organizational financial performance for the field of entrepreneurship (Carton and Hofer 2007), there is still no agreement in the literature on what constitutes the best way to measure entrepreneurial team or venture performance (Blatt 2009; Foo 2011). From a subjectivist standpoint, poor team performance can be seen as an outcome that has fallen short of team members’ own goals for their collective activities—goals which are themselves highly idiosyncratic to the team and context dependent (see also Tiplic 2016). If we are committed to a subjectivist perspective, as Dempster (1999, 76) points out, then “we must realize that that we cannot, with certainty, identify either the goals of economic actors or even the means by which they perceive those goals may be met”(see, also, Garello 1996). Along such subjectivist lines, Penrose (1959) argued that management teams develop subjective images of the firm’s resource base and external environment through learning and that these images, in turn, shape the distinct “productive opportunity set” of the firm, i.e., “what the firm can see and take advantage of” (Foss 1998, 484).
In keeping with the Penrosian insight that each entrepreneurial team is unique in the productive possibilities that it collectively envisions and seeks to exploit (Bjornali et al. 2017; Foss et al. 2008; Miozzo and DiVito 2018), the dependent variable in this study reflects the lead entrepreneur’s subjective judgment of how well his or her team is doing. Specifically, the following six items from Pearce and Sims (2002) were used to measure team effectiveness: my team copes with change very well; my team changes behavior to meet the demands of the situation; my team is highly effective; my team faces new problems effectively; my team works on important problems; my team does very good work.
Respondents were asked to indicate their level of agreement with these statements on a scale ranging from “totally disagree” (1) to “totally agree” (7). The Cronbach’s alpha coefficient for this scale was .895.
Internal Team Dynamics
One way in which Foss et al.’s (2008) concept of positive team dynamics can be measured is by using the well-established construct of behavioral integration. Behavioral integration, which was originally introduced by Hambrick (1994) as a way of capturing the essence of “teamness” in top management teams, is a metaconstruct comprised of three key elements: the level of collaborative behavior in the team, the quality and frequency of information exchange between team members, and the degree of shared decision-making that takes place in the team (Mendenhall, Butler, and Ehar 2014).
The behavioral integration items used in this study are derived from Mooney, Holahan, and Amason (2007) and read as follows: team members are mutually responsible for decisions; team members have a clear understanding of the issues and needs of each member; team members help each other solve problems; team members share relevant information with each other; team members share resources with each other. The response options ranged from “totally disagree” (1) to “totally agree” (7). The Cronbach’s alpha coefficient for this scale was .911.
External Team Dynamics
Positive external dynamics were measured with the following six items from Walter, Auer and Ritter(2006): we analyze what we would like and desire to achieve with each partner; we match the use of resources (e.g., personnel, finances) to the individual relationship; we inform ourselves of our partners’ goals, potential, and strategies; we judge in advance which possible partners to talk to about building up relationships; we appoint coordinators who are responsible for the relationships with our partners; we discuss regularly with our partners how we can support each other in our success.
The response options ranged from “statement does not apply at all” (1) to “statement applies completely” (7). The Cronbach alpha for this construct was .831. This variable was also mean centered. Further, team size and firm age were controlled for.
RESULTS Table 1 shows the descriptive statistics of the main variables in this study. We can see from the table that the average size of the new venture team is 3.50 members (standard deviation of 1.67) and the average firm age is 10.31 years (standard deviation of 3.50). We can also read items’ reliability in parentheses. These variables will be elaborated on in subsequent sections. After the two focal variables were mean centered, the collinearity diagnostics showed acceptable scores (e.g., VIFs < 1.57).
The data set was analyzed with PROCESS macro scripts from Hayes (2013). The next table, table 2, shows the findings of the analysis. The initial column shows the control model. Model 1 shows that the overall relationship between external dynamics and the effectiveness of venturing teams is statistically significant (B = .183; p < .01). This means that external dynamics relate positively to the effectiveness of the venturing teams, as judged by the lead entrepreneur, in support of hypothesis 1.
From table 2, we also see that the moderator variable directly influences the effectiveness of the venturing teams (.450, p < .001). With respect to the interaction hypothesis, we find that internal team dynamics moderate the relationship between external team dynamics and the effectiveness of venturing teams (B = –.061; p < .1).
Balancing Type I and Type II errors, the traditional cutoff for interaction is at the .1 level (Aguinis et al. 2011). The interaction term is significant at the .1 level. As such, there is support for hypothesis 2 regarding interaction. That is, not only does the moderator variable directly influence the effectiveness of the venturing teams, but the variable also negatively moderates the relationship between external dynamics and the effectiveness of the venturing teams, which means that higher levels of internal team dynamics reduce the influence of external team dynamics. Figure 1 below visually shows how the interaction works. The figure illustrates that higher levels of external team dynamics relate to improved effectiveness and that this is especially true when the internal team dynamics are high.
DISCUSSION As noted in the introduction, in spite of commendable efforts by many scholars to articulate the potential relevance and value of subjectivism for the field of entrepreneurship, entrepreneurship researchers have generally refrained from adopting subjectivism as a framework for their empirical research. To address this state of affairs, this paper has endeavored to provide a useful example of subjectivism in action which hopefully can inspire other entrepreneurship scholars to consider subjectivism as a metatheoretical foundation for their empirical research.
Although subjectivism may seem of concern only to a small group of scholars interested in the philosophical foundations of entrepreneurship research, it should in fact concern anyone who cares about the practical relevance of the field of entrepreneurship. In a recent essay, for example, Dimo Dimov, Reiner Schaefer, and Joseph Pistrui (2020) warn that the field of entrepreneurship is in danger of becoming irrelevant to practicing entrepreneurs unless entrepreneurship scholars take more seriously “entrepreneurs’ first-person practical decision-making perspective” (p. 2). Similarly, James C. Hayton and Magdalena Cholakova (2012) argue that we cannot understand the emergence of entrepreneurial opportunities without examining “the microprocesses by which entrepreneurial ideas and intentions are represented and interpreted in the minds of those who develop them.” (p. 41). These arguments are in basic accord with subjectivism, and suggest that the field of entrepreneurship can benefit from a much closer dialogue with the Austrian tradition.To be clear, while we agree with Dimov et al.’s (2020) basic claim that the field of entrepreneurship can gain in practical relevance by taking more seriously the ‘subjective perspectives’ of the entrepreneurs that it studies, we do not think that subjectivism is immune from criticism. For example, because subjectivism is an epistemological framework that axiomatically presumes human agency, it leaves itself open to the critique that it underestimates the extent to which situational factors (Ross and Nisbett, 2011) and unconscious processes (Wilson, 2004) drive human choices and behavior.
In addition to highlighting the potential value of Austrian subjectivism for the field of entrepreneurship, this study presents empirical findings that should be of interest to both entrepreneurial team researchers and Austrian economists. Specifically, by clarifying and highlighting the important role that positive external team dynamics play in promoting team effectiveness, this study not only extends the subjectivist approach to team entrepreneurship as originally formulated by Foss et al. (2008), but it also adds empirical weight to Austrian arguments about the practical need for entrepreneurs to invest in what Hunter Hastings, Fernando D´Andrea, and Per Bylund (2019) call “market-making activities.” The concept of market-making activities still lacks a crisp definition, but it includes (for example) information-gathering attempts by entrepreneurs to understand customers’ “felt uneasiness” (Hastings, D’Andrea, and Bylund 2019, 7) for the purposes of framing and designing a solution which can help alleviate that uneasiness (see also Godley and Casson 2015).
As with all studies, however, there are also limitations that offer opportunities for further research. For example, the key informants approach used in this study rests on the assumption that there is considerable homogeneity in perceptions and interpretations within the entrepreneurial team. However, other members of the entrepreneurial team could potentially have rated their team differently, which would have led to different results. In the earliest stages of entrepreneurial team formation, for example, there is likely to be considerable heterogeneity of perceptions and interpretations among prospective team members. Although we are beginning to learn more about entrepreneurial team formation processes (for an overview of this literature, see Lazar et al. 2020), we still lack a clear understanding of how team members are able to negotiate and arrive at a shared understanding of their team’s overall means-ends framework. Indeed, research has tended to focus primarily on the practical challenge that entrepreneurs face in negotiating intersubjective agreement with external market participants, whose resource contributions may be needed in order for the venture to develop and grow (Clough et al. 2019; see also Dew, Velamuri, and Venkataraman 2004; Zander 2007). However, reaching intersubjective agreement within the initial founding team itself is no less important. To borrow a fitting phrase from Roger Scruton (2014, 33), “There has to be a firstperson plural, a ‘we,’” if team members are to stay together and remain excited about their ideas (see also, Higgins 2019). Future research could shed light on this important topic by observing entrepreneurial teams closely from their earliest inception. This could be achieved, for example, in an incubator or entrepreneurship education setting.
Contra Marx, Mises understood that human desires and needs are not determined merely by biology.
Original Article: "Why Marx Never Figured Out How to Distribute Goods in a Socialist Society".
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Download lectures slides at Mises.org/MU20_PPT_02.
Recorded at the Mises Institute in Auburn, Alabama, on 13 July 2020.
Download lecture slides at Mises.org/MU20_PPT_01.
Recorded at the Mises Institute in Auburn, Alabama, on 13 July 2020.
The true test of our commitment to personal liberty doesn't come when we permit others to engage in those peaceable, voluntary acts with which we agree. It comes when we permit others to engage in peaceable, voluntary acts we find offensive. Walter Block's Defending the Undefendable II contains thirty chapters defending behavior that is probably offensive to most Americans, and many that are downright illegal.
This book features a foreword by Ron Paul. Narrated by Patrick Smith.
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ABSTRACT: In this paper we try to wrestle with the triviality objection to the concept of the same good. If we define two resources as serving the same list of ends, then whether these items can be subsumed under the rubric of the “same good” revolves around how we conceive of ends. If ends are at least partly language-dependent, that is, the way of individuating ends depends on the level of generality with which we refer to them, then the notion of the same good seems trivial. In extreme cases, we can specify ends in such a manner that no two items would fall into the-same-good category. Or, we can construe ends so generally that all resources would be conceptualized as the same good for they would serve the same general ends; e.g., of benefitting their owners. After presenting the problem in detail, we study the implication of our construal of ends. We conclude by showing that the triviality objection cannot undermine Austrian subjectivism.
KEYWORDS: supply curve, homogeneity, heterogeneity, consumption, consumer theory JEL CLASSIFICATION: B53, D11 Igor Wysocki (igorwysocki82@wp.pl) is an independent scholar in Poland. Dr. Walter Block (wblock@loyno.edu) is Harold E. Wirth Eminent Scholar Endowed Chair and Professor of Economics at Loyola University–New Orleans.
The authors wish to thank a helpful referee, who greatly improved this paper. The usual caveat applies: all remaining errors and infelicities are our own responsibility.
Quarterly Journal of Austrian Economics 21, no. 4 (Winter 2018) full issue, click here.
I. INTRODUCTION: STATING THE PROBLEM The problem of the triviality objection has already been hinted at (Wysocki and Block, 2018), in which these authors suggest an improvement on Machaj’s (2007, p. 236) contention that: “We recognize some things as ‘supplies,’ because we realized they could serve the same end.” What Wysocki and Block offered instead was:
We claim that Machaj’s grain of analysis is too crude to capture the concept of the same good. For let us imagine that an economic actor is confronted with a car and a scooter. Obviously, the two serve some common ends. Yet, unless the actor is blinded to the non-overlapping ends both serve, he would falsely treat them as the same economic good. If an actor’s crudely described end is to travel from A to B without specifying either the velocity of the travel or the overall comfort thereof, can these two (with a huge stretch of imagination) be considered two units of the same good?
On the face of it, it appears to be a satisfactory rebuttal of Machaj’s position. The fact that two items satisfy the same end is insufficient to make them the same economic good for there can be other non-overlapping ends they can serve, which would effectively make them distinct economic goods. So far, so good. Yet, there is a crucial intervening factor that is easy to miss. For the question arises: how do we construe ends; or, more precisely, how do we individuate ends? What level of specificity should be involved in individuating them? The proper way of referring to ends is no trivial matter because we are going to arrive at different conclusions as to a list of ends depending on how specifically/generally they are described.We should bear in mind that ends, being mentally envisaged, are described in intensional terms. For instance, when we have a need to go to a cinema to see a film, what would satisfy this need is at least some set of action-tokens. It could be a film F1 in cinema C1 or film F2 in cinema C2 etc. Our ends are rarely if ever specific as to be satisfied by only one action token. This fact allows us for referring to ends in intensional, rather than extensional, terms, which, in turn, gives rise to our problem of ends being at least party language-dependent.
In Section II we attempt to sharpen the formulation of the problem. The burden of Section III is to study the implications of the framework of ends and choices we propose here. In Section IV we explain why the notion of supply must be relative to a given economic actor. We conclude in Section V.
II. SHARPENING THE FORMULATION OF THE PROBLEM Let us illustrate our above rather abstract considerations. To give the triviality objection as sharp a formulation as possible, we make these two claims:
1) we can pick such ways of referring to ends that would necessarily render all resources as the same economic good (the same supply) and,
2) alternatively, we can choose such ways of referring to ends that would necessarily render all resources as distinct economic goods.
Both outcomes seem highly unwelcome. The first would render the predicate “the same economic good” utterly useless, for this relation would be always instantiated between any two resources (objects) to which we can refer. Hence, the predicate “the same good” would be utterly uninformative and therefore useless. It would be impossible to think of at least one pair of objects such that the relation of “the same good” does not hold between them. There is a rule in logic to the effect that if there is no object that this predicate does not apply to, then the predicate is dispensable for it does not refer to any distinctive property. After all, ex hypothesi, all the objects share it.
The second, on the other hand, renders “the same economic good” a relation sui generis, something which closely resembles the relation of identity. It would follow that the relation of the same economic good would divide the universe of resources into non-overlapping one-item categories. There would not be any two distinct objects that could instantiate the relation of the same economic good. In other words, such a concept of the same good would render as many singletons as there are individual physical objects.There would be an indefinitely large number of these, but not an infinite one. This is because for Austrian economists, resources are discrete, not infinitesimally small. That is, strictly speaking, no supply curve, nor any on the demand side either, are smooth, and thus differentiatable or integrateable. For a praxeological criticism of mathematics in mainstream economics that would deny this contention, see Anderson (2001, 2002); Barnett (2003, 2004); Barnett and Block (2006, 2010); Bratland (2000); Bylund (2011); Callahan (2001); Cachanosky (1985, 1986); Hazlitt (1959); Herbener (1996); Hutt (1979); Jablecki (2007); Kirzner (1990); Leoni and Frola (1977); Levinovitz (2016); Menger (1973); Mises (1977, 1998 [1949]); Murphy (2008); Murphy, Wutscher and Block (2010); Pfleiderer (2014); Reekie (1984a, 1984b); Rizzo (1979b); Röpke (1956); Rothbard (1960, 1988, 1993, 1997b, 2011a, 2011b); Shostak (2002); Spadaro (1956); Syrios (2017); Wolfram (2002); Wutscher (2005). Then, the notion of supply would not make any sense at all. There would always be only one element in the supply of any good.
Let us now illustrate how ends should be specified to arrive at our two—equally unwelcome—outcomes. First, for everything to stand in relation of “the same economic good” to everything else (and to itself!), we must refer to ends in most general terms possible. One such example is “to satisfy a need” (Wysocki and Block, 2018). When we choose such a criterion for identifying ends, then, trivially, everything that counts as an economic good satisfies that criterion, for it consists of the satisfaction of a need that distinguishes economic goods from all other matter. In this extreme case, we would end up with a supply of one economic good. The point is, all economic goods necessarily satisfy a need, otherwise, they would not be found in this category.Logical positivists would dismiss this claim as a mere tautology. We claim, in contrast, that it is, instead, a synthetic a priori insight. For more on this see Block (1973, 1980, 1999), Batemarco (1985), Fox (1992), Hoppe (1989, 1991, 1992, 1995), Hülsmann (1999), Mises (1969, 1998 [1949]), Polleit (2008, 2011), Rizzo (1979b), Rothbard (1951, 1957, 1960, 1971, 1973, 1993, 1997a, 1997b, 1997c, 1997d), Selgin (1988), Wiśniewski (2014). Given such a level of specificity of ends to satisfy, cars, women, films and music would be economically indistinguishable.
Now let us turn to illustrating how we can end up with each economic good constituting a distinct one from all the others, which is a situation of economic goods being as numerous as resources. Here, the whole universe of economic goods ordered by the thus conceived relation of sameness would yield sui generis sets. Each would contain only one economic good. There would be no two goods that would be considered identical; e.g., as part of the same supply. It is not difficult to determine how to yield such an outcome. It is enough to describe an end so specific that only one resource can fit the description. For instance, let us consider an end such as “quenching thirst at a unique place,” with the location being specified in terms of Cartesian coordinates. Our entire supply would then be the universe of drinks at this precise spot.Assuming that there are non-drinks that we can economize under such circumstances, there must be some other criterion to single out other economic goods in this example. Yet, the point remains valid: with an end specified in such a manner, all the drinks are economically distinct. But now, alas, each of them constitutes a different economic good. In this situation, we cannot speak of a supply of drinks but rather of as many supplies of drinks as there are drinks (as understood as physical objects) and as many spots or places there are in the universe. What is more, equipped with such a finely-grained conceptual apparatus, we can finally do justice to Machaj’s (2007) intuition that a wedding ring on your fiancée’s finger is a distinct economic good from all the other wedding rings physically indistinguishable from that one. Now, we can render Machaj’s insight trivially true by calibrating the level of specificity/generality of an end that the rings are supposed to serve. To make the ring actually given to a fiancée economically distinct from all the other physically identical rings, the specification of an end should run along, more or less, these lines: “to derive satisfaction from an actual fact of receiving a gift from a loved one.”
With the distinction between potentiality and actuality, we can easily make any otherwise physically identical stack of items economically distinct. At the very least, such a stack would split into two distinct classes of economic goods, with one a mere singleton containing the ring actually given as a gift. That is, one class would be a singleton encompassing an actually given ring, while the other ones would include all the other physically identical wedding rings. The same would apply to any other type of item in question.Similarly, we can attain this end simply by resort merely to geographical space. No two things can occupy the same exact location. Therefore, all rings, or anything else for that matter, necessarily occupy different places in the universe. No matter how identical they may be in other regards, in this one they are different. Hence, each constitutes the supply of a separate good. An actually received book can (on this account) be considered a different economic good from its identical copies, or counterparts, etc.
As an aside, it is worth noticing that the actuality/potentiality distinction applied as a criterion to determine whether a heap of items are the same economic goods or not closely resemble the well-identified fact that that two goods are the same economic good cannot be by any means demonstrated in action (Wysocki and Block, 2018). Action is analogous here to actuality and prior-to-actual-choice situation is analogous to potentiality. It has been long recognized by BlockBlock (2009), Block and Barnett (2010). that there can be no indifference demonstrated in action.And so the fact that two resources are the same economic goods cannot by the same token be demonstrated via human action. Now, we can see which assumption lay behind Block’s contention: he believed (and made it explicit) that when we are confronted with a heap of physically identical items and we happen to pick up a particular one, the inference is that the one actually picked up immediately starts constituting a different economic good, distinct from the ones we did not choose. Seen in this light, it is no surprise that Block maintainedSee fn. 9, supra. that a bunch of identical dollar bills are the same economic goods before action, but then split into two classes of distinct economic goods once a particular dollar bill has been picked up; e.g., for the purpose of making payment. However, we can specify serviceability in such a manner that actuality (an actual choice) plays no role. For example, we would be inclined to say that this bunch of dollars are all the same economic good whether they were acted upon or not because we construe their serviceability only as a potential. That is, even if we choose a particular dollar, we can claim that equally well any other dollar could have been picked up and that is why they are economically on a par. This counterfactual statement cannot be demonstrated in action either, but the relation of sameness between economic goods does not yield itself to demonstration easily.
III. IMPLICATIONS OF SPECIFYING ECONOMIC GOODS IN TERMS OF DIFFERENTLY CONSTRUED ENDS THEY SERVE Since we established (or stipulated?) that whether two goods fall into the same-good category depends on at what level of generality we specify the ends they respectively serve, we are now ready to carry on with our agenda and study the implications of our concept of supply and hence the supply curve.
First of all, we posit that whether two items represent the same economic good always depends on how a given economic actor envisages his ends. This, in turn, implies that there can be no inter-subjectively correct answer to the question of whether two physical goods can be subsumed under the category of the same good. For the answer thereto is always contingent upon the way of referring to an actor’s ends. Or, in other words, the decisive factor is the way an actor mentally frames his choices. For instance, consider a person who envisages his choices (in intensional mental terms) as (in the descending value scale):
-
Going to a cinema with a woman
-
Playing football with friends
-
…
Taking this description seriously, we must conclude that (prior to taking any real action), any ordered pair (a, b), where a stands for cinemas and b stands for the companionship of women, would do equally well. That is, as envisaged, there would be no real choiceAt least as believed by this actor. Equivalently, we might say that the actor believes that any cinema is as good as any other and the same applies to the companionship of women. Technically speaking, all available cinemas would constitute the same economic good and all female companionship also fall into one and the same class of economic goods—though that class is obviously distinct from a class of the cinemas mentioned earlier. between cinemas and neither would there be between accompanying women as the use of an indefinite article suggests. After all, an economic actor frames his most important end as going to a cinema with a woman. This implies that it is any cinema and any woman in combination that would allow this economic actor to achieve his end. Economically speaking, all female companionship falls into the same class (they constitute one and the same supply for this actor) and the same applies to available cinemas.There can be an interesting objection raised against us; that is how we do know that in our scenario female companionship and cinemas constitute distinct economic goods? After all, both female companionship and cinemas contribute to the satisfaction of this end and our very criterion of distinguishing between different economic goods is by consulting which ends (given by intensional descriptions) a given means can satisfy. Now, if it were the case that the only end a cinema can satisfy is to go with a woman thereto and the only end female companionship can satisfy is go to a cinema so accompanied, we would apparently be at a loss. For it would then be the case that the ends served by the two would be co-extensive and therefore equivalent. In the absence of cinemas, female companionship would cease to be an economic good; whereas in the absence of female companionship, cinemas would lose their economic character; nay, they would even lose the character of a good—they would then be useless. Our reply is two-fold. First of all, even if co-extensive, these two economic goods would be accounted for by different descriptions: cinemas would still serve as a place to take a woman, while female companionship would serve to go to a cinema so accompanied. Even if services are co-extensive (if female companionship is an economic good, you take the woman to a cinema; and when a cinema is an economic good, you go there with female companionship), these two rather constitute perfectly complementary goods. Second, and less philosophically, our economic actor could easily envisage some ends female companionship can satisfy outside cinemas, which would conclusively render cinemas and female companionship economically distinct. What is more, any pair instantiating the generically described action of going to a cinema with a woman would be preferred to any action-token exemplifying playing football with friends.
However, undeniably, the choice specification may be subtler. To that effect, consider what follows:
- Going to cinema C with a woman
…
Now, no other cinema than C would do equally well although the actor still considers the companionship of all available women as constituting the same economic good. Now, any ordered pair (C, b), where C is a proper name of that given cinema, and b again ranges over some universe of available women would be, from the point of view of the actor in question, as good as any other, which implies that all available female companionship falls into the category of the same economic good.
Finally, an end may be specified as specifically as possible, e.g.
- Going to cinema C with a woman W, traveling along the road R
Now, any means contributing to that end are necessarily heterogeneous; that is, it is only cinema C, woman W and road R that will do. No other alternatives are equally good. It follows that cinema C is economically distinct from any other cinemas available, and the same point holds for women and roads. Summarizing, whether any given pair of goods are in the same supply depends on how a given economic actor frames his ends. A pair of items would thus constitute the same economic good relative to one way of describing ends but not from the other.
IV. WHY THE NOTION OF SUPPLY MUST BE RELATIVE TO A GIVEN ECONOMIC ACTOR First, it must be noted that since we construe of the same economic good as encompassing the items that are believed by an economic actor to serve the same ends (goals being framed by that actor himself), physical sameness does not readily translate into economic identity (see: Machaj’s example of a wedding ring). What is more, belonging to the category of the same economic good could be imputed by an actor on items of different physical constitution since he might find them equally serviceable with respect to some end, as specified by him. In other words, there are no implications at work here: physical and economic sameness are not synonyms.
The correct inference from the above consideration is that a notion of a supply cannot be constructed along the lines of physical sameness. It is simply not necessarily the case that a stack of physically identical items would always constitute one and the same supply. Let us consider persons A and B and their respective, mentally framed, ends. A’s end is to travel from C to D (at any velocity, under any circumstances); whereas B’s goal is to depart from C and arrive at D with a velocity ranging from 80–100 mph. Certainly, different items would satisfy these respective ends. A would find all vehicles equally serviceable; whereas B would make some finer distinctions; that is, a car would do for him but not a bike or a plane for that matter. Since for these two persons, the items falling under the category of the same economic good would differ, we cannot stack those clearly distinct supplies on a two-person scale, let alone draw up a supply curve taking into account the both of them. What is worse, one man’s meat is another man’s poison. It can turn out to be the case that an item which is an economic good for A constitutes an economic bad for B or vice versa, which would again preclude the derivation of any social notion of the supply. Therefore, given that, it seems that our two extremes alluded to in the introductory section can be exemplified. There can be an individual for whom all goods would be perfectly heterogeneous, while there can be another one for whom everything is economically the same.
If we are to escape from the Scylla of only one good, and the Charybdis of an indefinitely large number of them, we must resort to Austrian subjectivism.States Hayek (1979, p. 52): “And it is probably no exaggeration to say that every important advance in economic theory during the last hundred years was a further step in the consistent application of subjectivism.” Also, see the following on this issue: Barnett (1989), Block (1988), Buchanan and Thirlby (1981), Buchanan (1969, 1979), Butos and Koppl (1997), Cordato (1989), DiLorenzo (1990), Garrison (1985), Gunning (1990), Kirzner (1986), Mises (1998 [1949]), Rizzo (1979a, 1980), Rothbard (1979, 1997), Stringham (2008). That is to say, for some people, cars, female companionship, films and music are the same good. For others, for most of us, this is just plain silly. Thus, there is no one right way to determine the supply of a good. It varies from person to person, and, for each individual, it varies over time, as tastes change.
Precisely the same dilemma confronts advocates of antitrust lawsuits under neoclassical monopoly theory. The plaintiffWhether a private party or the government. wants to define the industry as narrowly as possible, so that the concentration ratio can be maximized. For him, the desiderata are not all food, nor all breakfast food, nor all cereal, nor, even, all dry cereal. In his view, even further industrial considerations must be employed, for example, whether the product includes sugar, or raisins, or anything else he can think of to raise the concentration ratio. In sharp contrast, the defendant desires as wide as possible a definition, so that the concentration ratio vanishes into thin air. For this side of the lawsuit, cars, female companionship, films and music will do just fine, and, even better if ski vacations, violins, bananas, shoe laces, etc., are tossed into the mix as well. So, who is correct? The plaintiff or defendant? The response emanating from the subjectivist economist is, don’t be silly. Any answer will necessarily be arbitrary. And yes, as the entire antitrust philosophy requires a coherent response to this challenge, it, too, must be jettisoned.For an Austrian critique of this legislation see Anderson, et. al. (2001), Armentano (1972, 1982, 1989, 1999), Armstrong (1982), Barnett, et al. (2005, 2007), Block (1977, 1982, 1994), Block and Barnett (2009), Boudreaux and DiLorenzo (1992), Costea (2003), DiLorenzo (1996), DiLorenzo and High (1988), Henderson (2013), High (1984–1985), Hull (2005), McChesney (1991), McGee (1958), Rothbard (2004), Shughart (1987), Smith (1983), Tucker (1998a, 1998b).
V. CONCLUSION Does the triviality objection pose any problems for Austrian subjectivism?
We contend that the answer to the above question is ‘not at all.’ Quite the reverse, once we construe the same economic good as this class of items that are perceived as serving the same ends, these being specified intensionally, we predict that there can be such economic actors for whom perfect economic homogeneity or perfect heterogeneity of goods will hold.Neither is likely, but it does not constitute a logical contradiction to posit it exists. In fact, Austrians believe that any human action demonstrates heterogeneity of goods even if they are physically indistinguishable.
Finally, perfect heterogeneity and perfect homogeneity must be a part and parcel of Austrian subjectivism. Certainly, since economic actors usually exhibit some finer discriminatory abilities (they frame ends more specifically), these two extremes are expected to be rarely instantiated.To reiterate, heterogeneity is ubiquitous—any human action evidences it. After all, the claim that two items are the same economic good cannot be demonstrated in action. But two means can constitute the same economic good if they are believed to be equally serviceable with respect to some end/ends.
ABSTRACT: In the division of labor, economizing valuations require an appraisement of the structure of market prices of goods beforehand. Yet, investment decisions concerning the purchase of an entire business enterprise, for example, necessitate considerations beyond appraisement. An economizing valuation of businesses must be based upon both appraisement and a genuine investment appraisal which provides the valuing person with the marginal price he can barely accept. However, even though the computation of this marginal price is a necessary step towards an economizing investment decision, it is still not sufficient. In case of a company purchase, the price to be paid is unknown beforehand. Therefore, an economizing valuation of firms not only requires both appraisement and investment appraisal but also a negotiation of the final price to be paid. Because the corresponding negotiation process must be characterized as a terra incognita in Austrian economics, this paper investigates in depth the negotiation between the involved parties as the final step towards their economizing valuations and discusses purposive negotiation tactics.
KEYWORDS: value of the firm, investment appraisal, negotiation, value theory, subjectivism, purpose-orientation, Austrian school, neoclassicism JEL CLASSIFICATION: B53, C78, G32, G34 Florian Follert, M.Sc. (follert@iwp.uni-saarland.de) is a Research Associate and doctoral student with the Institute of Auditing at Saarland University, Germany. Dr. Jeffrey Herbener (jmherbener@gcc.edu) is Chairman of the Department of Economics and Sociology at Grove City College and a Senior Fellow at the Mises Institute. Dr. Michael Olbrich (olbrich@iwp.uni-saarland.de) is Professor of business economics and Director of the Institute of Auditing at Saarland University. Dr. David J. Rapp (rapp@iwp.uni-saarland.de) is an Assistant Professor with the Institute of Auditing and a regularly recurring Visiting Professor at Grove City College.
The authors wish to thank conference participants of the 2017 Austrian Economics Research Conference at the Mises Institute and two anonymous referees for constructive and helpful suggestions.
Quarterly Journal of Austrian Economics 21, no. 4 (Winter 2018) full issue, click here.
- INTRODUCTION In an autistic economy, valuation alone is a sufficient condition for economizing decisions (Mises, 1998 [1949], p. 329). In the market economy, however, things look different. In the division of labor, valuation needs to be based upon appraisement to result in economizing decisions (Mises, 1998 [1949], p. 329). While this insight holds true for each and every good to be valued, in the case of financial investment decisions, and particularly concerning the purchase of an entire business enterprise or a substantial share package, acting man’s final valuation must be based upon both appraisement and investment appraisal (Herbener and Rapp, 2016, pp. 10–11). Moreover, contrary to the typical purchase of a consumer good, the asking price of a business enterprise is unknown beforehand. In cases of particular investment decisions, therefore, valuing persons need to engage in a negotiation about the price to be paid (Matschke, Brösel, and Matschke, 2010, p. 6). Apart from appraisement and investment appraisal, this negotiation is the last condition necessary for this person’s final valuation. To date, the Austrian-informed literature lacks a comprehensive analysis of such negotiation process. This paper aims to fill this gap by thoroughly investigating what role negotiation plays for the valuation of, in particular, a business enterprise and how it can be operationalized purposefully.
In order to do so, the paper is structured as follows: In section 2, we will illustrate the requirements for economizing decisions in different economic settings and for different goods. Section 3 will serve to review the status quo of Austrian theorizing on the issue of negotiating in isolated exchanges, to analyze the negotiation process in depth, to illustrate its relevance for valuation, and to discuss tactics for successful negotiations. Finally, section 4 will present the main conclusions which can be drawn from our analysis.
- VALUATION, APPRAISEMENT, AND INVESTMENT APPRAISAL Value is neither intrinsic nor objective in any sense; rather, valuation is an individual act of comparing and, eventually, ranking alternative courses of action in aiming at particular ends, which is necessarily subjective in nature (Menger, 2007, pp. 120–121). Valuation is reflected in a value scale which varies both from one person to another and—for the very same acting human—as time goes by (e.g., Hering, Toll, and Kirilova, 2015a, p. 24; Olbrich, Quill, and Rapp, 2015, p. 20; Rapp, Olbrich, and Venitz, 2017, p. 16), and is demonstrated through action (Mises, 1998 [1949], p. 95). As a consequence of these facts, Mises (1990, p. 56) rightly rejects the very idea of intrinsic value as “the naive conception of the layman.”On the flaws and fallacies inherent in the investment strategy “value investing”, which claims and is built upon the existence of intrinsic value, see Rapp, Olbrich, and Venitz (2017) as well as Rapp, Olbrich, and Venitz (2018).
Mises (1998 [1949], p. 233) emphasizes that
[i]n order to conceive the market fully one is forced to study the action of hypothetical isolated individuals [...] [and in] studying interpersonal exchange one cannot avoid dealing with autistic exchange.
Mises (1998 [1949], p. 195) defines an autistic exchange as an “action [...] performed by an individual without any reference to cooperation with other individuals.”
In an autistic economy, then, economizing decisions are solely made through valuations without further ado, in particular without reference to money prices (e.g., Herbener and Rapp, 2016, p. 7). For example, if Robinson Crusoe had two options to choose from, say, to spend his time either (1) going fishing or (2) collecting berries to satisfy his hunger, he will make an economizing decision solely through preferring either (1) fishing to berry picking or (2) berry picking to fishing based upon his personal preferences.
In juxtaposing an autistic economy with society, Mises (1998 [1949], p. 195) asserts:
Within society cooperation substitutes interpersonal or social exchange for autistic exchanges. Man gives to other men in order to receive from them. Mutuality emerges. Man serves in order to be served.
The exchange relation is the fundamental social relation. Interpersonal exchange of goods and services weaves the bond which unites men into society. The societal formula is: do ut des.
Necessarily, interpersonal exchange both requires and reveals exchange ratios for the goods and services subject to market transactions. In a monetary market economy allowing for indirect exchange through the application of a generally accepted medium of exchange, these ratios become evident in market-clearing money prices (Mises 1998 [1949], pp. 206, 218, 287, 324). While valuation is a prerequisite for economizing decisions in the division of labor too, it is not by itself sufficient. Rather, it must be supplemented by appraisement, which aims at the anticipation of the structure of such market prices or—in other words—at the assessment of the purchasing power of the money concerned (Mises 1998 [1949],p. 329). To rank order in value a particular amount of money, say $1, against a particular good, say an apple, a consumer must know the alternative uses of the dollar, say the purchase of two oranges. Consequently, for decisions in the division of labor to be economizing they must not be based on valuation only; rather, valuation must be well-grounded on appraisement.
While combining both appraisement and valuation usually allows for economizing decisions of consumer goods, there are financial investments, in particular those concerning entire business enterprises, which require additional considerations (for this entire paragraph see Herbener and Rapp, 2016). In buying consumer goods, acting man aims at non-financial ends, for example, to satisfy hunger. A person can directly evaluate in his mind the contribution of a particular consumer good to reaching such ends. In contrast, financial investments are mostly undertaken to fulfill financial ends. How the possession of a firm, for example, contributes to reaching such ends cannot simply be assessed at first glance, that is, directly by one’s mind without economic calculation. In this respect, Menger (2007, p. 255) emphasizes that the “value [of factories] can be determined only after a careful investigation of all the relevant circumstances.” Therefore, acting man needs to apply a particular tool of economic calculation as a decision method, which allows him to evaluate the degree to which the firm contributes to reaching his (financial) ends. Specifically, this tool is to be found in a genuine investment appraisal.Note that the application of investment appraisal to compute the present value of the expected financial benefits of a particular course of action does not prohibit valuing man from complementing this financial analysis with considerations outside of the mere financial sphere. For the role of non-financial aspects in investment decisions and their impact on valuation, see Herbener and Rapp (2016, p. 11). Its purpose is to provide the decision maker with the most important financial piece of information he needs for his economizing decision: the marginal price he can barely accept in a transaction without suffering an economic loss (fundamentally Matschke, 1975; further, e.g., Hering, 2014, pp. 5–6). This marginal price is highly individual data, determined by the (financial) ends a person aims at and the (financial) means available to him in reaching those ends. Following investment theory, which is rooted in early Austrian economics (Schmalenbach, 1919, p. 334; Schmalenbach, 1937, p. 27; Hering, 2014, pp. 27–28; Olbrich, Quill, and Rapp, 2015; Herbener and Rapp, 2016, pp. 12–13), it equals the present value of the individually predicted future earnings, discounted with the correct individual discount rate, that is, the internal rate of return of the best alternative use of funds which is derived from the person’s consumption preference.In this respect, Herbener (2011, p. 14) notes: “As a temporal being, man distinguishes between sooner and later. He can, therefore, judge the value of attaining an end sooner differently than attaining it later. Just as the principle of preference is implied by man’s finitude, time preference is implied by his temporality.” In reflecting the present value of expected future earnings from a particular person’s perspective, the marginal price manifests the contribution a firm, for example, is expected to make in reaching particular ends and, therefore, allows for an economizing ranking against the asking price.
However, in contrast to the regular purchase of a consumer good, for example, an apple in a grocery store, in cases of the acquisition or sale of a firm, the asking price is unknown beforehand. Consequently, a person cannot establish his final value scale beforehand. Therefore, to rank the business concerned against a certain amount of money and, eventually, to act accordingly requires a negotiation about that price beforehand.
- NEGOTIATION AND ITS RELEVANCE FOR VALUATION 3.1 Catallactics and the Status Quo of Austrian Theorizing
Whately (1831, p. 6)—objecting to the formerly established term “political economy”—originally introduced the term “catallactics” to frame the sphere of economics and defined it as the “Science of Exchanges.”Rothbard (1951, p. 946) similarly defines catallactics as “The Theory of Voluntary Interpersonal Exchange.” Following Whately’s (1831, p. 6) definition of man as “[a]n animal that makes exchanges,” catallactics, then, ultimately deals with exchanges conducted by acting man in the marketplace. As Mises (1998 [1949], p. 233) describes it:
[T]he task of this branch of knowledge [is] to investigate the market phenomena, that is, the determination of the mutual exchange ratios of the goods and services negotiated on markets, their origin in human action and their effects upon later action.
It was Mises who revived the term “catallactics” (Rowley, 1994, p. 289) integrating it into his broader analysis of human action, that is, praxeology (Mises, 1998 [1949], p. 233). Mises (1998 [1949], p. 3) concludes:
The economic or catallactic problems are embedded in a more general science, and can no longer be severed from this connection. No treatment of economic problems proper can avoid starting from acts of choice; economics becomes a part, although the hitherto best elaborated part, of a more universal science, praxeology.
Ever since Carl Menger’s (1871) fundamental work, Austrian economists have approached market phenomena progressively by distinguishing various forms of interpersonal exchange, based on the structure of both the supply side and the demand side of markets. Apparently, the simplest case of interpersonal exchange one can imagine consists of one particular seller and one particular purchaser only and, thus, has been labeled “isolated exchange” (Menger, 1871, p. 179 [2007, p. 197]). The investigation of such isolated exchange has been used frequently as a starting point to gain deeper understanding of market transactions in more complex circumstances (e.g., Menger 1871, pp. 175–212; Mises, 1998 [1949], p. 324; Rothbard, 2001, pp. 106–126). However, Austrian economists characterize isolated exchanges as rather rare and occasional while mainly occurring at early stages of the emergence of civilization. For instance, Menger (2007, p. 197) notes:
This case, which could be termed isolated exchange, is the most common form of human trade in the early stages of the development of civilization. Its importance has survived to later times in sparsely populated backward regions and it is not completely absent even under advanced economic conditions, since it can be observed in highly developed economies wherever an exchange of goods that have value only to two economizing individuals takes place, or where other special circumstances economically isolate two persons.
Mises (1998 [1949], p. 324) describes such isolated exchange as “an occasional act of barter in which men who ordinarily do not resort to trading with other people exchange goods ordinarily not negotiated.”
However, even in highly developed economies, such as our own, isolated exchanges turn out to be much more than merely occasional acts. Most of the firms or larger share packages being bought and sold in the market are subject to situations, in which there is neither competition on the demand side nor on the supply side; the latter being impossible anyway due to the uniqueness of the asset concerned, at least as long as the potential exchange concerns a share package exceeding 50 percent of a company’s stocks. Therefore, the Austrian investigation of isolated exchange matches the circumstances in which most presumptive sellers and presumptive purchasers of a business enterprise find themselves. In consequence, it seems worthwhile to review the status quo of Austrian theorizing on the catallactics of isolated exchanges in order to ascertain which fundamental insights can be drawn from previous analyses for the assessment of the role of negotiations for the valuation of firms.
In a monetary market economy, “objective prices [...] are reflections of subjective values” (Ritenour, 2016, p. 21). Mises (1998 [1949], p. 324) explicates, prices
are determined between extremely narrow margins: the valuations on the one hand of the marginal buyer and those of the marginal offerer who abstains from selling, and the valuations on the other hand of the marginal seller and those of the marginal potential buyer who abstains from buying.
Due to the lack of competition on both the supply side and the demand side within isolated exchanges, however, “the ratio of exchange is determined only within broad margins” (Mises, 1998 [1949], p. 324). These margins result from the individual marginal prices of both the presumptive seller and the presumptive purchaser (e.g., Olbrich, Quill, and Rapp, 2015, p. 31). Austrian economists have concluded that catallactic analysis proper cannot say with certainty what the final price involved parties eventually agree upon will look like (Mises, 1998 [1949], p. 324; Rothbard, 2001, p. 109); one thing catallactics can tell us, though, is that if the exchange is finally conducted, the given margin must have allowed for a mutually beneficial agreement, and that the final price is established somewhere within that margin. For instance, Menger (1871, p. 177 [2007, p. 195]) concludes:
Hence, whatever the price that is finally established for 40 units of wine in an economic exchange between A and B, this much is certain, that it must be formed between the limits of 80 [the seller’s minimum price in this example] and 100 [the buyers maximum price in this example] units of grain, above 80 and below 100 units.
Böhm-Bawerk (1930, p. 199) forms the following general proposition:
In isolated exchange—exchange between one buyer and one seller—the price is determined somewhere between the subjective valuation of the commodity by the buyer as upper limit, and the subjective valuation by the seller as lower limit.
Accordingly, Mises (1998 [1949], p. 324) underscores that
[c]atallactics, the theory of exchange ratios and prices, cannot determine at what point within these margins the concrete ratio will be established. All that it can assert with regard to such exchanges is that they can be effected only if each party values what he receives more highly than what he gives away.
Similarly, Rothbard (2001, p. 109) emphasizes that
[a]ll analysis can say about this problem is that, since the exchange must be for the mutual benefit of both parties, the price of the good in isolated exchange will be established somewhere between the maximum buying price and the minimum selling price [...] We cannot predict the point that the two will agree on, except that it will be somewhere in this range set by the two points.
While any sound attempt to deduce a generally applicable law of how the price eventually established will look like in isolated exchange is doomed to failure,We classify the attempts to formulate a general bargaining theory as unsound for such “bargaining theory [is] rarely applicable in the real world” (Rothbard, 2011, p. 365). Austrian economists have at least named potential determinants of that price. Particularly, they have pointed to the fact that the opposing parties will engage in a process of negotiating about the final price (Menger, 1871, p. 177 [2007, p. 195]; Gross, 1884, pp. 46–47; Schullern-Schrattenhofen, 1889, p. 31; Böhm-Bawerk, 1930, pp. 198–199; Rothbard, 2001, p. 109) which will be influenced by both the negotiators’ abilities (e.g., Endres, 1995, p. 4) and their position within the negotiation (e.g., Gross, 1884, p. 131).With reference to Hermann (1874) and Schäffle (1873), Gross (1884, p. 131) argues that “whether or not the price will approximate the minimum or maximum limit, apparently depends on the position the entrepreneur has within the price duel, whether his position is superior to his counterparty’s one or not” (authors’ translation). For example, Menger (1871, p. 177 [2007, p. 195]) while coining the term “Preiskampf”This term has been frequently used by Menger’s disciples Gross (1884) and Schullern-Schrattenhofen (1889), see Streissler (1972, p. 437, footnote 54). For more recent applications see, for example, Spitznagel (2013, p. 22). (“price duel”; “price conflict”; “price war”) states that
it appears equally certain to me that the outcome of the exchange will prove sometimes more favorable to one and sometimes more favorable to the other of the two bargainers, depending upon their various individualities and upon their greater or smaller knowledge of business life and, in each case, of the situation of the other bargainer.
Similarly, Rothbard (2001, p. 109) analyzes that the finally established price “depends on the data of each particular case, on the specific conditions prevailing. In particular, it will depend upon the bargaining skill of the two individuals.”
Moreover, Böhm-Bawerk (1930, p. 199) explicates with more detail:
According as in the conduct of the transaction the buyer or the seller shows the greater dexterity, cunning, obstinacy, power of persuasion, or such-like, will the price be forced either to its lower or to its upper limit.
Rothbard (2001, p. 363) notes that “[l]ittle of value has been said about bargaining since Böhm-Bawerk” (footnote 27) and that “[e]conomists have always been very unhappy about bargaining situations of this kind, since economic analysis is estopped from saying anything more of note.”
Unlike economists in the tradition of Menger, Böhm-Bawerk, Mises, and Rothbard, however, neoclassical economists have attempted to overcome this barrier to economic analysis by formalizing the bargaining process. This development has been a natural extension of their formal-modeling approach to explaining human behavior. To construct a mathematically tractable model of human action, neoclassical economists assume economic agents, instead of human persons, whose simulated behavior is determined by stipulated underlying conditions, namely, the agent’s utility function and objective circumstances whose value in an agent’s behavior is determined by its utility function. Neoclassical economists have modeled every functional type of human action as optimization under constraint: consumption, production, and exchange. Price setting eluded formalization, however, until the advent of game theory after the Second World War. Before that time, neoclassical economists typically assumed the existence of an auctioneer compiling bids and offers made by all buyers and sellers in a market, then computing the equilibrium price, and finally announcing the price after which all trades would be made.See Hahn (2008) for an overview of the Walrasian auctioneer in general equilibrium theory and Negishi (2008) on advancements beyond tâtonnement as a process of price setting in neoclassical economics. Since the early 1950s, neoclassical economists have developed game-theoretic models of bargaining.See Serrano (2008) for an overview of game-theoretic bargaining.
As Rothbard notes in the quote above, economists in the tradition of Mises have considered bargaining an entrepreneurial activity not subject to economic-theoretical laws.The quote (Rothbard, 2001, p. 363) was originally published in 1962, before the game-theoretic treatment of bargaining gained ascendency in neoclassical literature. Such laws describe the universal, cause-and-effect structure of human action. Under adequately competitive conditions, for example, the level of the price of a good is completely determined by the preferences of buyers and sellers, which in turn are subject to the laws of utility. The preferences of the marginal traders are so near to each other that no bargaining range exists. Any seller can always sell to the marginal buyer if any buyer attempts to negotiate for a lower price. And any buyer can always buy from the marginal seller if any seller attempts to negotiate for a higher price. If a market is inadequately competitive, then a bargaining range will exist and the level of price will be determined, not solely by the laws of utility which are universal principles of human action, but by the particular conditions of person, place, and time in which bargaining takes place as noted above in isolated exchange, the extreme case of an inadequately competitive market.
Although it is indeed true that catallactics has no means to completely determine the actual final price in any isolated exchange, additional theoretical insights can be discovered about isolated exchange in cases of investment appraisal in contrast to cases of valuation (and appraisement) alone. The following two sub-sections are devoted to a praxeological investigation of the negotiation process between a presumptive seller and a presumptive purchaser in the special case of an entire business enterprise.
3.2 Negotiation Process and Possible Scenarios
The negotiation about the purchase/sale of a firm, basically, consists of price offers executed by the involved parties, either directly or indirectly through the proposal of an appraisal method or corresponding data (Matschke and Brösel, 2013, pp. 615–616). Every potential price offered by one of the parties is the outcome of that party’s valuation. Through the action of proposing a certain price, that party demonstrates its particular value scale, that is, how it has ranked the business concerned against the suggested price. Inversely, to the opposing party, the offered price serves as an input variable for its valuation. The opposing party compares the quoted price to its marginal price and, eventually, ranks the offered price against the business enterprise in question. Therefore, the negotiation process must be interpreted as a series of repetitive valuations reflected in the proposal, acceptance, or rejection of price offers, both from the presumptive buyer’s and the presumptive seller’s perspective.
In the potential transaction of an entire business enterprise, basically, we can distinguish three scenarios:
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The presumptive seller’s marginal, that is, barely acceptable price exceeds the presumptive purchaser’s marginal price; in other words, the presumptive seller needs to earn more than the presumptive purchaser is willing to pay.
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The presumptive purchaser’s marginal price is identical to the presumptive seller’s barely acceptable price; in other words, the presumptive buyer may at most pay what the presumptive seller at least needs to earn.
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The presumptive purchaser’s marginal price is greater than the presumptive seller’s barely acceptable price; in other words, the presumptive buyer can be willing to pay more than the presumptive seller needs to earn.
In scenario 1, no potential area of agreement exists, since the presumptive seller needs to earn more than the presumptive purchaser may pay:
Figure 1: Presumptive Seller’s Marginal Price > Presumptive Buyer’s Marginal Price
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Rothbard (2001, pp. 107–108) illustrates this scenario using two opposing parties’ value scales as follows:
Smith would be willing to acquire a horse from Johnson if he could give up 100 barrels of fish or less. One hundred barrels or less are less valuable to Smith than the horse. On the other hand, 101 or more barrels of fish are more valuable to him than the horse. Thus, if the price of the horse in terms of the fish offered by Smith is 100 barrels or less, then Smith will make the exchange. If the price is 101 barrels or more, then the exchange will not be made [...] Johnson will not give up his horse for less than 102 barrels of fish. If the price offered for his horse is less than 102 barrels of fish, he will not make the exchange. Here, it is clear that no exchange will be made; for at Johnson’s minimum selling price of 102 barrels of fish, it is more beneficial for Smith to keep the fish than to acquire the horse.
In this scenario, consequently, the negotiation process will be rather short, since there is no price both parties will accept voluntarily which they will realize fairly quick. In any case, one party will value the status quo higher than the transaction, which will be reflected in the rejection of the deal.
Contrary to scenario 1, in scenario 2 a potential area of agreement exists, since the presumptive purchaser may offer a price which is also acceptable to the presumptive seller:
Figure 2: Presumptive Seller’s Marginal Price = Presumptive Buyer’s Marginal Price
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If both the presumptive purchaser’s and the presumptive seller’s marginal prices equate to one another, however, the only price acceptable to both parties equals their common marginal price. Rothbard (2001, p. 109, footnote 23) discusses the same scenario and eventually concludes: “Thus, if Smith’s maximum buying price is 87, and Johnson’s minimum selling price is 87, the price will be uniquely determined at 87.”
Given the identical marginal prices, however, while both parties would not suffer engaging in the transaction which might indeed lead them to conduct it at their shared marginal price, neither can the presumptive purchaser benefit from the transaction by paying less than the business is worth to him nor can the presumptive seller benefit earning more than the business is worth to him respectively (e.g., Menger, 2007, p. 185). Consequently, as both parties cannot improve their state of affairs by means of the transaction, they might—as their equally valuable action alternative—simply abstain from undertaking it, that is, no price at all might be established. The fact that conducting the exchange does not make any of the involved parties better off, leads Menger (2007, p. 185, footnote 5) to classify “indifferent exchanges such as this as definitely non-economic since in them the provident activity of men is set in motion aimlessly quite apart from all the economic sacrifices they may entail.”
Hence, the process of negotiating between the involved parties might again be rather short, since none of them has an incentive to actually conduct the transaction. Either of the parties’ valuations will most likely become evident in the rejection of the deal eventually. Rothbard (2001, p. 108), thus, concludes that “[i]n order for an exchange to be made, then, the minimum selling price of the seller must be lower than the maximum buying price of the buyer for that good” since, as Menger (2007, p. 194) points out, “[both buyer and seller] will agree to an exchange only if it enables [...] [them] to make better provision for [...] [their] needs than would be possible without the exchange.”
Similarly, Böhm-Bawerk (1930, p. 193) argues that
[exchanges] are not made simply for amusement. People who take the—not always trifling—trouble to exchange the goods which they possess for other goods, do so for a rational and material end, and, in nine hundred and ninety-nine cases out of a thousand, this end is to better their economical condition by the exchange.
Unlike scenario 2, scenario 3 allows for more than one particular solution to the Preiskampf. The potential area of agreement is established because the purchaser’s barely acceptable price exceeds the seller’s minimum selling price:
Figure 3: Presumptive Seller’s Marginal Price < Presumptive Buyer’s Marginal Price
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Any price offer within the range between the marginal prices serves as a potential final price, since each of them is mutually beneficial (e.g., Matschke, Brösel, and Matschke, 2010, p. 10). In discussing the same scenario, Böhm-Bawerk (1930, p. 198), therefore, appropriately claims that “it is certain that there will be an exchange; in the assumed circumstances each of the contracting parties can make a considerable profit by the exchange.”
Owing to the existence of potential prices beneficial to both buyer and seller, the involved parties have an incentive to seriously negotiate with each other about the final price since both parties seek to improve their state of affairs through means of the transaction.
3.3 Negotiation Tactics and Appraisal Methods
Before engaging in negotiation, both presumptive seller and purchaser separately compute their strictly confidential (Matschke, 1975, p. 11; Matschke, 1976, p. 519; Matschke, 1979, p. 18) individual marginal prices applying investment appraisal (e.g., Hering, Toll, and Kirilova, 2015b, p. 1), which, then, limit the range of acceptable prices, that is, the potential area of agreement (Matschke, 1979, p. 57). Since man is a purposeful being (e.g., Herbener, 2011, p. 14), his action always aims at particular ends. Mises (1998 [1949], p. 11) emphasizes:
Human action is purposeful behavior. Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment, is a person’s conscious adjustment to the state of the universe that determines his life.
The action of negotiating does not form an exception to this rule; rather, acting man engages in negotiation to reach a certain goal, his negotiation tactics serve a particular purpose. According to the end involved parties aim at, that is, wealth maximization (e.g., Mises, 1998 [1949], pp. 241–243; Rothbard, 2001, pp. 104, 213, 231), both buyer and seller intend to maximize their share of the transaction’s benefit through negotiating with each other (Matschke, 1975, p. 11; Matschke, 1976, p. 521; Olbrich, Quill, and Rapp, 2015, p. 32).For practice-oriented guidance on how to negotiate, see, e.g., Ury (1991); Fisher, Ury, and Patton (2011); Voss and Raz (2016). Herbst et al. (2018) as well as Nagler et al. (2018) provide some current insights on negotiation management. To do so, they will want to reach an agreement at a price as close as possible to the opponent’s marginal price, that is, one that is still acceptable since beneficial to him. Rothbard (2001, p. 109) explicates:
Clearly, Johnson will try to set the price of the horse as high as possible, while Smith will try to set the price as low as possible. This is based on the principle that the seller of the product tries to obtain the highest price, while the buyer tries to secure the lowest price.
Even though a price slightly below (purchaser) or slightly above (seller) the marginal price is beneficial and, hence, acceptable, both parties will engage in a purposive negotiation aiming to maximize their share of the gain to be established through the exploitation of the potential exchange. Menger (2007, p. 195) notes:
It is easily seen that A [, given his marginal price of 100 units of grain,] could provide better for the satisfaction of his needs even if he should have to give 99 units of grain for the 40 units of wine, and that B [, given his marginal price of 80 units of grain,] would be acting economically on the other side if he were to accept as little as 81 units of grain in exchange for his 40 units of wine. But since there is an opportunity for both economizing individuals to exploit a much larger economic advantage, each of them will direct his efforts to turning as large a share as possible of the economic gain to himself. The result is the phenomenon which, in ordinary life, we call bargaining. Each of the two bargainers will attempt to acquire as large a portion as possible of the economic gain that can be derived from the exploitation of the exchange opportunity, and even if he were to try to obtain but a fair share of the gain, he will be inclined to demand higher prices the less he knows of the economic condition of the other bargainer and the less he knows the extreme limit to which the other is prepared to go.
In order to reach a worthwhile agreement, involved parties, therefore, necessarily need not only know their own marginal prices but also need to form an assumption about the opponent’s marginal price (Matschke, Brösel, and Matschke, 2010, p. 6; Brösel, Toll, and Zimmermann, 2012, p. 95; Matschke and Brösel, 2013, p. 622).
Within the negotiation about the transaction of a firm, involved parties usually agree upon a certain appraisal method and negotiate about the corresponding input data rather than merely proposing actual price offers as commonly known from, for example, auctions or flea markets (Matschke, 1976, p. 520; Matschke and Brösel, 2013, pp. 615–616). A party’s negotiation tactics and its proposal for applicable appraisal methods being subject to the negotiation are neither arbitrary nor random; rather, acting man will select the appraisal method and choose the negotiation tactics he prefers purposefully in light of the overall end of the negotiation process, that is, to reach the most profitable agreement. Basically, every imaginable method, which serves to support the quoting party, can be reasonably applied for that purpose. However, methods that are widely known, generally accepted, arbitrarily adjustable, and considered to result in “fair” and “impartial” prices suit best to convince the opposing party of a particular agreement (Matschke, 1976, p. 523; Matschke and Brösel, 2013, p. 624). In other words, conventional appraisal methods are the best fit for negotiation purposes. In recent years, so-called market-value-orientedMises (1951, p. 113) emphasizes: “Only the individual thinks. Only the individual reasons. Only the individual acts.” Since individual action is the visualization of man’s valuations (Mises, 1998 [1949], p. 120), furthermore, only individuals value. Therefore, the prevalent term “market value” is—at best—delusive. Unlike any individual, the market in the aggregate does not and cannot value anything; rather, the market reflects prices resulting from individuals’ valuations and actions. Only under the rigid and unrealistic assumptions that underpin neoclassicism, values and prices equate to one another. Only then does a reference to “market value” make any sense. In the real world, however, the term is nothing but preposterous. methods dominate among business appraisals and, hence, are considered the state of the art (e.g., Olbrich, Quill, and Rapp, 2015, pp. 6–8). Market-value-oriented methods subsume both (1) neoclassical finance-theory-based discounted cash flow methods (DCF) and (2) methods of so-called relative valuation (e.g., Matschke and Brösel, 2013, pp. 125–126).
While both concepts suffer from various profound issues and are, hence, of no use to support valuing man in an investment decision (e.g., Olbrich, 2000, pp. 458–459; Hering, Olbrich, and Steinrücke, 2006, pp. 411–413; Brösel, Matschke, and Olbrich, 2012, pp. 241–242; Olbrich, Quill, and Rapp, 2015, pp. 12–17; Herbener and Rapp, 2016, pp. 20–23), they perfectly meet the demand for negotiation purposes (e.g., Brösel, Toll, and Zimmermann, 2012, p. 96–97; Matschke and Brösel, 2013, p. 624),Functional business valuation theory stresses the significance of purpose-orientation for each and any business appraisal. See, for example, Matschke, Brösel, and Matschke (2010) and Matschke and Brösel (2013). since they are (for whatever dubious reason)Olbrich, Quill, and Rapp (2015, pp. 7–8) provide some insights on the unbounded popularity of prevalent DCF methods. generally accepted, adjustable as needed, and seemingly objective. As long as market participants believe in the superiority of such “objective” methods of business appraisal, subjectivists can make use of that misbelief in order to reach a preferable negotiation result (e.g., Matschke and Brösel, 2013, p. 624; Hering, 2014, p. 222).
One exemplary DCF variant, the flow-to-equity method, can be illustrated as follows (similarly Matschke and Brösel, 2013, p. 725):
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To allow for face saving of the quoting party throughout the negotiation, an appraisal method suits best if it incorporates a certain degree of adaptability without seeming questionable (Matschke, 1976, pp. 523–524; Matschke and Brösel, 2013, pp. 620, 665). DCF methods’ adaptability can, for example, be shown by means of analyzing the popular and Nobel Memorial Prize awarded Capital Asset Pricing Model (CAPM) usually serving to deduce the so-called cost of equity,Even though frequently applied in the broader sphere of finance, the term “cost of equity” is meaningless. (Money) costs are caused by the input factors of, for example, a product, such as raw materials or labor. The dividends distributed to a company’s shareholders, however, reflect the appropriation of a firm’s net income, that is, the output of its operations. Therefore, to refer to (money) costs while actually meaning appropriation of net income mixes two entirely different things up and is, hence, both inaccurate and fallacious that is, (parts of) the discount rate (e.g., Fama and French, 1997, p. 153; Koller, Goedhart, and Wessels, 2015, p. 286). CAPM’s essential conclusion (the expected return of a particular security j (“µj”) equals a “risk-free” rate (“i”) plus a risk premium which reflects the surplus of the expected return of the market portfolio (“µM”) over the “risk-free” rate multiplied by the beta-factor (“βj”)) can be visualized as follows (e.g., Hering, 2015, p. 301):
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The practically applied data for the “risk-free” rate, the expected market return, and the beta-factor cannot perfectly match the theoretical demands of the CAPM (e.g., Hering, 2017, p. 309) simply because its assumptions are not met in reality as the model has an entirely hypothetical nature (e.g., Herbener and Rapp, 2016, p. 22). Hence, the input data are never correct or false; rather, they are the outcome of a willful choice. For instance, the appraiser will usually select a particular government bond (country, maturity, ...) as an approximation for the “risk-free” rate (Damodaran, 2012, pp. 154–155), and a certain stock index (country, industry, period, ...) as a substitute for the theoretically correct market portfolio (Hering, 2017, pp. 302, 309) which shall incorporate the performance of every risky asset rather than merely stocks (Damodaran, 2012, p. 66; Hering, 2017, p. 298). Therefore, CAPM’s inherent degrees of freedom alone—apart from other factors within a DCF appraisal such as the estimation of future cash flows or the computation of a weighted average cost of capital—allow for the justification of basically any price offer supporting the quoting party taking into account both its own and the opponent’s marginal price.
In contrast to the present-value-based DCF methods, so-called “relative valuation”The pleonastic term “relative valuation” fails to describe the special features of this approach sufficiently, since every valuation is in relative terms in the sense that it takes into account at least one alternative course of action. aims to capture the “market value” of a business either based on that business’s market capitalization or the market capitalization of or prices recently paid for (seemingly) comparable companies (Olbrich, 2000, pp. 455–457). For instance, one particular variant of “relative valuation” seeks to compute the appraised firm value of a particular company (“A”) through assessing the market capitalization of one comparable company or several comparable companies (“CC”), dividing it by a particular reference figure of the comparable company or the comparable companies, such as the EBIT, EBITDA, or net income, and to multiply the resulting factor with the respective reference figure of the company being appraised (Olbrich, 2000, p. 456). Hence, it can be visualized as follows:
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Comparable to the application of DCF methods, “relative valuation” suits well for negotiation purposes, since this approach incorporates a high degree of both adaptability and credibility. For example, the selection of comparable companies, the assessment of their market capitalization, and the selection of applicable reference figures allow for more or less arbitrary modeling (e.g., Olbrich, 2000, p. 459; Matschke and Brösel, 2013, p. 680). Moreover, the justification of “fair values” based on observable prices in the marketplace appears to be credible (e.g., Matschke and Brösel, 2013, p. 678). Therefore, this approach suits well for negotiation purposes too.
- CONCLUSIONS Robinson Crusoe engages in autistic exchange only. His actions aim at substituting one state of affairs by a more preferable state of affairs without referring to other individuals. In such an autistic economy, valuation alone is a sufficient condition for economizing decisions. In a market economy, in contrast, economizing decisions concerning, for example, consumer goods rely on both appraisement and valuation. While economizing decisions concerning investments, for example, the purchase of a firm necessitate both as well, however, they are different in two respects: First, appraisement and valuation are necessary yet not sufficient. Investment decisions require knowledge of the barely acceptable price, that is, the application of investment appraisal. Second, the final valuation of a business enterprise is infeasible in the first place, since one lacks knowledge of the asking price beforehand. The price, therefore, must be negotiated. Praxeologically, the negotiation process has to be interpreted as a repetitive series of valuations reflected in the proposal, acceptance, or rejection of price offers. To maximize their share of the benefit of the transaction, both buyer and seller will purposefully engage in a negotiation aiming to reach a price which ought to be as close to the opponent’s marginal price as possible. To accomplish such worthwhile agreement, application of DCF methods and “relative valuation” suit best as they are both highly adaptable and credible.
ABSTRACT: In exalting the subjectivity of value, the marginalist revolution posed a fundamental problem for economic theory. Each person chooses how to allocate his means and thereby, economize his actions by rank ordering the value of alternatives. Being interpersonally incomparable, ordinal ranks cannot serve directly to economize means within a division of labor. Neoclassical economists solved this problem by foregoing an explanation of the division of labor grounded in the reality of human persons and instead, constructed formal, mathematical models. F.A. Hayek’s subjectivist response to the neoclassical project was to augment formal, mathematical models with select characteristics of human persons. In contrast, Ludwig von Mises grounded economic theory in the reality of human persons. He demonstrated how voluntary exchange of goods for and against money generate cardinal numbers from ordinal ranks. Actual money prices emerging from actual human choices constitute the necessary condition for economizing resources across the division of labor. Unlike subjective valuations, which cannot be compared interpersonally, and barter exchange ratios which are incommensurate, money prices can be compared. Economic calculations of net income and net worth, furthermore, are a phenomenon of the market economy alone. Mises’s approach not only solved the problem of economizing resources in a division of labor, but provides a robust framework for economic research.
KEYWORDS: economic calculation, subjectivism, economizing, general equilibrium, socialism JEL CLASSIFICATION: B13, B14, B24, B25, P11, P21, P51 Jeffrey Herbener (jmherbener@gcc.edu) is chair of the Department of Economics and Sociology at Grove City College.
Quarterly Journal of Austrian Economics 21, no. 3 (Fall 2018) full issue, click here.
It is probably no exaggeration to say that every important advance in economic theory during the last hundred years was a further step in the consistent application of subjectivism (Hayek, 1955, p. 52).
INTRODUCTION F.A. Hayek (1955, pp. 52–53) appended the following footnote to his famous maxim concerning subjectivism quoted above:
This is a development which has probably been carried out most consistently by Ludwig von Mises, and I believe that most peculiarities of his view which at first strike many readers as strange and unacceptable trace to the fact that in the consistent development of the subjectivist approach he has for a long time moved ahead of his contemporaries. Probably all the characteristic features of his theories—from his theory of money (so much ahead of the time in 1912) to what he calls his a priorism—his views about mathematical economics in general and the measurement of economic phenomena in particular, and his criticism of planning all follow directly (although, perhaps, not all with the same necessity) from this central position. See particularly his Grundprobleme der Nationalökonomie (1933) and Human Action (1949).
One achievement of the Salerno camp in the second calculation debate was to demonstrate that Hayek, at least, leaves the wrong impression of the relationship between Mises’s work and his own. By referring to “the subjectivist approach,” Hayek seems to imply that his approach and that of Mises are fundamentally the same. Although Hayek admits to some differences in particulars, since Mises’s views, as he puts it, “all follow directly (although, perhaps, not all with the same necessity) from this central position.”
Mises, however, did not accept the subjectivist approach of Friedrich von Wieser, on which Hayek patterned his own framework, but instead worked within the causal-realist approach of Carl Menger and Eugen von Böhm-Bawerk.On Wieser’s approach, see Bostaph (2003). In discussing the two traditions in Austrian economics, Joseph Salerno (1999, p. 37) wrote:
It is important to note that even at this early stage, the Austrian school was deeply divided on a crucial issue of basic theory. On the one hand, Böhm-Bawerk fully absorbed Menger’s causal-realist approach to price theory and endeavored to develop it further and apply it to new areas. Wieser, on the other hand, seized narrowly on Menger’s “subjectivism” as embodied in the principle of marginal utility and, while usefully elaborating some of the implications of this principle, completely ignored the structure of reality-based price theory that Menger had labored to build upon it. Wieser’s purpose was to construct his own peculiar ideal of social welfare based on a state of general equilibrium that he called “natural value,” and to link it through the concept of marginal utility to foundations in human psychology.
With his acceptance of general equilibrium and emphasis on human psychology, Hayek belongs to the Wieserian wing of the Austrian school. Hayek attempted to graft onto the neoclassical general equilibrium conception his own insights into human learning, knowledge, and other “subjectivist” elements. In discussing the main contributions to modern price theory for an entry in The New Palgrave: A Dictionary of Economics in the early 1980s, which remained unpublished at the time, he wrote (Hayek, 1992, pp. 53–54):
Equally important is what may well be regarded as the final formulation of the marginal utility analysis by J.R. Hicks of the marginal utility analysis of value in the concept of the marginal rate of substitution, based on the indifference curve technique introduced by Irving Fisher and F. Y. Edgeworth. This conception of varying rates of substitution or equivalence, wholly independent of any conception of measurable utility, may well be regarded as the ultimate statement of more than half a century’s discussion in the tradition of the Austrian school….
Arguably, Hayek’s claim about Mises leading the advance of subjectivism may not be mistaken per se, however, Mises’s approach to grounding economic theory on a proper subjectivist foundation differed dramatically from that of Wieser and his followers.
ECONOMIC CALCULATION AND SUBJECTIVISM IN HUMAN ACTION In his magnum opus, Human Action, Mises subsumes subjectivist aspects of catallactics within the concept of economic calculation. The book is organized into seven parts containing 39 chapters. He devotes one entire part of the book, part 3, to economic calculation. It contains three chapters. In one of those chapters, Valuation without Calculation, we find Mises’s discussion of the subjectivity of value. He did not offer insights about how the advance of the concept of subjectivity can make the general equilibrium framework more suitable to economic theorizing. Instead Mises focused on two fundamental principles concerning the subjectivity of value.
First, he juxtaposed the ordinal ranking inherent in valuation with cardinal numbers in which the goods being ranked are measured. He did this to demonstrate a principle of economic calculation. He wrote (Mises, 1998, p. 201):
The immediate goal of acting is frequently the acquisition of countable and measurable supplies of tangible things. Then acting man has to choose between countable quantities; he prefers, for example, 15 r to 7 p; but if he had to choose between 15 r and 8 p, he might prefer 8 p…. This is tantamount to the statement that he prefers a to b and b to c…. It certainly does not render reckoning with cardinal numbers possible. It does not open a field for economic calculation and the mental operations based upon such calculation.
Second, he referenced the principle he (Mises, 1998, p. 699) would call in his critique of socialist schemes to provide a method of economic calculation, “the fundamental theorem of modern economics,” namely diminishing marginal utility. His purpose was, again, to make a fundamental point about economic calculation. Mises (1998, p. 206) wrote:
There is no method available to construct a unit of value. Let us remember that two units of a homogeneous supply are necessarily valued differently. The value attached to the nth unit is lower than that attached to the (n–1)th unit.
Mises (1998, p. 206) concluded this line of argument with the following words:
It is a fictitious assumption that an isolated self-sufficient individuals or the general manager of a socialist system, i.e., a system in which there is no market for the means of production, could calculate. There is no way which could lead one from the monetary computation of a market economy to any kind of computation in a nonmarket system.
In the subsection that closes out this section of the book, which Mises titled, “The Theory of Value and Socialism,” Mises (1998, p. 207) wrote the following about subjectivism:
The illusion that a rational order of economic management is possible in a society based on public ownership of the means of production owed its origin to the value theory of the classical economists and its tenacity to the failure of many modern economists to think through consistently to its ultimate conclusion the fundamental theorem of the subjectivist theory.
ECONOMIC CALCULATION AND THE PROBLEM OF ECONOMIZING As noted above, Mises considered the “fundamental theorem of modern economics” diminishing marginal utility, which can be deduced from a person economizing with homogeneous units of a good. Although diminishing marginal utility is accepted by all modern economists, Mises was the first to perceive the implication of its reasoning for making economizing decisions about the use of resources in society and its application to this problem in socialism. Concerning the proposal of mathematical economists to solve the problem of economizing in socialism, Mises (1978, p. 112) wrote:
They failed to see the very first challenge: How can economic action that always consists of preferring and setting aside; that is, of making unequal valuations, be transformed into equal valuations, and the use of equations? Thus the socialist came up with the absurd recommendation of substituting equations of mathematical catallactics, depicting an image from which human action is eliminated for the monetary calculation in the market economy.Quoted in Salerno (1999, p. 58).
The deficiency in economic theory that needed correcting, according to Mises, was a fallacy economists held concerning economic calculation. Mises (1998, p. 202) wrote:
The elaboration of economic theory is heuristically dependent on the logical processes of reckoning to such an extent that the economists failed to realize the fundamental problem involved in the methods of economic calculation…. They misconstrued economic calculation. They took it for a category of all human action and ignored the fact that it is only a category inherent in acting under special conditions…. But they did not comprehend that money prices are the only vehicle of economic calculation. Thus most of their studies are of little use. Even the writings of the most eminent economists are vitiated to some extent by the fallacies implied in their ideas about economic calculation.
Contrary to Hayek, who thought that general equilibrium theory could be corrected by grafting subjectivist insights onto it, Mises perceived that the deficiency of the general equilibrium construct stemmed from its fallacious treatment of money. He identified two mistakes. First, the general equilibrium construct conceived of a market economy with only direct exchange and concomitantly asserted the neutrality of money. He wrote (Mises, 1998, pp. 203–204):
A serious blunder that owes its origin and its tenacity to a misinterpretation of this imaginary construction [a market with direct exchange] was the assumption that the medium of exchange is a neutral factor only…. This is, of course, what the fable of money’s neutrality implies. The whole theory of catallactics, it was held, can be elaborated under the assumption that there is direct trade only. If this is once achieved, the only thing to be added is the “simple” insertion of money terms into the complex of theorems concerning direct exchange. However, this final completion of the catallactic system was considered of minor importance only. It was not believe that it could alter anything essential in the structure of economic teachings. The main task of economics was the study of indirect exchange.
Only later economists realized that some of the most important and most intricate problems of catallactics are to be found in the field of indirect exchange and that an economic theory which does not pay full regard to them is lamentably defective.
Second, Mises noted a more momentous error drawn from the imaginary construct of a fictitious barter world, namely, that value is objective and can be measured by money.Mises (1998, pp. 697–699) repeats his indictment of the general-equilibrium framework in chapter 26 in which he criticizes mathematical economists for perpetuating the fallacy that economic calculation was possible in socialism. He wrote (Mises, 1998, p. 205):
Even Friedrich von Wieser and Irving Fisher took it for granted that there must be something like measurement of value and that economics must be able to indicate and to explain the method by which such measurement is effected. Most of the lesser economists simply maintained that money serves as “a measure of values.”
Mises’s corrective of the deficiencies of general equilibrium theory was based on his integration of money into subjective-value theory. He demonstrated (Mises, 1953) in 1912 how ordinal ranks are transformed into cardinal numbers suitable for economic calculation in a market economy. Buyers and sellers have preferences for a good they intend to exchange relative to money. They exchange to acquire the mutual benefit latent in the reverse ordering of their preferences. Competitive bidding by the buyers and competitive offering by the sellers results in a market-clearing price. As Rothbard (1991, p. 65) recounts it:
In the course of that notable integration of monetary theory and “micro” marginal utility theory, Mises was one of the very first to realize that subjective valuations of the consumer (and of laborers) on the market are purely ordinal, and are in no way measurable. But market prices are cardinal and measurable in terms of money, and market prices bring goods into cardinal comparability and calculation (e.g., a $10 hat is “worth” five times as much as a $2 loaf of bread).
Mises did not fully work out this integration and its implications until the German-language predecessor of his magnum opus, Human Action.See Rothbard (1991, p. 65) and Salerno (1999, p. 56). In that work, he demonstrated that the market economy is the only solution to transforming rank orders of value into cardinal numbers suitable for making economizing decisions in a division of labor. Only three alternatives to the market solution of monetary prices exist, according to Mises.
One is inter-personal value comparisons among the participants in the division of labor. Yet, modern economists all agree that inter-personal comparisons of value are impossible and therefore, this alternative is not entertained by modern economists as a solution to the economizing problem. A second alternative is imputation of value across the division of labor by a single person. Valuation, Mises argued, can be applied only to a self-sufficient economy, i.e., an economy in which a person is the producer of everything he consumes.As Mises (1998, p. 210) concedes, valuation is adequate to economizing resources within a family economy or that of a small tribe as well as a single person. In this case, a single mind can integrate the use of its resources across the entire array of producer goods with which it acts. It does this by imputing the value of lower-order goods to those of higher order. According to Mises, however, a single mind cannot decompose the value of the end achieved into the value of each factor’s contribution. He wrote (Mises, 1998, p. 332):
Valuation as it can be practiced by an isolated actor (Robinson Crusoe or a socialist board of production management) can never result in a determination of such a thing as quotas of value…. It is permissible to declare that, due allowance being made for time preference, the value attached to a product is equal to the value of the total complex of complementary factors of production. But it would be nonsensical to assert that the value attached to a product is equal to the “sum” of the values attached to the various complementary factors of production. One cannot add up values or valuations. One can add up prices expressed in terms of money, but not scales of preference…. The process of value imputation does not result in derivation of the value of the single productive agents from the value of their joint product. It does not bring about results which could serve as elements of economic calculation.
Mises insisted that in making economizing decisions about the use of resources in an extended division of labor, it is necessary to disentangle the contribution of each complementary factor of production used in producing each good. The necessity arises because factors of production are neither perfectly specific to each good nor perfectly non-specific among all goods. Absent either of those extreme conditions, economic calculation cannot be done by knowing only the value of goods of first order and the technical conditions of production of these goods. Which raises the third alternative: using the cardinal numbers of production possibilities as the basis for economic calculation. Although technical consideration allow the decomposition of the physical contribution to output made by each factor, these numbers have no connection to value of the ends attained. Mises wrote (1998, p. 208):
[The fact that] the various means allow for various uses, set man the tasks of allocating them to those employments in which they can render the best service. Here the computation in kind as applied by technology is of no avail. Technology operates with countable and measurable quantities of external things and effects; it knows causal relations between them, but it is foreign to their relevance for human wants and desires…. [Technology] ignores the economic problem: to employ the available means in such a way that no want more urgently felt should remain unsatisfied because the means suitable for its attainment were employed—wasted—for the attainment of a want less urgently felt.
In an extended division of labor, individual factors of production can be shifted from one line of production to another and configured in various combinations with other complementary factors of production in each production process. Therefore, to know whether or not a particular configuration of complementary factors of production will be more economizing for society than another configuration, prices of individual factors of production must exist. Mises (1998, pp. 209–210) wrote:
[The practical man] must know whether what he wants to achieve will be an improvement when compared with the present state of affairs and with the realizable projects which cannot be put into execution if the project he has in mind absorbs the available means. Such comparisons can only be made by the use of money prices…. Where there are no money prices, there are no such things as economic quantities. There are only various quantitative relations between various causes and effects in the external world. There is no means for man to find out what kind of action would best serve his endeavors to remove uneasiness as far as possible.
Mises concluded this line of inquiry by returning to the starting point in Robinson Crusoe, i.e., production in self-sufficiency instead of a division of labor. Crusoe could compare the value of output with the value of the complementary factors used because the possible combinations he can exploit are simple enough for him to impute value adequately for economizing.All of the combinations of factors of production can be valued by Crusoe through his own experience. Such cannot be done by a single person in a division of labor, especially the extended division of labor in a modern, capitalist economy. He wrote (Mises, 1998, p. 210):
There is no need to dwell upon the primitive conditions of the household economy of self-sufficient farmers. These people performed only very simple processes of production. For them no calculation was needed, as they could directly compare input and output. If they wanted shirts, they grew hemp, they spun, wove, and sewed. They could, without any calculation, easily make up their minds whether or not the toil and trouble expended were compensated by the product. But for civilized mankind a return to such a life is out of the question.
ECONOMIC CALCULATION AND THE SCHEMES OF SOCIALISM With his theory of economic calculation in hand, Mises critiqued the schemes of socialists to rationally allocate resources in chapter 26 in Human Action. Both the title of the chapter, “The Impossibility of Economics Calculation under Socialism,” and the summary list of schemes indicate Mises’s emphasis on economic calculation. He wrote (Mises, 1998, pp. 699–700):
The various schemes proposed can be classified in the following way:
-
Calculation in kind is to be substituted for calculation in terms of money....
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Starting from the ideas of the labor theory of value the labor-hour is recommended as the unit of calculation….
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The unit is to be a “quantity” of utility….
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Calculation is to be made possible by the establishment of an artificial quasi-market….
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Calculation is to be made with the aid of the differential equations of mathematical catallactics….
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Calculation is to be made superfluous by resorting to the method of trial and error….
All of these socialist schemes, except number 6, are attempts to have economic calculation under socialism. And Mises’s critique of the socialist director using the method of trial and error to make economizing production and investment decisions relies on his views of economic calculation. He argued (Mises, 1998, p. 700) that economizing decisions fall into a category of trial and error in which “the only mark of the correct solution is that it has been reached by the application of a method considered appropriate for the solution of the problem.” His example is solving a multiplication problem. He wrote (Mises, 1998, p. 700):
One may try to guess the correct result by trial and error. But here the method of trial and error is no substitute for the arithmetical process. It would be quite futile if the arithmetical process did not provide a yardstick for discriminating what is incorrect from what is correct.
In the case of economizing decisions, the only way to discover if trial and error has succeeded is by a computation of profit and loss. Mises wrote (1998, p. 701):
The problem of socialist economic calculation is precisely this: that in the absence of market prices for the factors of production, a computation of profit and loss is not feasible.
We may assume that in the socialist commonwealth there is a market for consumers’ goods and that money prices for consumers’ goods are determined on this market…. But the characteristic mark of the socialist system is that the producers’ goods are controlled by one agency only in whose name the director acts, that they are neither bought nor sold, and that there are no prices for them. Thus there cannot be any question of comparing input and output by the methods of arithmetic.
Concerning the socialist scheme for a quasi-market, Mises noted that it represents the triumph of his approach to economics. He wrote (Mises, 1998, p. 702):
It is therefore nothing short of a full acknowledgement of the correctness and irrefutability of the economists’ analysis and devastating critique of the socialists’ plans that the intellectual leaders of socialism are now busy designing schemes for a socialist system in which the market, market prices for the factors of production, and catallactic competition are to be preserved. The overwhelmingly rapid triumph of the demonstration that no economic calculation is possible under a socialist system is without precedent in the history of human thought. The socialist cannot help but admitting their crushing final defeat.
Finally, Mises made it perfectly clear that the defeat of socialism owed nothing to the mathematical economics of general equilibrium. The problem of directing the use of resources in an economizing manner must start with existing conditions, which are not those of equilibrium but have been brought about by both successes and failures of the past. Even if the final equilibrium configuration of resource allocation is known, the economizing problem remains: how to move step-by-step from existing conditions to those of final equilibrium. For the solution to this problem, the mathematical expression of the state of final equilibrium is of no use. Mises wrote (1998, p. 709):
Even if, for the sake of argument, we assume that a miraculous inspiration has enabled the director without economic calculation to solve all problems concerning the most advantageous arrangement of all production activities and that the precise image of the final goal he must aim at is present to his mind, there remain essential problems which cannot be dealt with without economic calculation. For the director’s task is not to begin from the very bottom of civilization and to start economic history from scratch. The elements with the aid of which he must operate are not only natural resources untouched by previous utilization. There are also the capital goods produced in the past and not convertible or not perfectly convertible for new projects. It is precisely in these artifacts... that our wealth is embodied. Their structure, quality, quantity, and location is of primary importance in the choice of all further economic operations…. [The director] must try to take advantage of every piece of the already available capital goods in the best possible way.
CONCLUSION Mises’s integration of money into the subjective theory of value did more than put monetary theory on solid ground. It set the entire body of economic theory on the causal-realist foundation laid by Carl Menger. Doing so required a reconstruction of price and production theory. Not merely grafting subjectivist elements onto general equilibrium theory, but rebuilding this theory from the bottom up. No better evidence of the soundness of this approach exists than Mises’s demonstration that central planners cannot allocate resources in an economizing manner in socialism for lack of economic calculation.
Since the second calculation debate made apparent Mises’s achievement in providing a truly general theory of economics, the causal-realist approach has been advancing on several fronts. To mention just a few: business cycle theory has been refined (Salerno, 2012); the theory of entrepreneurship and organizational theory has been developed (Klein, 2010); the theory of cost has been reconsidered (McCaffrey, 2018); the theory of interest has been further considered (Herbener, 2011); and Mises’s concept of entrepreneurial appraisement has been extended (Herbener and Rapp, 2016).
ABSTRACT: Contrary to the Austrian community’s former perception, we revealed value investing’s incompatibility with Austrian economics (Rapp, Olbrich, and Venitz, 2017). However, Leithner (2017) disagrees with this conclusion. He primarily argues that an analysis of value concepts should be neglected in favor of a discussion of the methods value investors apply to “measure” value to diagnose whether or not they adhere to Austrian value theory. Moreover, he claims that value investors use terms imprecisely and that intrinsic value is actually meant to be subjective, even conceptually. However, we believe Leithner’s remarks suffer from fundamental misunderstandings and error. He is mistaken on Austrian value theory, subjectivity, and the conceptual foundations of value investing. Therefore, we gladly accept the offer to address his misapprehensions and to sharpen the Austrian understanding on investment decisions in general.
KEYWORDS: Value investing, Austrian economics, value theory, intrinsic value, subjectivism, arbitrariness JEL CLASSIFICATION: B31, B53, D46, D52, G11, G32 I. I. CONCEPTUALIZATION AND (IM)MEASURABILITY OF VALUE In a paper previously published in this journal (Rapp, Olbrich, and Venitz, 2017) we debunked the myth of an alleged compatibility between value investing and Austrian economics. Unsurprisingly, one of the advocates of that myth, namely Leithner (2017), disagrees with our conclusion. Apart from both untenable allegationsSpecifically, Leithner (2017, pp. 173–174) accuses us of overlooking important personalities and their work, one of whom is suggested to be John Burr Williams. However, we did not overlook anyone; our list of references is rather extensive. The reason for not citing Williams, for example, in our original paper is quite simple. We addressed the question of conceptualization of value rather than methods of investment appraisal. Williams did not contribute anything new to the former and, hence, his work is of no importance to our initial discussion. and demonstrably incorrect claims,For instance, Leithner (2017, p. 174) falls for the misconception that “John Burr Williams [...] wrote the first treatise that systematically applied the insights of the marginal revolution to the conceptualisation and measurement of securities’ values.” However, Williams’s (1938) treatise is neither the first of its kind nor is it—compared to its predecessors—systematic. For an earlier and more systematic treatise of the application of marginal utility to investment appraisal see, in particular, Liebermann (1923). his critique can be cut down to the following main argument: Leithner (2017, p. 172) rejects the emphasis we put on the fundamental conceptualization of value while favoring an analysis of “the concrete method by which the investor measures a given security’s value” to conclude whether or not he adheres to the subjective theory of value. Moreover, Leithner (2017, p. 175) alleges that value investors use terms, in particular the crucial term intrinsic value, “sloppily” but that what they “label ‘intrinsic value’ is, both conceptually and empirically, actually subjective.” Alas, Leithner’s remarks suffer from fundamental misunderstandings of and even some unfamiliarity with Austrian value theory, subjectivity, and value investing’s conceptual foundations. Therefore, we gladly embrace the opportunity to discuss Leithner’s critique in this reply to shed some light on the issue. By so doing, we seek to sharpen the understanding of both Austrian value theory and subjectivity in the context of investments, not least among the Austrian-friendly community of practitioners.
Leithner (2017, p. 172) criticizes us for solely discussing and contrasting value concepts rather than dealing with the technical application of methods with which “the investor measures [...] value.” He incorrectly believes that “if they did then they would undermine their key contention” (p. 172). However, the actual reason why we purposely focus on the conceptualization of value at the expense of what Leithner (2017, p. 172) refers to as “measurement” of value is twofold. First, Austrian economists not only pointed out that value is necessarily subjective; they also revealed that subjective value is inevitably immeasurable. For instance, Mises (1953, p. 38) unambiguously explains:
So long as the subjective theory of value is accepted, this question of measurement cannot arise. In the older political economy, the search for a principle governing the measurement of value was to a certain extent justifiable. If, in accordance with an objective theory of value, the possibility of an objective concept of commodity-values is accepted, and exchange is regarded as the reciprocal surrender of equivalent goods, then the conclusion necessarily follows that exchange transactions must be preceded by measurement of the quantity of value contained in each of the objects that are to be exchanged. And it is then an obvious step to regard money as the measure of value.
Therefore, if one accepts the Mengerian, subjective notion of value, one necessarily has to regard “[a]cts of valuation [...] [as] not susceptible of any kind of measurement” (Mises, 1953, p. 39) since there “is no [...] objective unit in the field of human valuation” (Rothbard, 2009, p. 19). Mises (2012, p. 9) notes: “Marginal utility does not posit any unit of value” and, thus, “the notion of a measurement of value is vain” (Mises, 1998, p. 205). The very fact that Leithner claims value investors (including himself) can and do measure value reveals both fundamental ignorance of one of the most basic cornerstones of Austrian value theory and sympathy for objective concepts of value due to their characteristic of being amenable to measurement.
Second, the underlying conceptualization can never be side-stepped in a serious and informed discussion about value. The question of whether or not particular methods of investment appraisalHerbener and Rapp (2016) not only present an Austrian approach to investment appraisal but also relate it to Austrian value theory. (which Leithner perhaps has in mind when erroneously discussing the “measurement” of value) serve their purposes, for instance, is inseparably linked to the concept of value (Schmalenbach, 1926, p. 297; Schmalenbach, 1956, p. 138; Matschke and Brösel, 2013, pp. 49–50). If the calculation is supposed to follow a hypothetical objective value concept, for example, for fiscal matters, methods resulting in highly subjective numbers are inadequate. In contrast, if the appraisal aims to provide a presumptive investor with his highly individual barely acceptable price, methods seeking to assess, for example, an objective “market value”—as attempted by prevalent contemporary DCF models springing from neoclassical finance theory—obviously fail (Matschke, Brösel, and Matschke, 2010, p. 35; Brösel, Matschke, and Olbrich, 2012, pp. 241–242; Matschke and Brösel, 2013, p. 50; Hering, 2014, p. 297; Herbener and Rapp, 2016, p. 22). In any case, analyzing methods of investment appraisal independently of the underlying value concept is pointless. Alas, Leithner (2017) overlooks the fact that methods of investment appraisal can only be judged in light of the underlying value concept, and mistakenly suggests instead that analyzing the process of “measuring” value alone allows for a conclusion regarding the underlying nature of value. Yet following Mises’s above-mentioned quote, the only thing the attempt to “measure” value reveals is the inconsistency with subjective value theory. Generally, the relevant object of analysis in contrasting Austrian theory with value investing’s foundations, however, is to be found in the underlying conceptualization of value only.
II. OBJECTIVE VALUE AND “SUBJECTIVITY” According to the concept of value investing, a firm’s (or rather a share’s) intrinsic value and its market price should equate to one another theoretically; however, primarily investors’ emotionally driven behavior (mistakenly termed “irrational”) is seen to cause temporary deviations—either “overvaluations”, that is, the market price exceeds intrinsic value, or “undervaluations”, that is, intrinsic value exceeds the market price.Bildersee, Cheh, and Zutshi (1993, p. 198)—empirically studying Graham’s net current asset value approach—note: “They [fundamental analysts] believe that stock prices sometimes deviate from ‘fundamental value’; the true underlying value that the security should have in the market, if properly valued” (italics added). Whenever such temporary periods of investors’ seemingly “irrational” actions come to an end, the market price is believed to approximate the share’s intrinsic value because of the “inherent tendency for these disparities to correct themselves” (Graham and Dodd, 2009, pp. 69–70). Value investors try to make a profit from this alleged relation by investing in temporarily “undervalued” companies whose share prices are supposed to rise.Value investor Vick (1999, p. 8) asserts “that undervalued situations, by definition, must end sometime.” In sum, while market prices can and do deviate from intrinsic value, they are believed to consistently tend toward intrinsic value which is, therefore, deemed to be the fundamental yardstick of price trends. Value investing’s conceptualization of value is hence purposely objective.Vick (1999, p. 4) emphasizes that “the notion of intrinsic value is not subjective but generic […] In the absolute sense, intrinsic value is the real worth of a company, the sale price investors could reasonably place on the company if they all possessed the same information and insight” (italics added). If intrinsic value was meant to be subjective—despite the term’s apparent meaning—by contrast, the market price would either have to oscillate around thousands of “intrinsic” values resulting from different market participants’ subjective appraisals of one and the same share at once, which is evidently impossible; or alternatively, the market price would have to oscillate around one particular subjectively appraised “intrinsic” value. However, which of the thousands and thousands of subjective appraisals for the very same share would then cause the market price to oscillate? Why should one particular subjectively appraised “intrinsic” value cause the market price, which can be the outcome of thousands and thousands of independent valuations, to oscillate? Hence, if intrinsic value were indeed a subjective concept, the very idea of value investing would go up in smoke. Leithner (2017, p. 175) seems to not even get these conceptual foundations of value investing right and, hence, is demonstrably in error when he alleges that what value investors “label ‘intrinsic value’ is [...] conceptually [...] actually subjective”—nothing could be further from the truth.
One thing Leithner (2017, pp. 175–176) correctly realizes, though, while referring to both John Burr Williams and Warren Buffett, is the fact that different value investors will arrive at different figures when trying to appraise a particular share’s intrinsic value. However, he misdiagnoses this fact as the result of the appraisal’s subjectivity and, hence, is barking up the wrong tree again. Value investing requires the assessment of a certain share’s intrinsic, that is, its one and only “true value” (Graham and Dodd, 2009, p. 69). Yet intrinsic value is nothing but a mere phantom.As Mises (1998, p. 96) puts it: “Value is not intrinsic, it is not in things.” Value investing’s perception of value, therefore, must be characterized as “the naive concept of the layman” (Ritenour, 2016, p. 192). The fact that such a phantom cannot be properly grasped by nature, however, does not at all allow for the conclusion that the concept of intrinsic value was actually subjective. Rather than subjectivity, intrinsic value’s non-existence causes differing appraisals among value investors. How could it be possible for independent investors to assess a particular figure equally if that figure does not even exist, and, hence, is incalculable? Apparently, the appraisal of intrinsic value is not subjective in the sense that it considers a particular individual’s actual (financial) ends and means guiding his actions; because intrinsic value does not exist and, hence, value investors stumble about in the dark when trying to appraise it, instead, it is nothing but entirely arbitrary.
The essential fallacy inherent in Leithner’s reasoning can be illustrated by analogy with the cost/labor theory of value as similarly applied by both classical economists and Marxists (Mises, 1998, pp. 204–205). While they undoubtedly “shared the desire to objectify value” (Cole, 2010, p. 216), different appraisals will result in differing figures too. For example, if a particular product requires certain input factors on a large scale (such as screws) that were obtained over a period of time at various costs, one has to pragmatically assess an average cost which will—due to plenty of possible ways to make the calculation—result in differing numbers. The same applies to both the allocation of overhead costs and the selection of the method of depreciation employed for the involved manufacturing tools. Not least, time spent to manufacture the product can be calculated to the split second or one might consider only full hours, for instance. However, does that space necessarily resulting in differing figures lead to the conclusion that the Marxist theory of value is conceptually actually subjective and, therefore, resembles the Austrian perception? While Leithner’s reasoning strongly suggests this conclusion, thus revising the history of economic thought, it is evidently fallacious. Both Marxism and value investing purposely apply objective perceptions of value; yet the attempts to appraise such value are, owing to its absence, solely characterized by arbitrariness.
III. SUBJECTIVE VALUE AND SUBJECTIVITY Contrary to the conceptual foundations of value investing, Austrian analysis holds that it “is ultimately always the subjective value judgments of individuals that determine the formation of prices” (Mises, 1998, p. 329). Menger (2007, p. 120) emphasizes that the “value of goods arises from their relationship to our needs, and is not inherent in the goods themselves.” Intrinsic value is, hence, considered an erroneous belief (Ritenour, 2016, p. 192). Rather than a company’s one and only “true, intrinsic, or ultimate worth” (Greenwald et al., 2001, p. 26) fundamentally determining price trends, Austrians have pointed to the fact that it is indeed the inequality of values causing exchanges and, thus, prices (Mises, 1998, pp. 328–329). In valuing two alternative courses of action, such as buying or abstaining from buying a particular share, an investor compares the benefits associated with both alternatives and ultimately ranks them in light of his ends (Mises, 1998, p. 94). A financial investment decision, then, requires knowledge of the marginal price the investor can just barely accept without suffering an economic loss as prerequisite for a nonarbitrary valuation (Herbener and Rapp, 2016, pp. 10–11). Such marginal price is not an objective indicator, and is even less reflected in intrinsic value; instead it will differ both from individual to individual and as time passes, because it is determined by a particular person’s alterable (financial) ends and means (Hering, Toll, and Kirilova, 2015, p. 24; Olbrich, Quill, and Rapp, 2015, p. 20; Rapp, Olbrich, and Venitz, 2017, p. 16). Hence, a genuine investment appraisal aiming to arm an investor with his barely acceptable price needs to take that individuality into account. Time preference makes it necessary to place a discount on future satisfaction (Herbener, 2011, p. 14; Herbener, 2018). Consequently, investment appraisal must discount an investment’s expected future benefits, that is, it must rely on the present value technique. The subjective nature of value and, hence, of a genuine investment appraisal is, then, reflected in a threefold manner (Herbener and Rapp, 2016, pp. 16–18, 19–20). First, the projection of future earnings is inevitably subjective due to both the necessity to form expectations given uncertainty and individually differing financial circumstances, particularly tax rates, tax loss carry-forwards, and the potential capability to control corporate policy as well as to gain from synergies if, for instance, an investor already owns one of the target firm’s competitors. Second, the only correct discount rate on imperfect—that is, real—capital markets equals the internal rate of return of a particular investor’s best alternative application of funds, either another investment or the settlement of a loan (fundamentally Schmalenbach, 1908/1909; Hering, 2014, p. 29). Since an individual’s best investment or funding alternative is determined by both that person’s financial ends reflecting his time preference and the overall pool of investment and funding projects available to him, it will necessarily differ from individual to individual. Third, uncertainty is an obstacle to optimal problem-solving; investors can only rely on heuristics. Contrary to the popular but fundamentally flawed risk premium concept (Hering, 2017, pp. 292–310; Hülsmann, 2018), one promising approach to structure uncertainty’s effects associated with an investment lies in the application of a Monte Carlo simulation (Hertz, 1964, pp. 95–97; Coenenberg, 1970, pp. 793–795). Both the forecast of future earnings and discount rates as well as the selection of the final marginal price out of the distribution provided by the simulation, then, are subject to highly individual entrepreneurial judgments.
Leithner’s (2017, pp. 172–173) summary of methods he and his fellow value investors apply to “measure” value, therefore, exposes nothing but the methods’ fundamental uselessness. Appraising “a company according to the external prices of its assets” (p. 173) is in fact flawed in three respects (Olbrich, 2000, p. 454; Rapp, 2014, p. 1067).Schmalenbach (1917/1918, p. 6) already uncovers such a procedure as a bad blunder. First, it entirely disregards a particular investor’s subjective ends and means, such as his planning horizon or alternative available financial opportunities. Second, it neglects the significance of both a future-orientation and combination effects as it exclusively considers the sum of past or present prices of individually appraised assets rather than the future earning power of the company as a whole. Third, it conflates two inevitably distinguishable things, namely values and prices. Leithner (2017, p. 173) also errs when he alternatively suggests using “some rate” to discount (undefined) “cash flows [...] to the present” in a DCF appraisal. As outlined above, there is only one correct discount rate for genuine subjective appraisals; nor is it proper to apply “some rate”, and nor does the discount rate reflect an “opinion” investors “believe in” as claimed by Williams (1938, pp. 16–17) whom Leithner (2017, pp. 174–175) invokes prominently. It instead stems from a sound causal chain deduced from the concept of marginal utility by advocates of investment theory developed in the German-speaking world whose lineage is consistently traceable to early Austrian economics (Schmalenbach, 1919, p. 334; Schmalenbach, 1937, p. 27; Matschke and Brösel, 2013, p. 6, fn. 11; Hering, 2014, pp. 27–28; Olbrich, Quill, and Rapp, 2015, pp. 15–16; Herbener and Rapp, 2016, pp. 12–13). Hence, while Leithner (2017, p. 175) seems to acknowledge the Austrian perspective when he explicates that value stems from “the importance an acting individual places upon the good (security) for the achievement of his desired ends,” he clearly is grievously mistaken on the methods he considers proper in preparing investment decisions from an Austrian perspective.
Needless to say, in conclusion, value investing remains fundamentally at odds with the Austrian school.
Quarterly Journal of Austrian Economics 20, no. 3 (Fall 2017)Public Debt: An Illusion of Democractic Political Economy, by Giuseppe Eusepi and Richard E. Wagner, Edward Elgar, 2017
Professors Giuseppe Eusepi of Sapienza University of Rome in Italy and Richard E. Wagner of George Mason University have added another book to the already extensive list of literature on the political economy of public debt. The purpose of their book is to correct two major flaws in the existing literature. First, they argue that it is “pure illusion to treat a democratic regime as being indebted.” Second, they try to show that it is “pure mythology to treat so-called fiscal policy as the means by which governments manipulate public debt to promote systemic stability” (Eusepi and Wagner 2017, p. vii). Surely, both claims will strike the average reader as bold and by no means self-evident. They require analytical substantiation and clarification of terms. What exactly is illusory and mythical about the indebtedness of democratic regimes and their fiscal policy? Eusepi and Wagner’s analysis spans 164 pages separated into 6 chapters.
In the first chapter of the book, the authors provide a very brief overview and some fundamental criticisms of the conventional macroeconomic approach to fiscal policy and public debt. The legacy of Keynes’s General Theory in putting deficit spending at the forefront of fiscal policy measures to promote macroeconomic stability and full employment is well known and has been widely discussed among modern economists. Eusepi and Wagner argue that treating “political activity as a balance wheel to offset changes in private activity is overwhelmingly at work in contemporary political economy” (p. 7) and critically add “that the image of the balance wheel reflects the hold of myth and not the power of logic and observation.” According to the authors, underlying the balance wheel view is a “mythical” as opposed to a “realistic” type of theory, because it is merely “postulating” instead of actually “generating” the outcomes under consideration. In their view, the conventional “theory contains no explanation grounded in individual action that is able to generate the observed result.” In other words, it lacks microfoundations.
The authors themselves draw the connection to the famous microfoundations debate in modern macroeconomics. However, following Kirman (1992), they argue that representative agent analysis has not actually solved the problem, but only added another layer of “mythical” thinking. In this respect, one might say that Eusepi and Wagner are close to the “ultimate in microfoundationalists,” a label Hartley (1997, p. 107) used to describe Austrian economists in the Misesian tradition. Yet, the book is not a contribution to the latter, but rather to public choice theory.
The authors’ main point of contention seems to be that fiscal policy and public debt do not actually serve as a balance wheel, regardless of whether policy makers should try to use it as such. They do not engage in prescriptive policy analysis. Rather, they try to explain fiscal policy as an emergent phenomenon. They argue that a theoretical framework for the explanation of policy measures that we observe around us must take due account of the actual institutional environment within which the relevant actors make decisions, and needs to abstain from idealizing assumptions about their underlying motives. Eusepi and Wagner put themselves in the tradition of The Machiavellians (Burnham, 1943), including Niccolò Machiavelli himself, Gaetano Mosca, Roberto Michels and Vilfredo Pareto, who did not idealize politics, but treated it, arguably more realistically, as a struggle for power. In particular, they build upon the work of Antonio de Viti de Marco.
The authors do not intend to contribute to modern macroeconomics, but explicitly to the political economy of public debt. They hold that a “realistic line of analysis […] cannot rest content with positing relationships among aggregate variables, for to proceed in this fashion is to make it impossible to generate insight into the causal forces that are in play within a society” (Eusepi and Wagner, 2017, p. 32). Moreover, they explain that what they call “realistic” analysis is akin to Peter Boettke’s (2007) “mainline” in economic thought. The latter provides a broader and more encompassing perspective on social phenomena than conventional macroeconomics. It includes, for example, analyses of the relevant political regimes. In chapter 2, Eusepi and Wagner thus develop some preliminary thoughts on the differences between monarchical and democratic regimes as well as some implications for the analysis of public debt.
According to the authors, debt in monarchical regimes, where state activities are financed out of income from royal property, can analytically be treated just like debt in any individual case. Monarchs would certainly be more powerful than regular persons, but they remain individuals that manage their private property and take credit using their own property as collateral. The authors mention that the “macro literature contains many references to sovereign debt and the possibility of sovereign default” and claim that this “literature is reasonable for monarchical and dictatorial regimes, but it is not reasonable for democratic regimes” (p. 39). They argue that the “theory of choice is a useful framework for personal debt as well as for a monarch’s debts. It is not, however, generally useful for democratic debt because democratic debt emerges through some institutionally governed process of interaction” (p. 38).
While democratic debt may indeed emerge out of a somewhat more complex process, in which many individuals, negotiations and political bargains are involved, it strikes the reviewer as a rather odd claim to deny that the theory of choice is a useful framework for its analysis. After all, taking out a loan to finance public expenses, or increasing taxes as an alternative, is always a matter of choice on the part of government officials, regardless of the political system. It might be true that the theory of choice as such does not tell us very much about the subject matter, but that would also be the case when analyzing the indebtedness of monarchical regimes. A detailed analysis of the structural differences, that is, the institutional circumstances and incentives, under which representatives of democratic governments on the one hand and monarchs on the other make decisions, is required. Different arrangements of property rights are in fact a key issue. Put differently, monarchical debt also “emerges through some institutionally governed process of interaction,” although it is a very different one.
Eusepi and Wagner recognize the role of property rights and briefly discuss their relationship with taxes, the latter being the most important source of finance for democratic regimes. According to the authors, taxes represent an infringement upon private property rights or a transfer of property rights from private citizens to public officials, depending on what view of democracy is underlying the analysis. They move on, focusing mainly on the differences between the idealized version of democracy as self-governance, in which property rights are voluntarily transferred by consent, and its actual features in the real world, which include varying degrees of coercion. In reference to Schmitt (1996), they argue that power and subordination are relevant features of all political systems, but “democratic regimes generate mythologies that disguise that power by invoking an ideology of self-governance.” However, “power operates all the same.” (p. 40)
While this is a very important point, the authors overlook that the masquerade of power and despotism in democratic regimes is just an instance of a more general phenomenon that is not unique to democracies. Whoever is in power under whatever political system has an incentive to create and spread an ideological justification for their position in order to protect it. This is as true for democratically elected officials as it is for monarchs or dictators. Take North Korea and the personality cult around the Kim family as a timely example of a hereditary dictatorship.
In the third chapter of the book, the authors provide some further discussion of what characterizes the democratic process of political decision making. In particular, they suggest that an economy is better thought of as an “ecology” instead of an “engine.” The former view stipulates a system that comprises multiple economizing agents and allows for a realistic analysis of the subject matter, while the latter view pictures an economy as a machine constructed for a specific purpose. It is congenial to the mythical mode of analysis in modern macroeconomics. Chapter 3 picks up some of the thoughts from the beginning of the book and provides a transition towards the analysis of public debt under two types of democracy that follows. The subsequent chapter focuses on what de Viti de Marco (1936) called “cooperative” democracy, an idealized system that reflects the consent of the governed and represents an analytical benchmark. Chapter 5 covers public debt under “monopolistic” democracy, a more realistic form of democracy, which generates “gains for some people by imposing losses on other people” (Eusepi and Wagner, 2017, p. 85).
At the core of their argument lies the idea that public debt in democratic regimes does not follow the same principles as private debt under private law, namely, the principles of private property and freedom of contract, precisely because public debt generally emerges at the expense of some people, that is, against their will. The authors claim that “public debt falls within the rubric of public law and public ordering,” (p. 84) which operates differently, since it allows for coercive property transfers.
Chapter 4 starts with the benchmark case of public debt under the ideal of cooperative democracy. The conclusion should be straightforward, but is not drawn explicitly in the book. If state activities always reflect the consent of the people, there is no difference whatsoever between private law and private ordering on the one hand and public law and public ordering on the other. State activities would fall under the nexus of voluntary and mutually beneficial exchange relationships. In reality, however, the benchmark condition of consent is virtually never met. The authors still regard it as a useful point of analytical departure against which to compare real-world monopolistic democracies.
Eusepi and Wagner try to provide what they call a “canonical model of democratic debt” and explain that a
truly explanatory theory of democratic debt within the framework of a cooperative state must be able to explain the emergence of public debt from an initial situation where such debt did not exist. The model of the cooperative state requires that we explain how a set of people might choose to create public debt, just as it must explain how a set of people will agree to tax themselves. Otherwise, all one can do is start with the existence of debt or taxation and assert that this prior existence reflects the consent of the governed because the analyst presumes that consensus is an inviolable property of democracy. (pp. 85–86)
Now, interestingly, the authors are of the opinion that a meaningful notion of public debt is very difficult to conceive even within a cooperative state, or at least, that it is not plainly obvious how public debt could emerge under such a state. This is surprising. Indeed, the assumption of perfect consent is entirely heroic when it comes to actual nation states as they exist, but if we decide to start with that assumption for analytical purposes, it is not very challenging at all to explain the emergence of public debt, that is, a debt contract for which all citizens of the state collectively pledge to pay back a loan plus interest over some period of time.
All citizens might agree, given their time preferences, that it is preferable to finance some desirable government project not out of savings and their current incomes, but via a loan that they promise to repay out of future income. In order for the people truly to be indebted collectively, the creditor must come from outside. Otherwise, only a subgroup of the people would be indebted while the rest would not. Analytically, there would be no difference between this case and, for instance, a married couple taking out a loan together to purchase a house. Of course, it is not the husband who gives a loan to his wife, or vice versa, but there has to be an external creditor for the couple to be collectively indebted.
The word tax might not be very helpful when describing the sum of money voluntarily given to pay back the loan, but this is a semantic issue, not a substantive one. In fact, all taxes paid under a cooperative state would be voluntary payments made because the expected benefit of the government projects so financed exceeds the opportunity costs from the individual perspective of every person in the community. We would be entirely in the realm of private ordering based on the principles of private property and freedom of contract. This is the implication of the assumption of consent, but it goes without saying that it is not “an inviolable property of democracy” in the real world.
Eusepi and Wagner do not provide such a general and simple analysis. Instead, they give the example of a town that by consent of the inhabitants decides to build a dam. They invoke all kinds of complications in the form of disagreements among the citizens about how to finance the dam. Some might prefer to pay the tax directly out of current income or savings. Others might prefer to take out a loan. In such a scenario, the town would of course not collectively go into debt. Only some citizens would, collectively in subgroups or individually. Other citizens of the same state might even become their creditors. This would not be an instance of public debt as described above.
Eusepi and Wagner argue that when the town’s council decides to issue bonds to finance the dam, it would inevitably replace private ordering by public ordering (p. 88). However, the authors forget that under a cooperative system, it can do so only if every citizen gives consent. In such a case, we would remain within private ordering. What the authors convincingly convey, however, is that when we relax the assumption of cooperative democracy, which they implicitly do already in their discussion of the benchmark case, various problems with respect to public debt arise. These include that some inhabitants may be forced against their will to pay back a sum of money that government officials have borrowed to finance projects they themselves disapprove of. This precisely is the problem of political power.
The relevant question then is how can we approach the limiting case of cooperative democracy without coercion? Eusepi and Wagner make the important observation that as “a practical matter of democratic operation, the ideal of a cooperative democracy is surely limited to relatively small-scale democracies,” which is why they work with the example of a town “that contains a few thousand people at most, and where people can easily and nearly costlessly move somewhere else if they choose to do so” (p. 86).
The obvious conclusion seems to be that the right of opting out of public programs, including full-blown secession for sub-communities, must be granted in order to approach cooperative forms of governance. However, the authors do not dwell on this point. It is ironic that these rights exist, for example, in the monarchy of Liechtenstein.
Approaching the cooperative state is not primarily a question of public debt. Yet, it is reasonable to assume that genuine public debt would be extremely low, if it existed at all, under a cooperative state. Again, the tiny monarchy of Liechtenstein has practically no public debt outstanding. The authors conclude the fourth chapter by claiming that “de Viti’s ideal of a genuinely cooperative state is a limiting case that is difficult even to approach with respect to public debt, though it might be more easily approached without public debt” (p. 110). This might be true, but public debt ultimately does not seem to be a cause of non-cooperative or monopolistic governments. Quite to the contrary, it is, at least in its excessive form, one important effect of monopolistic governments. There are numerous problems involved in public debt, and it exists in such large quantities, because virtually all governments are monopolistic in de Viti de Marco’s terms.
Chapter 5 explicitly turns to the analysis of public debt under monopolistic democracies. In reference to Mosca (1939) and Pareto (1935), the authors hold that for “the most part, actual democratic systems operate in monopolistic fashion, meaning that they entail the dominance of a relatively small number of people over larger numbers” (Eusepi and Wagner 2017, p. 111). The authors explain that “people differ in their interests in and talents for acquiring political power. Possessing and wielding power will be more attractive to some people than to others. In this setting, political activity will become the province of subsets of people within any geographical territory.” Following Mosca, one might call this relatively small number of people the ruling class. For these people, public opinion and sentiment are the most important sources of power as explained, for example, in Wieser (1926) and de Jouvenel (1948). The characteristic feature of power, not only in monopolistic democracies, but in any political system, is that those who “hold positions of power can […] distribute costs and gains among the population over which they rule” (Eusepi and Wagner, 2017, p. 112).
According to the authors, debt contracts of monopolistic governments never reflect the will of all the people, but merely the will of some. Given that most actual states are monopolistic rather than cooperative it becomes clear what the authors could mean by calling public debt an “illusion.” It is illusory to take public debt for what the generated ideological tale of democracy as self-governance would have us believe. Public debt does not emerge out of consent, but is imposed upon the people by the ruling class that has successfully provided “ideological formulations that resonate with voter sentiments, such that people can support measures they would have opposed had they engaged truly in logical reasoning” (p. 130). This could include increased deficit spending.
More precisely, the burden of debt is imposed on a subgroup of the people. After all, there are also supporters of deficit spending among the electorate, and it is strictly speaking impossible to say, whether their support for public debt truly stems from a lack of logical reasoning as Eusepi and Wagner suggest. As a matter of fact, it might stem from perfectly logical reasoning. It is of course possible to personally benefit, directly or indirectly, from public debt. The authors do not consider this possibility. They realize that public debt virtually always “creates both voluntary and involuntary debtors” (p. 153), but even more importantly it creates voluntary creditors, who bring themselves in a position to benefit from the government’s power to tax. Others may benefit from public debt indirectly, when they become recipients of the additional government spending made possible by debt finance.
Under monopolistic democratic rule, public debt becomes a tool of power. Eusepi and Wagner correctly emphasize that it covers up a redistribution of wealth behind “illusory” slogans and “ideological images” such as “we owe it to ourselves” (p. 163). The authors point out that the bulk of public debt is in fact not even made explicit through the sale of bonds, but remains implicit in the form of other liabilities that the governments hold, for example, social security programs. They call this implicit public debt a “systemic form of collective lying” (pp. 138–141). They argue that it “is systemic and not personal lying because it is an emergent quality of a system of public ordering more than a quality of any politician, though it is also easy enough to find lying politicians, just as it is possible to point to lying business people for that matter.”
However, it seems rather odd to call lying a quality of a system. Here, the authors have forgotten, for a very brief moment, their ultra microfoundationalist inclinations. It is always individuals that lie, and if the system of public ordering encourages lies for personal benefit and the benefit of selected parties, it will attract opportunistic characters ready to tell them.
In the final chapter of their book, Eusepi and Wagner conclude that “there can be no such thing as public debt in a democracy because a democracy is not a sentient creature.” And furthermore, they claim that there “is no public that can pledge its wealth in exchange for credits from other people” (p. 163). Taken as such, these claims are exaggerated and slightly confusing. It is true that a democracy is not a sentient creature, of course, but neither is a monarchy. Democracies are composed of sentient creatures, if you like, and it is conceivable that they unanimously engage in a debt contract and pledge their wealth as collateral. It might be very unlikely to observe in any given community of a certain size, since such an arrangement would imply a socialization of personal default risk, but it is not impossible.
However, it is clear that much of the image of public debt, generated in ideological discourse is completely illusory. Professors Eusepi and Wagner have provided a fair number of arguments to substantiate this somewhat adjusted claim. The reviewer would hold that public debt is not an illusion of democratic political economy, but simply a very different creature from what it is made to be.
Quarterly Journal of Austrian Economics 20, no. 3 (Fall 2017)Abstract: Ludwig Lachmann claimed that expectations are subjective, and argued that this phenomenon, coupled with the ceaseless change characterizing market data, greatly undermines the strength of any process of equilibration. This paper compares his views on this subject with those of Mises. It argues that Mises also viewed expectations to be subjective. But contrary to Lachmann, he did not conclude that this phenomenon undermines the process of equilibration. Thus, in Mises’s view, a thoroughgoing subjectivism goes hand in hand with a belief in a dynamic market economy where there are strong forces at work ensuring that the decisions of entrepreneurs are coordinated with those of consumers.
KEYWORDS: subjectivism, expectations, equilibrium, coordinationJEL CLASSIFICATION: B20, B53, D50, D84
Quarterly Journal of Austrian Economics 20, no. 1 (Spring 2017)
ABSTRACT: Within the Austrian economists’ community, value investing is characterized as a useful investment strategy, and one that is in line with Austrian economics, in particular Austrian value theory. In fact, value investing shares some basic findings with Austrian value theory, especially the crucial distinction between values and prices. However, value investing also contradicts some fundamentals of Austrian economics. Therefore, the authors argue that value investing’s seeming compatibility with Austrian economics must be characterized as a myth. The aim of this article is to illustrate what makes value investing incompatible with Austrian economics and, hence, to terminate this myth.
KEYWORDS: Value investing, Austrian economics, value theory, intrinsicvalue, subjectivismJEL CLASSIFICATION: B31, B53, D46, D52, G11, G32
The Austrian Economics Core Curriculum course lays out the fundamentals of Austrian Economics. Drawing on the tradition of Mises and Rothbard, the course begins with Praxeology, the study of human action, from which economic principles are deduced. An exposition of subjective value and the division of labor follow, providing the requirements for exchange and markets. From there, the concepts of money’s origin and value are explored, with the interest rate coordination of consumer preferences and the structure of production and business cycles. Finally, the crucial role of the entrepreneur in the market economy and economic calculation are explained.
Featuring lectures by David Gordon, Jörg Guido Hülsmann, Jeffrey M. Herbener, Lucas M. Engelhardt , Roger W. Garridon, Joseph T. Salerno, and Peter G. Klein.
Students that complete this course will earn a certificate of completion.
Quarterly Journal of Austrian Economics 19, no. 1 (Spring 2016): 3–28
ABSTRACT: Ludwig von Mises developed the theory of economic calculation in the context of his argument that the central planning of socialism cannot make economizing decisions concerning the use of resources in a division of labor economy. Focus on the problem of allocating resources in society led to a stress on the calculation used by entrepreneurs in making production decisions. Theory concerning other facets of economic calculation used by entrepreneurs in making investment decisions, i.e., decisions concerning the economizing combination of assets an entrepreneur should own in his enterprise, for instance, was left relatively underdeveloped. The purpose of this paper is to further explore the implications of Mises’s theory of economic calculation for asset acquisitions and disposals, especially the acquisition and disposal of entire business enterprises. In particular the paper seeks to demonstrate that the subjective approach to investment appraisal developed in the German-language, business-management literature is compatible with Austrian value theory.
KEYWORDS: value of the firm, appraisement, investment appraisal, value theory, subjectivism, Austrian school, neoclassicismJEL CLASSIFICATION: B31, B41, B53, G32
The perennial promises of free stuff from political candidates are front and center again now that we are ensnared in another US election cycle. The knee-jerk response from some economists and libertarians is “TANSTAAFL!” And of course it’s true that There Ain’t No Such Thing As A Free Lunch, because somebody must bear the costs of the supposedly “free” stuff. Nothing is free because every action has an opportunity cost.
Especially when the government is involved in doling out the gifts, all it means is that it was bought with money taken from others. Or, sometimes, the money is taken from the person receiving the gift, who thinks he’s gotten something for nothing. (This is a sleight-of-hand political trick that has fooled many for centuries.)
But what if we interpret “free” in a more colloquial sense? Is it still preferable for the government to give away free stuff? Do unhampered markets provide for free stuff?
Two Definitions of “Free”Today’s promises include free college, free healthcare, free paid time off of work, and all sorts of goodies. Although the above conclusion (no such thing as “free”) applies to all of these, I want to consider a different, more liberal definition of “free”: gifted.
For example, if Bernie gives Jonathan an apple that Bernie either grew in his orchard or bought at the store and Bernie expects nothing in return, the apple is a free gift from Bernie to Jonathan. The production, purchase, and loss of the apple is costly, but Jonathan bears none of these costs. Jonathan would technically have to expend some time and effort to hold and consume the apple, and he would lose an apple’s worth of carrying capacity on his person, but ignoring these and other technicalities, we can casually say that the apple is a free gift from Jonathan’s perspective.
So now consider this definition for the above examples: freely gifted college, freely gifted healthcare, freely gifted time off, etc. We realize that these already exist, and would exist absent government provision.
There are innumerable scholarships offered by individuals, organizations, and colleges who want certain students to attend college. Organizations like St. Jude’s, Doctors Without Borders, and Operation Smile offer freely given medical services to patients. And many businesses already allow their employees vacation days, medical leave, and family leave without them skipping paychecks, although there is an important caveat here that this would be priced into their regular salary or wage unless the employing entrepreneurs want to give from their own means.
This is all not to mention the freebies, BOGO coupons, “freemium” apps, and other marketing strategies retail stores employ.
Why Do People Give Gifts?First, we must have more than we want to keep for ourselves.
Widespread abundance like this is only possible with relatively unhampered markets and roundabout production in place, where entrepreneurs are correctly guessing consumer demands and a large capital structure made possible by saving yields plenty of consumer goods. We have to create wealth before we can exchange it, consume it, or give it away.
But once we have such an abundance of means, the reasons for giving are countless and outside the scope of economics. An altruist might give out of generosity, but even a greedy businessman could give because of increased storage costs for all of their inventory, or as a plan to attract customers.
It should be noted that self-interest motivates both the altruist and the greedy businessman. The altruist’s actions are self-interested because he is satisfying one of her own ends by relinquishing ownership of the donated means to somebody else.
Voluntary vs. Involuntary GivingWhen the giver gives voluntarily and the receiver accepts the gift, we can say it represents a mutually beneficial arrangement. The same cannot be said for forced redistribution.
When Bernie gives Jonathan the apple, Bernie is satisfying the highest ranked end he has for that apple. If, however, Bernie stole the apple from somebody else before giving it to Jonathan, then we can say with certainty that the exchange of the apple is not mutually beneficial.
The same goes for college scholarships and medical care. If the government takes the means to give somebody free college, then it does not represent a mutually beneficial arrangement, or else the individual would have voluntarily donated the money for the student to go to school.
Unlike private charities and scholarship funds, the government has no reason to dispense the gifts prudently or to minimize their own cut to maintain a donor base that is confident their donations are used efficiently and for the intended cause.
Forced redistribution also tends to spur bitterness and conflict, as opposed to gratitude and goodwill.
Proponents of Free Stuff Should Look to Capitalism, not RedistributionismThe conclusion we can draw here is that we get just the right amount of “free” stuff through the voluntary interactions of individuals in unhampered markets. And, not only that, but as capitalistic economies inevitably grow and the people become increasingly wealthy, charitable giving can increase as well. As the supply of goods that satisfy our ends gets larger, those marginal goods are more likely to be valued in terms of giving them away rather than keeping them ourselves.
Therefore, those that desire more free stuff should try to encourage more voluntary giving (maybe even leading by example), not forced redistribution. They should also be the loudest proponents of unhampered markets as any voluntary giving must come from wealth that has already been created and in such abundance as to allow for greater giving.
These days it seems that everything in our lives revolves around taxes. Taxation has always caused problems. Taxes distort the structure of production and the price system reducing the real wealth of society.
Yet not everything that people consider a “tax” is indeed a tax. A tax is something that a person is forced to pay, under threat of punishment, by the government. This does not include what has become known as the “pink tax.” The pink tax is the notion that women pay more than men for products that are female-oriented. For example, those who believe in the pink tax often claim that women pay more than men for razors, and that these women’s razors are the same product as men’s razors.
Men and Women Are Not IdenticalWhen discussing the pink tax, we can dispense with the notion that women pay more money for exactly the same products that men use. In order for goods to be identical, the two products must be viewed as homogenous units by the consumers themselves.
Clearly this is not the case, and hygiene products — even ones designed to do similar things — are viewed differently by men and women. First of all, men’s and women’s products generally smell different from one another. This fact alone is enough to distinguish them as separate products if the sexes treat the products differently.
Moreover, in terms of physical amenities, men’s and women’s razors are different in a number of ways. As indicated here, women’s razors are often larger and have more stuff around the blades to help women shave a larger area.
Women pay more for dry cleaning and haircuts. This is partially due to the fact that women’s dry cleaning and women’s haircuts takes more time, and is more labor intensive. More importantly, female consumers of dry cleaning are willing to voluntarily pay the higher prices. But these facts haven’t stopped some from calling for a federal law outlawing differences in prices.
Perhaps the largest “injustice” related to the pink tax is the fact that women often pay more for health insurance. As pointed out here, however, women are more likely to have chronic health conditions. And, as studies suggest, women use health care services differently than men.
Prices Are Not ArbitraryThe cost of producing a good will affect the price, but ultimately, how the goods are valued, relies on the subjective valuations of the consumers. This valuation manifests itself in the form of objective money prices, and it is the consumers who actually determine what products are on the market, and what the price of these consumer products will be.
In the case of hygiene products, it must be remembered that men and women have different standards of hygiene leading to very different demand curves.
Thus, prices in a functioning market will be set at the point where the aggregation of the supply and the demand schedules intersect. That is, it will be set at the level where both sellers and buyers can agree to voluntarily exchange money for the goods.
Companies must set the price as close to this equilibrium price as possible because above this price the company will have a surplus of product to sell, and if it is below this price the company will have shortages, causing a loss in revenue. This works for whole industries too; if suppliers of women’s products are actually charging a higher price for an identical product, and reaping profits, then other firms will start producing women’s products, thus increasing supply and, ceteris paribus, drive prices down.
By continuing to buy differently priced goods for men and women, the consumers have indicated that they think there is nothing wrong with there being price differentials between men’s and women’s products. On the contrary, this “price discrimination” is achieving the most efficient distribution of goods to those who value them the most. If the two different products were truly the same, then women would simply buy the male version of the products.
Moreover, nobody forces these women to pay more for the products they purchase. These products reflect what a woman deems as her most preferred product on the market with given prices. In an unhampered market there are no correct or incorrect prices. There are only the prices that people freely choose to pay. To believe that women only buy women’s products that are identical to men’s due to clever advertising campaigns would be to assume that women have no brains and can be endlessly manipulated by firms. If this where the case, why would companies not just raise their prices for all products and shift most of their funds to advertising?
This Is Not About EqualitySupporters for abolishing the nonexistent pink tax do so under a façade of “equality,” and many groups who believe in the pink tax advocate for legislative action to force companies to lower the price of women’s products so they are equal to prices charged for men’s products. This is nothing more than a form of price control, which as shown here, eventually leads to very bad things.
It is wrongly accepted by many liberals (i.e., libertarians) that most, if not all, social problems can be “solved by the market.” But clearly, the “market” cannot magically solve our problems. Let it be clear that there is no doubt that the best way to have social progress is to have a free market economy. However, free markets are not solutions to problems, per se, but are rather what gives us the opportunity to find our own solutions to our own problems by finding the most valuable way to serve one another. For example, Frédéric Bastiat famously wrote in The Law that: “At whatever point of the scientific horizon I start from, I invariably come to the same thing — the solution of the social problem is in liberty.”
By speaking about the virtues of the market, we tend to forget that markets do not have virtues, only people do. As Murray Rothbard once wrote, “it is overlooked that the ‘market’ is not some sort of living entity making good or bad decisions, but simply a label for individual persons and their voluntary interactions. … The ‘market’ is individual acting.”
The “What Should Government Do?” BiasDuring each crisis, politicians and intellectuals systematically presume that “we should do something.” Thus, when liberals emphasize the importance of not violently intervening in the free market order because of the harmful, but yet unseen, consequences of state intervention, they are often accused of favoring inaction. This is a misconception of the liberal argument.
The free market is not superior because it offers solutions. It is superior because its basis is freedom, a freedom that is used by individuals to find new ways for them that are in harmony with the interests of their fellow men. Of course, there are many problems and abuses with the market, but entrepreneurs — if not prevented from entering the marketplace by governments — seek to solve these problems in the pursuit of profits. Through these entrepreneurs, the market is a process that tends to satisfy the most urgent, not-yet-satisfied, needs of the consumers.
To be clear, liberalism — used here to denote the philosophy of laissez-faire — should not be considered as being the utopian opposite of socialism. It is not a magic recipe that guarantees perfect solutions at all times and for all things. Socialists like to imagine that liberals believe the market can cure every ill. In other words, they think liberalism is a mirror reflection of socialism. It is not. True liberalism does not promise perfection, it does not even promise a solution. There will always be problems. Our goal should be to find the best way to improve the situation, not to achieve an ideal world of fantasy.
When a social problem arises and somebody asks a liberal what must be done, he instinctively argues that “we” should free the markets, that “we” should liberalize, or that “we” should commit to deregulation.
But those proposals are not solutions to our problems at all, they are just a necessary step in the process of setting people free to solve problems. By pretending that “the market” is the solution that “we” should adopt, many liberals are victims of the top-down fallacy and deny the polycentric nature of markets. By calling “the market” a solution, we create the illusion that the free market is just another kind of government policy where the rulers offer us a solution. But the real solutions are offered by free individuals, by the free innovator, the free worker, the free capitalist, and the free entrepreneur.
Solutions to problems are not offered by the market, they are offered on the market. As development economist William Easterly brilliantly writes:
The “what should we do?” industry does not show any signs of going out of business soon. It gives us public intellectuals something to do and it gives politicians something to recommend. Much more positively, it does engage the very welcome idealism of altruists who want to make the world a better place. But the Sustainable Development Goals may be the best demonstration yet that action plans don’t necessarily lead to action, “we” are not necessarily the right ones to act, and that there are alternative routes to progress. Global progress has a lot more to do with the advocacy of the ideal of human freedom than with action plans.
Thus, free markets are a sort of meta-solution. They are the solution to the problem of finding solutions. And it is striking that liberalism might be the only political philosophy that does not have a blueprint for an ideal society.
The “Market Provides Incentives” MythAs the market is not a solution, the market does not give incentives. Leading institutional economists Acemoglu and Robinson, in their celebrated 2012 book Why Nations Fail, focused mainly on “incentives.” Whereas they — moderately — praise capitalism as an “inclusive institution,” they criticize “extractive institutions” because they “fail to protect property rights or provide incentives for economic activity.” They also write:
As institutions influence behavior and incentives in real life, they forge the success or failure of nations. … Bill Gates, like other legendary figures in the information technology industry … had immense talent and ambition. But ultimately responded to incentives.
There is no doubt that Why Nations Fails is, for the most part, a good book. However, Robinson and Acemoglu’s appraisal of incentives seems to be problematic. First of all, they assume that institutions should give “incentives.” But this is a constructivist fallacy, to use Hayek’s concept. It implicitly supposes that some external force should direct human actions.
Furthermore, it gives too much importance to top-down approaches. Acemoglu, like many other economists, seems to think something — e.g., the government — should incentivize. But what does it mean to say that government, property rights, or institutions give you an incentive? In fact, when wrongly used, the term “incentive” seems to invoke determinism. This is why Acemoglu writes that people “ultimately responded to incentives,” as if a mysterious force called incentives was influencing the choices each one of us make.
Incentives are not something that can be understood as being independent of individuals, they are purely subjective. An incentive can only be understood as the correct discovery of an individual’s own subjective preferences in order to lead him to act as you wish. Therefore incentives are not something you can “give,” it is something you have to discover.
The free market does not “provide” an incentive to work, it lets you work freely. The free market does not “provide” an incentive to invest, it lets you use your savings in order to make a profit by serving the consumer. There is no such thing as a god called “market” that will furnish you some incentive to be productive. However, the market is the best institutional framework to create harmony between the plans of a vast number of individuals — hence the title of Frédéric Bastiat’s magnus opus Economic Harmonies.
Because they are free, different individuals can understand each other’s preferences and exchange. Only in this way do people “give an incentive” to each other in order to commit to exchange and enhance their situation. Therefore, institutions do not provide incentives, people do. The sentence “the market provides incentives” contains the same problem as the sentence “the market is the solution.” It is just not so. The market is merely an institutional framework in which people can make plans freely. As Hayek says in a famous rap song “the question I wonder is who plans for who, do I plan for myself, or I leave it to you? I want plans by the many, not by the few.”
ConclusionThe modern state can be defined as the institution that pretends to have the monopoly of solutions to social problems. But since the state operates like a monopoly, it behaves like a monopoly and therefore exploits the very people it is supposed to serve. In fact, proponents of government action imply that the members of the civil society are not able to find their own solutions nor able to identify what the problems are. But the most competent men do not need the state to answer our problems, they just need freedom. When a problem arises, the right question is not “what can the government or the market do,” the right question is “what can I do.”
In their new book, Phishing for Phools, Nobel-prize winning economists George Akerlof and Robert Shiller use a behavioral economics approach to criticize the “manipulation and deception” that can exist between businesses and consumers.
According to Shiller,
[a] fundamental concept of psychology is that people often make decisions they’re not happy about. … If businesses have a chance to profit by tempting us into making decisions that are good for them but bad for us, they will take it. They have just as powerful an incentive to provide us with what we don’t want as to provide us with what we do want.
According to the Wall Street Journal, this is one of the main contributions of the book: the market is the best mechanism to offer people things they do not want to have.
We Do Not Buy What We Do Not WantNo one denies that sometimes we do things we later regret. Most of us once bought something that we later regretted spending money on.
However, the fact that these errors in judgment may occur — on the part of the consumers — is not evidence that businesses attempt to sell products that customers do not want.
It’s important to understand that individual decisions are made prospectively, looking forward in time. When an individual buys a product or service, he does so because he expects it to remove his “uneasiness.” At the time of the transaction, this person making the purchase is indeed revealing his desire to have that good. Otherwise, he would not make the purchase. This does not mean that, in retrospect, our decision may be judged to have been a success or a failure, depending on whether it really served the purpose it was meant to serve.
But it doesn’t follow from here that the market is as good at delivering what people want as it is at delivering what people do not want. If this was the case, then business would continue to sell audio cassettes, VHS videotapes, and other products to consumers who have been “manipulated” into buying them.
Obviously, this is not what happens.
Who Regulates the Regulators?Another weak point in Akerlof’s and Shiller’s argument is their implied solution: government regulation. In a recent article, Shiller writes
While we confirm the importance of free markets, we have found that market regulation has been crucial, and believe that will continue to be true in the future. [Standard economic theory] usually ignores the fact that, given normal human weaknesses, an unregulated competitive economy will inevitably spawn an immense amount of manipulation and deception.
One can’t help but notice the central contradiction in this analysis. On the one hand, it is assumed that markets fail because of “normal human weakness.” On the other hand, it is assumed that regulation, which must necessarily be implemented by human beings with equal or greater “weaknesses,” will somehow solve the problem.
Akerlof and Shiller simultaneously demonize human beings who operate in the private sector while idealizing human beings who operate in the public sector.
Lessons From South AmericaFor evidence of the problem with this approach we need look no further than South America where government agents are quite adept at giving people “what we do not want.”
For example, we can note the fact that a process of impeachment recently began against the president of Brazil because, according to the allegations, she tried to hide the true extent of increases in public spending. Meanwhile, in Argentina, former Vice President Amado Boudou cannot leave the country because he is accused of misappropriating funds from the company responsible for printing pesos bills.
These are just some recent examples in a nearly endless list of corruption cases, and if democratically elected officials such as these are capable of such large-scale deception and malfeasance, why should we think that these same people can help reduce “manuipulation and deception” in the market place?
The situation we face in South America is exactly the opposite of the free-wheeling under-regulated markets described by Shiller and Akerlof. We live in highly regulated economies which are being suffocated and corrupted by an excess of political power.
Meanwhile, according to the latest IMF estimates, Venezuela, Brazil, and Argentina have been among the slowest growing economies from 2011 to 2015. Not surprisingly, all three of these countries have been implementing highly interventionist policies, boosting public expenditure, manipulating credit markets, and controlling prices of certain goods and services.
And, of course, South America is hardly the only place on earth that experiences political corruption.
The focus, then, contra Shiller and Akerlof, must be placed on how to dismantle this system, not in providing it with more weapons and arguments to continue growing.
Lego — the company that makes stackable toy bricks — has become a toy powerhouse in recent years, even surpassing Mattel in toy sales during 2014. Lego has become so popular, in fact, that the company has problems avoiding “brick shortages.”
Lego’s success as a fun and educational toy has been helped along by the fact that — finally — Lego has managed to find success with girls.
With the launch of the Lego Friends line, Lego has tapped into 50 percent of the child population:
according to research firm NPD Group, the market for girls’ construction toys in the U.S. and the main European countries tripled to $900 million in 2014 from $300 million in 2011, largely on the back of the Lego Friends sets. And Lego says the share of girls among Lego players, which stood below 10% in the U.S. before the launch of Lego Friends, has increased sharply.
The Feminist ControversyPerhaps predictably, Lego has been condemned by feminists and culture warriors for making Lego too “girly.” Those familiar with the Friends line already know how, instead of red and blue bricks for making fire stations, the new line designed for girls features purple and pink blocks (among other colors) for constructing yachts, homes, and restaurants.
The Wall Street Journal recently examined the controversy, noting:
After five years of work, [Lego] was enthusiastic about launching Lego Friends. The new sets, however, immediately unleashed a torrent of criticism from feminist groups. A U.S. activist organization, the Spark Movement, gathered 50,000 signatures with an online petition in 2012 and requested a meeting with Lego executives. Another group, Feminist Frequency, also complained.
“We were so disappointed,” said Dana Edell, executive director of the Spark Movement. “Lego was sending a message that girls get to play with hair dryers while boys get to build airplanes and skyscrapers.”
Ms. Edell, however, should probably aim her disappointment and disdain at seven-year-old girls rather than at Lego. After all, Lego’s success, or lack thereof, in marketing these products depends on the decisions of little girls.
Profit Seekers: Make Toys Girls LikeThat is, Lego can only make money from the girl demographic if it makes toys little girls decide they want to play with. Following years of focus groups and surveys, Lego has produced toys that it thinks will attract their attention and demand.
Lego has said exactly this in interviews:
Our methods are simple; meet children’s needs by testing prototypes on them and getting their opinion. We have realized that girls like building too, so LEGO gave them the chance to customise their world, until then their needs were not met. We also realised that girls wanted to be able to identify with the figures and we therefore had to develop figures closer to their expectations: more feminine, less “square” than our standard mini-figurines. Since friendship is a core value for little girls, we created a universe which centred around a story of friendship between our 5 heroines.
Anyone who has daughters — and listens to what they say — can see this is a plausible scenario.
The Lego Friends line, which is just as rigorous in terms of construction difficulty as any other line, was designed to appeal to girls in ways that Legos did not before.
Lego wanted girls to buy their products, so it designed products that appealed to them, based on market research.
How Lego Became a Boy BrandIf Lego ignored what girls really wanted, and marketed something else, they would not make as much money. Or no money at all.
This explains how Lego became a “boy’s brand” in the first place.
After marketing its toys for years in a unisex manner, Lego found by the 1980s that all its best-selling sets were “boy” sets featuring pirates and knights and spacemen.
The company then began to market more aggressively to boys, since like most companies, it ended up focusing on the most profitable sector of its customer base.
Lego Finally Figures Out What Girls WantLego still attempted to market to girls, but failed, perhaps even due to genuine sexism. Thinking that girls did not want the same level of rigor in construction as boys, Lego in the 1970s and afterward marketed a variety of “simplified” types of Legos that failed. These included Lego jewelry sets known as “Scala” and easy-to-build sets based on mimicking doll houses.
If Lego was being sexist, it was punished by the market for it. Lego simply failed to cater to the wants and needs of girls. And it endured foregone profits because of it.
With Lego Friends, Lego finally found a line that girls actually like, and the market is rewarding them accordingly. Meanwhile, feminists attack Lego for making toys that children want to buy, but which feminists think girls should not want to buy.
The real problem the anti-Lego feminists have then, is not with Lego but with the fact that girls like to play with the sort of toys found in the Friends line. The blame for this lies with the girls themselves.
After all, Lego did not raise these girls or tell them what to like. Lego simply wants to make toys that they will buy based on their existing preferences.
Indeed, any competent toy executive will be agnostic as to the question of what girls should like. They must focus instead on what girls do like. Toy companies make money by selling toys that will be popular with as little effort (for the company) as possible. And, it turns out, much to the annoyance of some activists, girls like a Lego experience that includes pink and purple bricks.
Producers Don’t Dictate to ConsumersNow, the source of the misunderstanding here is apparent. The activists think that Lego is responsible for deciding what girls should want because — like many people who don’t understand how markets work — they think that producers dictate to consumers what to buy.
The idea at work here is that girls will buy and like whatever it is that Lego Corp. wants to market to them. Thus, by extension, it is Lego’s job to fight culture wars and tell girls what the “correct” play experience is.
But it doesn’t work that way. Companies make money by selling what people want. At the same time, companies that make products few people like will ultimately fail, no matter how many commercials they put on the television.
Consumers Decide What Is ProducedAfter all, if people will buy whatever they’re told to buy, then why not just spend nearly 100 percent of the toy company’s budget on marketing and advertising? The rest can go to making a low-quality product. If it breaks easily or turns out to be no fun, then that’s all the better because then they’ll just buy another one because an ad told them to.
If a slick ad campaign is all that is necessary to make someone like a product, just make a slick ad showing the sub-par product in a good light. People will just keep on buying it because the advertisements say so.
Everyone instinctively knows this is not true, though. McDonald’s can run TV commercials all day long, but that, apparently, isn’t enough to keep people buying Mickey D’s food at the price the company prefers. Subway can repeat the “eat fresh” mantra, but that won’t keep sales from slipping, as they have been doing for several years.
And if we’ll buy whatever toy makers tell us to buy, why aren’t children playing with the same toys they were playing with thirty years ago? It costs money to develop new toy lines and design new sets. Why go through the trouble of creating new toys, when it’s possible to make customers like your products by just running ads for existing ones?
The reason for this, as Murray Rothbard observed long ago, is that every consumer has the ability to simply refuse to purchase what she’s asked to buy for whatever reason or whim she deems important. Ludwig von Mises called this “consumer sovereignty.”
Even more frustrating to producers is the fact that consumer preferences change constantly due to a variety of — often inscrutable — factors far beyond the control of marketers and producers. Producers thus have a choice: adapt to changing customer preferences, or die.
Here Eugen von Böhm-Bawerk--Mises's teacher and a huge figure in the history of thought--explains and argues for the subjective theory of value, the theory of marginal utility, and their relationship to price.
This book was originally published in German in 1886 as an elaboration on Menger--driving home points concerning value as against every non-Austrian point of view.
He completely demolishes not only the labor theory but also the value theory that rests on claims of aggregate economic value or social worth. In so doing, he clarifies points that Menger himself hadn't entirely spelled out. He also outlines for the first time in this article the modern marginal productivity theory of factor pricing.
The author covers the nature and origin of value, the measurement of value, the value of complementary goods, the scientific significance of subjective value, and the theory of objective exchange value.
Walter Block has assembled thirty chapters defending behavior that is probably offensive to most Americans, such as dwarf tossing and stereotyping, and many that are downright illegal, such as dueling and smuggling. Plus, he's provided us with humorous cartoons at the end of many chapters. The bottom line message in Freedom in All Realms: Defending the Undefendable is that the true test of our commitment to personal liberty doesn't come when we permit others to engage in those peaceable, voluntary acts with which we agree. It comes when we permit others to engage in peaceable, voluntary acts we find offensive. (Walter E. Williams)
Elections took place across the country this past Tuesday with some interesting results. Voters in Ohio decided they hated monopolies more than they liked marijuana, while residents in Houston voted down the left’s latest egalitarian menace. While there is never a reason to trust the empty promises of pandering politicians, elections can occasionally offer insight into who is winning the battle for ideas. So there may be reason for optimism when you see Hawaiians’ discussing secession or the fact that there is global momentum in the fight against prohibition. While central planners struggle — both in the US and abroad — to maintain the status quo, bad government will never be able to repeal good economics.
The question then turns to how to we advance the cause of Austrian economics, peace, and freedom? That is the topic of this weekends’ Mises Circle in Phoenix, Arizona. One of our speakers, Dr. William Boyes, joined Jeff Deist this week to offer a preview of his talk. The founder of Arizona State University’s Center for Economic Liberty and a successful author of economics textbooks, Dr. Boyes discusses how to advance liberty and capitalism in the face of a statist educational system. One option — our new Online Mises Boot Camp!
In case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Activists Seek to Impoverish Thai Villagers to Save Monkeys from "Slavery" by David AdamsFor WHO, Red Meat Is a Red Herring by Yuri N. MaltsevThe Fed Desperately Tries to Maintain the Status Quo by Ronald-Peter StöferleHow Beijing and the West Work Together to Manipulate the Global Currency War by Brendan BrownWhy We Need Private Property to Deal with Scarce Resources by Patrick Barron"Social Expenditures" In the US Are Higher Than All Other OECD Countries, Except France by Ryan McMakenZwolinski and Woods on the Basic Income Guarantee by David GordonPot Battle in Ohio by Mark ThorntonPoverty Does Not Cause Obesity by Ryan McMakenWill Regulation Destroy a Revolution in Physics? by Matt McCaffreyMy Irish Eyes Are Smiling by Mark ThorntonA Practical Guide to Hawaiian Secession by Ryan McMakenMexico, Canada, and Ten American States Look Toward Marijuana Legalization by Ryan McMakenYellen on Negative Interest Rates by Jonathan Newman
Scarcity of resources exists in many forms and is the problem in economics. If resources were not scarce, there would be no need to economize. The existence of scarcity is true of all resources (such as time, human energy, and natural resources). However, it is not necessarily intuitive that allowing scarce resources to be owned privately is the solution to this problem.
Consequently, socialism appears attractive to many and they turn to having all resources owned collectively for the “common good.” Unfortunately, a society which spurns private property — and hands resources over to government planners instead — often learns the terrible lessons of central planning and the tragedy of the commons (i.e., commonly held resources will be plundered to extinction).
If society spurns allowing private ownership of resources, it must find some other means to prevent the tragedy of the commons and to allocate goods. Historically, the means chosen is the use of force and central planning. Throughout history, most of mankind has been divided into a hierarchical system of masters and slaves with some gradations between the two extremes. The masters (pharaohs, emperors, kings, sultans, warlords, etc.) devised complex rules-based systems for resource distribution that were decided by a small number of people and not by markets. And ultimately, these plans depended upon pure terror for enforcement. But this so-called solution to the problem of scarcity — restricting the people’s liberty through the use of force — does not work.
Problem 1: We Can’t Economize Without Effectively Ordering Our Preferences FirstThe gradual growth in the understanding of what we now regard as basic economics eventually ended thousands of years of subsistence existence for the masses in the West. Modern economics explained that without private ownership of resources, there was no mechanism for observing or acting on ordinal preferences in which persons prioritize desires from highest to lowest. Without a way to allocate goods according to ordinal preferences, there is no rational means to economize for the betterment of society.
In other words, without markets and prices, there is no way to know what people really want or need, so the masters never really knew what to order the slaves to produce, what technical means to use, what alternative materials to use, the quality desired, or how much to produce. Thus, the commissars of the Soviet Union ordered the production of inefficiently produced, shoddy goods. The Soviet empire collapsed, despite the fact that Russia is blessed with vast natural resources and an industrious population.
Problem 2: Few Raw Materials Are Ready to ConsumeA second fatal problem with common/government ownership of resources is that few readily available, consumable resources actually exist. There are no resources on the planet that do not require at least a minimum of effort to transform into a consumable product. Even edible berries growing in the wild must be harvested, meaning that someone must transport himself to the berries’ location and pull them from the bush at just the proper time. The cost of doing so is the value one places on forfeiting his leisure. Of course, other natural resources require much more effort to convert to consumable products, passing through many stages of production.
For example, timber and minerals must be extracted, harvested, etc. and then molded into something that can be consumed. Consider a hiker lost in the wild. It matters not at all to him that great stands of timber lie within easy reach or that valuable minerals lie under foot. These natural resources require great effort over very long time periods to be converted into something consumable, as is the case with converting timber into a shelter or crude oil into gasoline. A lost hiker does not have the knowledge, time, or previously produced means to convert these basic resources into consumable products to ensure his survival. All this is far beyond anyone's autarkic abilities.
Now let us assume that someone did harvest trees by felling them, transporting them to a lumber mill, milling them, storing them in a ventilated and dry place for many months before kiln-drying them (all processes that are required to turn trees into useable lumber), advertising their availability to contractors, keeping sales records, sending out bills, and collecting the bills, only to have a socialist call him a plunderer and confiscate his lumber for free distribution to whomever the masters deemed to be politically advantageous to their continued privileged position. No one other than the favored cronies of government would ever harvest another tree. In other words, production of usable lumber would be monopolized, and as with all cases of monopolies, prices would increase and quality would decline. Moreover, with no voluntary market at work in timber and forest land, there would be no means of knowing if these resources were being used in a way valued by those who valued them most.
At the same time, the central planners could not let just anyone harvest the trees or access the land. If the trees had no owners, great forests would be denuded in short order because there would be no social mechanism to prevent what would amount to a tragedy of the commons by order of the state.
Problem 3: We Need Private Property to Build CapitalWithout the ability to profit from privately owned property, there would be no incentive to provide or withhold capital for any endeavor. Also, a system of private ownership is necessary to determine if that capital is being used in a way the consumers value. The consequences of ignoring this fact of economic science is most evident today in China's ghost cities, where resources, both natural and human, have been expended for no observable benefit except to advance the careers of politicians who can claim to have met the requirements of the latest Five Year Plan. Timber and other resources were provided to build ghost cities, not because the owners of the resources sought to be economical with their resources, but because government edicts required that timber, concrete, gasoline, and more be used to produce what are now empty cities.
The opposite case of resource waste comes from special interest groups who capture the political apparatus of the state and prohibit exploitation of resources by private individuals. In the name of protecting Mother Gaia from being plundered, modern environmentalists have convinced the political class that most progress is unsustainable, dangerous to our health, or any number of other specious claims. Society is prevented from benefiting from their conversion to consumable products. The poor suffer the most from these policies as the prices of raw materials — and thus finished consumer goods — are driven up.
Private ownership insures that valuable resources will never be plundered to extinction, because their value will have been capitalized. Instead, private owners will seek to make resources as widely available as possible without endangering the long-term prospects for future harvesting of resources. The process of determining a resource’s capitalized value is impossible absent free-market capitalism with strict defenses of property rights.
Despite both the theoretical and empirical evidence to the contrary, socialists tell us the opposite; i.e., that state ownership of all resources will prevent their plunder and ensure prosperity for all. As Ludwig von Mises explained, though, socialism is not an alternative economic system of production. It is a system of consumption only, and a system of economic ignorance and economic plunder.
“Buy land — they’re not making any more!” is an old investing chestnut, and a common sense one to boot. Economically, it’s also completely false.
As counterintuitive as it may seem, we make land all the time. It just doesn’t look like land.
Why? Because land’s value doesn’t come from its ability to cover up the naked earth. Land’s value comes from its economic usefulness. From the value of things that can be done using that land (Rothbard’s “marginal revenue product” of the land). And that value is, indeed, changing all the time. Economically, from a price perspective, then, we make land all the time.
Step back a moment and ask why land has value anyway. Why do people want land? Well, obviously, because you can put stuff there — including yourself — plus buildings, swimming pools, and factories.
Now, anybody who’s visited West Texas knows there is plenty of building space in the world. You could drive for hours and meet nobody. There’s lots of space for that factory of yours. But it’s not really space itself that makes land valuable. It’s location. As in, there’s only so much room in Manhattan. Or Central London.
Once again, though, it’s not the actual space that matters. It’s the access. Put a strip mall on Manhattan surrounded by crocodile-filled moats and snipers and it will have low value. The value is in access. So Manhattan is valuable because it’s easy to get to other parts of Manhattan. And it’s easy for other people to get to you. Customers, partners, and friends can all easily visit you if your apartment or office is in Manhattan, moatless and sniperless.
So if it’s the access that matters, are they making new access? Of course. They’re doing it all the time.
New highways, new exits, new streets, mass transit, pedestrian malls are being regularly constructed. These all effectively “make new land” because they offer access to existing space. They turn relatively “dead zones” into "useful zones," or new land.
What are some of the meta-trends on land as investment, then?
First: roads. This was a bigger value-driver a generation ago in the US, as new roads made the suburbs more accessible, helping to drain many cities even as US population grew. Outside the US (Mexico, Thailand, Russia), new roads are still a big deal, and even in the US, new highways can reshape values — draining old neighborhoods and building value in new ones. The decline of cities like Baltimore or Detroit are partly thanks to those beautiful roads that redistribute access to the suburbs.
Second: population. In the US “rust belt” of declining manufacturing, many regions have dropped in price simply because people are leaving. Detroit homes for $100 is emblematic, although of course there are also political reasons some cities are so cheap — in particular, taxes and crime.
And that brings us to politics. Real estate can be cheapened shockingly quickly by taxes and crime, and those traditional drivers have been joined in recent decades by environmental politics.
Environmentalists, by taking land off the market, effectively squeeze the remaining accessible locations. Driving up the price. Regions like Seattle or San Francisco are poster children of this environmental squeeze, with modest homes even in remote suburbs costing upward of a million dollars. On the other extreme, cities like Dallas or Houston have kept prices down despite exploding populations by allowing farmland to be converted to residential, commercial, or industrial use.
Beyond the access and political angles, land is also vulnerable to “network effects.” In other words, the neighbors matter. Gentrification or urban decay can be hard to predict. Even in a compact city with rising population like Washington, DC, it can be hard to predict where the middle class or rich want to colonize, and where they want to flee.
There are clues, of course — in large US cities, gays moving into a neighborhood, new coffee shops or art galleries are some leading indicators that property prices might swing up. But gentrification has it’s own mind; even in a booming city it might go into some other neighborhood. New York’s Harlem or Silicon Valley’s East Palo Alto are two very accessible locations with low prices because of perceptions of the neighbors.
So, while they’re not “making” land, they are constantly making things that affect land price. Access, regulations, changing neighbors. These are the kinds of factors that make land valuable, not it’s ability to cover the earth.
And so land comes back to earth, joining boring old commodities like wheat or copper. Just as vulnerable to changing supply and demand factors.
And if you are looking for something they’re not “making more of?” Well, gold does come close. Hence its appeal. They do mine new gold all the time, but the costs are high enough that gold is a very “inelastic” commodity. It comes close to “they’re not making more.”
Beyond that? Develop your ultimate resource: yourself.
Taught by Professor Peter G. Klein, this course provides a systematic overview of Austrian microeconomics, starting with the basics of scarcity, choice, and value; then moving to exchange and demand; the determination of prices; factor markets and factor pricing (including labor); profit, loss, and the entrepreneur; the structure of production; and competition and monopoly.
University of Sussex Professor Mariana Mazzucato is making headlines with her 2013 book The Entrepreneurial State, which argues that government, not the private sector, ultimately drives technological innovation. In a series of detailed case studies from information technology, pharmaceuticals, biotech, and other industries she argues that government labs and public agencies are mainly responsible for the fundamental, high-risk discovery and development that makes these technologies possible, with profit-seeking entrepreneurs jumping in only later, after the difficult work has been done.
This is a very old argument, skillfully brought to life in Mazzucato’s writings (and a popular TED talk). Remember President Obama’s “you didn’t build that” remark to entrepreneurs, during his 2012 presidential campaign? “Somebody invested in roads and bridges. If you’ve got a business — you didn’t build that. Somebody else made that happen. The Internet didn’t get invented on its own. Government research created the Internet so that all the companies could make money off the Internet.”
The view that private actors are short-sighted, and that only government can afford (or is willing) to make the long-term, high-risk, patient investments in research and development needed for technological progress is in every basic economics textbook. Even economists who are generally favorable toward free markets and limited government will say sure, the market is good at producing shoes or trucks or laptop computers, but the market cannot provide basic research — it is a “public good” that only government can provide. The New York Times recently opined:
Fundamental innovations such as nuclear power, the computer and the modern aircraft were all pushed along by an American government eager to defeat the Axis powers or, later, to win the Cold War. The Internet was initially designed to help this country withstand a nuclear exchange, and Silicon Valley had its origins with military contracting, not today’s entrepreneurial social media start-ups. The Soviet launch of the Sputnik satellite spurred American interest in science and technology, to the benefit of later economic growth.
There are several problems with this kind of argument. First, it confuses technological innovation (impressive to engineers) and economic innovation (valuable to consumers). Second, it confuses gross and net benefit — of course, when government does X, we get more X, but is that more valuable than the Y we could otherwise have had? (Frédéric Bastiat, call your office.) Third, it confuses treatment and selection effects of government spending — government typically funds scientific projects that would have been undertaken anyway, such that a main benefit of government spending on science and technology is to increase the wages of science and technology workers. Fourth, as writers like Terence Kealey have pointed out, if you look carefully at the details of the sorts of programs lauded by the Times, you find they were grossly inefficient, ineffective, and potentially harmful. (Kealey offers a powerful critique of Mazzucato’s specific views here.)
Does War Drive Innovation?It’s useful to illustrate these points by considering the specific argument that war is an important, and even necessary, source of scientific progress, because technologies developed by the state to fight wars often have important civilian uses. Innovation is a side benefit of war, say war’s defenders.
Social science textbooks also assume that war spurs innovation and note that the large-scale manufacturing of penicillin, for example, and the development of nylon and aerosol sprays occurred during the First World War. But that’s nothing compared to the many benefits of the Second World War, we’re told, which brought us benefits ranging from atomic energy to jet engines and the world’s first electronic computing devices, which were developed to break the Nazi “Enigma” codes. Moreover, key innovations in management practice came out of the Second World War, we’re reminded, including management techniques used to improve logistics, procurement, and operations research.
The Second World War changed the nature of scientific research as well. After the war, large-scale federally-funded laboratories devoted to practical applications for new research replaced the small academic laboratories that had existed before the war. Naturally, these new laboratories were geared toward producing new technologies that the federal government wanted, and scientists flocked toward these jobs and new well-funded facilities.
It’s true that many (though not all) of these technologies were developed — typically not invented, but refined — by government scientists working on military projects. The question nevertheless remains as to whether or not this model of innovation benefits society at large. Is this a “good side” of war?
“Crowding Out” and Interest-Group PoliticsThe answer is no, for multiple reasons. First, if we look at each of these cases carefully, we find that the government was usually inefficient, chose bad technologies that crowded out other, privately-funded technologies, and led to inertia in research in directions that the private sector would likely never have supported.
But there is a more basic theoretical problem with the claim that military research gives us great new technologies we otherwise wouldn’t have.
It is certainly true that governments spend money on building things or doing things that otherwise would not have been built or done. But this is not necessarily a good thing.
Take the Egyptian pyramids, for example. Had there been no pharaoh, commanding a huge budget, with the ability to mobilize vast quantities of resources (including labor), there would be no pyramids. But were the pyramids unambiguously good for the people of Egypt? They were not, of course, and the pyramids were simply monuments to the power of the pharaoh and the state religion. To this day, governments build monuments to themselves all the time, whether they’re huge statues or atomic bombs. Sure, without the federal government, we might not have the Lincoln Memorial. Is that an argument for government?
Pyramids and statues are cases of the state producing a good that likely would not have been produced in any form by the private sector, but even in cases in which the government shapes the development of private goods and technologies, the distorting effects on the final outcome of research and development can be significant.
We can see these distortions in the effects of the work of Vannevar Bush, the initiator of the Manhattan Project. Bush was chairman of the National Defense Research Committee (NDRC), and later director of the Office of Scientific Research and Development (OSRD), in the Second World War.
Bush wanted a peacetime successor to the OSRD and pushed for creation of the National Science Foundation, which was established in 1950. The NSF was controversial (one proposal was vetoed by Truman in 1947) because of the lack of accountability. A key figure was Senator Harley Kilgore of West Virginia, who initially opposed Bush’s plan to distribute the money through universities (he preferred the government to own the labs) but later agreed to Bush’s model. As Kealey describes it, Kilgore’s goal was not to generate new knowledge. Rather,
Kilgore wanted to create a reserve of scientifically trained personnel who could be mobilized for strategic purposes. ... The National Science Foundation, therefore, was created in 1950, in the same year (and for the same reasons) as the National Security Council.Economic Laws of Scientific Research, p. 154.
A few scholars have recognized the potentially harmful effects of this approach. Best known is the “distortion thesis” of historian Paul Forman, which holds that WWII and Cold War national security concerns distorted the path of the physical sciences.
Applied to technology, there is the “crowding out” thesis, most closely associated with Seymour Melman, which maintains that, during the Cold War, commercial R&D was crowded out by government-funded R&D. As summarized by the distinguished historian of technology David Hounshell,
“Research, development and manufacture for a single customer (the national security state or the military) led firms and whole industries into a kind of fatal attraction, which ultimately undermined their ability to compete in the global economy in which consumers had very different wants than those of the military; “spin offs” from military projects into the civilian economy simply did not compensate for the drawbacks of being dependent on military contracting.
Again, the Broken Window FallacyWe see once again the relevance of Frédéric Bastiat’s Broken Window Fallacy. That is, the research and development institutions created and sustained by government are like the pane of glass in the broken window. We see it being repaired but cannot see what might have been produced with those same resources had the glass not been broken.
Similarly, we see what is produced by government scientists producing R&D for the state, but we don’t see things we would have had the market been able to function in the absence of a giant militaristic government.
There is no doubt that military spending had a substantial effect on technological innovation. But was it a good one? Military spending distorts the efforts of scientists and engineers, and redirects them to particular projects, ones that do not necessarily generate benefits for consumers.
Military-funded R&D, like any government-funded projects, does not have to pass any kind of market test, so there is no way to know if it is actually beneficial to consumers. We cannot rely on the judgments of government scientists and scholars to say what are the “best” technologies. Remember Betamax? The experts told us that Betamax technology was superior to VHS tapes, from an engineering point of view. Yet, in the end, VHS proved to be economically superior in that consumers ultimately chose VHS over Beta. Betamax failed the market test in spite of its arguably superior technology.
Today, when we look at private companies like Google, Apple, and Facebook and marvel at their innovations, we should remember that these companies are constantly subject to market tests, and that the goods and services they innovate must be accepted by consumers to be profitable. When they succeed, we know that they are creating value for society because consumers have chosen their products and services over others.
Success, for government-funded researchers and engineers, on the other hand, means winning grants and contracts, and getting more money from the taxpayer, who has little say in what gets done.
The reality is far more complicated than the myths repeated by those who claim that many of the technologies and innovations we now value were produced single-handedly by government. Yet, the historical reality does not diminish the ease with which Obama and other fans of government spending can point to innovations like the internet and the interstate highways and say “you didn’t build that.” We can only speculate on what might have been produced had the market been allowed to function. Likewise, we can still see the pyramids today and marvel at the innovation that went into their construction, but unfortunately, the wealth and labor stolen from ordinary Egyptians to build them has now been long forgotten.
In an almost daily debate over economic and monetary policy politicians complain if prices — such as home prices — do not rise, and some complain if they think other prices — such as health care prices — are going up too much. This situation begs the question: do we want rising prices or falling prices?
The truth is that prices are neutral, at least as far as social welfare is concerned. Constant changes in prices indicate that an economy is working to coordinate the wants and needs of consumers and entrepreneurs. They are the mechanism by which buyers communicate with sellers, and vice versa.
For this reason, before we can understand the role of prices, it is important to distinguish between “prices” and “offers,” even if in our daily dealings we tend to conflate both terms. A price is the ratio at which two commodities have been interchanged by two individuals in a concrete transaction. However, the “prices” we see in a supermarket for each of the available goods are not actually prices, but offers, and will only become prices if the good is actually bought. If the “price” for an apple is set at, say, 100 euros per apple, and consequently no one buys any apples, it would be wrong to say that the price of an apple is 100 euros, just because the supermarket tried to sell apples at such a price.
With this in mind, let’s try to answer the question: does social welfare improve, when prices increase or when prices decrease? If the price of a concrete good rises, it is clear that people who already own the good will be better off. Those people which have the means to produce it, be it labor or assets, will likely profit from the increase too. Conversely, people who do not own the good will be worse off, especially if they are planning to buy it in the short term. The contrary will of course happen if the price goes down.
So, what is the balance for society? There is no answer. In fact, from the point of view of “society,” the rise and fall of various prices are simply the marketplace at work. For concrete individuals in specific concrete transactions, there are costs and benefits, but in relation to “social welfare” or “the economy,” we can conclude nothing.
The Role of Prices in SocietyHowever, this is not the end of the story: prices have also a fundamental role to play in the market. They are the signals by which entrepreneurs guide their decisions on investment. As such, prices are an indicator of the relative scarcity of a good with respect to its uses.
If a price rises, this means that a good is more valued by society, and conveys the signal to entrepreneurs that more resources should be deployed to the production of that good, because this is what society is currently demanding. Conversely, if a price decreases, the good is losing value for society, and resources should be moved from its production to other more productive uses. This process, as explained, is not automatic, but driven by entrepreneurs using prices as signals.
When We Mess With PricesWhat happens if prices are tampered with through price controls or other coercive government controls? Of course, the first effect will be that some individuals will lose and others will win. For example, if prices are not allowed to increase, people owning the product — or the means of production — will lose wealth, while people intending to buy it will increase their own wealth. Politicians normally think that this is good for “the people,” because — in the minds of many populists — firms are “rich” and this action re-distributes wealth from “the rich” to other people.
This may be good for the individual consumer for a particular transaction; but individuals are much more than consumers: they may be shareholders of firms, or they may have a pension plan which is invested in the firm, or they may work for the affected enterprise or for any of their providers upstream in the value chain. So, in the end, it is not even easy to clarify if a concrete individual, much less society, is better or worse off as a result of the price control.
However, this is not the gravest effect of price tampering. The biggest problem is that disrupting the price system jams the price signal system, and thus entrepreneurs are hindered from calculating how they should devote resources to a particular enterprise. The entrepreneurial process will go on, but the resources will be taken to the wrong places, impoverishing the society with each investment.
One other thing should be considered: entrepreneurs, being human, may make mistakes. An entrepreneur may offer a good at too a high “price” and then find he is not able to sell enough units to make the investment worthwhile, being forced to bring the price down in order to increase the sales. This does not make the initial price wrong and the new price right: it just means that the entrepreneur is reacting to the new information acquired after the first attempt. If further information comes along, the price may be revised again, be it upward or downward. This is the essence of the entrepreneurial process, to react to changes in the environment trying always to adapt to the new preferences shown or anticipated by individuals.
To maximize this essential interplay between consumers and producers — through which consumers exercise their control over the marketplace and even society at large — the goal needs to be freedom in prices, and not “high” prices or “low” prices. Tampering with prices prevents them from doing what they’re supposed to do, making the process of resource allocation harder and more ineffective. And this would definitely harm all of us.
Image source: https://www.flickr.com/photos/civisi/2611679744
The unhampered market creates economic inequality. Free marketeers tend to concede this fact as an unfortunate defect in an otherwise laudable system. F.A. Hayek, however, in a chapter from The Constitution of Liberty, argued that inequality is fundamental to a society's progress. Hayek explained how, by purchasing luxuries unimaginable to the average man, the rich unwittingly perform a vital public service. Indeed so fundamental is inequality to economic progress that egalitarian societies, Hayek concluded, would be faced with no choice but to deliberately re-inflict upon themselves the very class systems they had sought to escape, should they wish to achieve well-directed economic advancement.
Leaders and FollowersThere never exists sufficient material resources to institute all technically feasible innovations at once: fantastic ideas are always in a surplus relative to our physical means. Hence, there is a need for choice between paths — not every new idea can be successful at revolutionizing the lives of consumers. But who decides which innovations are to be successful? The rich.
Those new goods that prove sufficiently popular in the marketplace will spread through the upper echelons of society; they will come in time to be strongly associated with the finer things in life. Though of course desirable on their own terms, it cannot be denied that their appeal is enhanced by this association. The rich are mannequins over which these new ways of life are seductively draped. And in observing this display of "better things," the poor come to see something concrete to which they might personally aspire; they envisage those same goods in their own homes.
The rich's consumption decisions have the effect of giving the future a specific and achievable form. The future is no longer an abstract concept: it is a tangible item that one expects for himself or his children to someday enjoy.
To be sure, the rich intend only to buy luxuries for themselves — they do not intend, when browsing new technologies, to inform the very direction of societal progress. Regardless, they find the poor attentive to their tracks, tracing their steps forth.
Hopefully, the role played by the rich is clear: it is they who provide the market on which new and expensive technologies might find success; it is their spending which is the lifeblood pioneers seek. Their choices are scrutinized by those behind and, like a contagion, the desire for their lifestyle spreads, prompting a frenzy of further, cost-cutting developments and innovations which eventually climaxes in provision for all. Ultimately, the consumption decisions of the rich set the path for those behind; they sculpt the horizon for which society is bound.
Why Is this Good?This piece began with the claim that, when the rich spend lavishly, they perform (albeit inadvertently) a vital public service. Admittedly, it remains unclear how exactly anyone could defend this claim. Why should we favor the state of affairs outlined above, whereby the consumption decisions of the rich guide our progress? One is required to imagine a counterfactual, characterized by perfect egalitarianism, before he may come to appreciate the important function served by inequality (i.e., by the rich) in society.
The Department of Research and DevelopmentClearly an egalitarian society, existing by definition without wealth disparities, could provide no market for expensive, nascent technologies. Hence, in such a society no consumers would nurture technological saplings. Without a high-end market on which to sell, innovators would find less incentive to innovate: they wouldn't earn a dime until the economy had advanced to a stage at which general provision of their new product was feasible. This wait might in some cases exceed the innovators' life spans. But could not the State plug this hole?
We will posit a Dept. of R&D, created to overcome this problem. They provide a State-funded forum for innovation. It is this Dept. of R&D, in the absence of a rich class, which is tasked with providing rewards to innovators. Innovators need wait no longer to be compensated for their brilliance. In this way, a role for the rich has been entirely omitted; goods need never be the preserve of any privileged few. The State keeps in its employment a host of innovators, whose products will be released from the labs only once general provision is feasible.
Here is the problem: who will decide which innovations are to be instituted first, second, and third, i.e., which ideas and designs should receive the bulk of the innovators' time? In unequal societies, this is determined by the rich. The rich's consumption decisions provide information as to the relative importance of new, expensive luxuries. And on reflection, it is clear that they are best equipped to make such judgments. The rich live in an advanced state: their present lifestyle anticipates that of the future. It is, therefore, the rich who are best able to predict what average men of the future will want, and hence it is also the rich who may best direct modern-day innovators, who, because of the long timeframe of their work, are engaged in anticipating today the preference scales of tomorrow.
As an extreme (and possibly tasteless) illustration of the foregoing, imagine an impoverished Zambian boy being asked to choose Christmas presents for his middle-class, American counterpart from a 2014 catalog. The Zambian might well understand that a copy of The Crew on PS4 would grant the American a fantastical virtual adventure; that Water Dancing Speakers would illuminate his room as he listened to music; and that a Remote Control Robot would entertain him as it "danced, spoke and fired disks." He would not, however, be well-placed to judge the ranking of the goods in the catalog on the American boy's preference scale. The Zambian lives in a far less-advanced material state, and hence finds it hard to think beyond those more basic things to which he presently aspires.
The people of an egalitarian society would similarly struggle in thinking beyond their current, more meager aspirations. In an unequal society a rich class exists ahead of the rest, with a view of the way forth; the desires that spring from their lives of luxury are a map for those at the helm of material progress. Without such a class of people, innovators would be without much indication as to the likely ordering of future preference scales, and as a result they would provide less effectively for future generations.
As mentioned in the introduction, the egalitarian society could overcome its problem only by destroying itself. It would be forced to create sectors of society that lived in more advanced states, so that innovators in the employment of the Dept. of R&D would have the ability to compile focus groups with which they could consult and by whose preference scales they could be guided. Hayek remarked that this "situation would then differ from that in a free society merely in the fact that the inequalities would be the result of design and that the selection of particular individuals or groups would be done by authority rather than by the impersonal process of the market and the accidents of birth and opportunity."
ConclusionIn an unequal society, even when innovative new products are still in their infancy and costly to manufacture, it is possible to subject them to a market test. The results of these tests may be used to direct innovators and entrepreneurs: they will abandon their efforts to further develop those goods that proved unpopular among the rich, focusing their resources instead in the refinement of those goods that proved popular. The rich's lavish spending, then, is a signal for innovators, providing direction as to how they might best focus their efforts — the rich's preferences, remember, act as a proxy for those of future average men. When there is no class of rich people, as in egalitarian societies, there is no longer anybody to channel the preferences of tomorrow. Innovators are left in this case to stumble without guidance. They will find no indication as to the popularity of their products with future men, and hence will be far more likely to find themselves engaged in worthless endeavors, to the detriment of themselves and society.
Image source: iStockphoto.
Volume 4, No. 1 (Spring 2001)Ingo Pellengahr’s doctoral dissertation, The Austrian Subjectivist Theory of Interest, focuses on one small aspect of these ongoing debates. He traces the development and evolution of what is generally referred to as the (pure) time preference theory (PTPT) of interest. The PTPT is historically associated with the Austrian School, whose characteristically subjectivist members stress the primacy of individual valuations—versus objective facts concerning the productivity of capital—in any discussion of interest. Pellengahr offers a largely critical review of the major Austrian contributions to the evolving PTPT and then presents an original, “essentialist” synthesis which he hopes will be acceptable to the various factions in the debate.
Volume 4, No. 1 (Spring 2001)Though little known among the economics establishment during his lifetime, Ludwig M. Lachmann was always widely connected. The range of scholars whom he knew and with whom he communicated was truly impressive. Since his death in 1990, he has become better known, particularly among heterodox economic scholars representing a wide variety of viewpoints. His appeal to such a heterogeneous group is undoubtedly to be found in his insights regarding the nature and importance of knowledge. This is reflected in this interesting book of essays honoring his memory. The book is edited by two scholars who, while differing in their approaches to economic doctrine and policy, share an appreciation of Lachmann’s scholarship, and an appreciation of his intellectual honesty, his methodological subjectivism,and his interest in endogenous change.
Volume 15, No. 3 (Fall 2012)
How rational are humans? Many important implications hinge on this seemingly innocuous question hinge, for not only economists, but all social scientists. In Thinking, Fast and Slow, psychologist and recipient of the 2002 Nobel memorial prize in economics (alongside Vernon Smith), Daniel Kahneman, gives a summary view of the question. At first glance the book seems to be an overview of Kahneman’s lifework, but upon closer inspection it offers much more. Kahneman synthesizes the research of the past forty years to give the reader a more or less complete answer to the question: how rational are we? He also explains the special cases where humans resort to alternative heuristics in their decision-making.
Volume 13, Number 1 (Spring 2010)ABSTRACT:
We examine the strict preference approach to the interpretation of human action and the assertion that a choice cannot be made between actions in which the actor is indifferent to the outcomes. We show that this view is incompatible with decision problems involving equally optimal actions and we examine various attempts to avoid the existence of these decision problems. We argue that attempts to avoid these decision problems are contrary to the causal-realist approach and lead to unnecessary confusion about the nature of choice and indifference. We show that the alternative approach of using non-strict preferences allows indifference to be given a praxeological interpretation and derived directly from non-strict preference relations as a praxeological category. This leads to a sensible approach to economic analysis that is compatible with the causal-realist approach of the Austrian School. This also avoids the attendant problems of the strict preference approach and allows decision problems to be described in accordance with ordinary language
Indifference and choice are surprisingly tricky issues in economics. They have been the subjects of much debate, particularly within the literature of the Austrian school. At the core of the matter is the question of whether indifference has any praxeological meaning or whether its meaning is purely psychological, a matter which falls outside the domain of economics. This question has important ramifications, at least for the proper exposition of economic theory. Since praxeology is concerned with intentional action, a praxeological concept of indifference has implications for the relationship between indifference and choice. Most particularly, it determines whether choice of an action contradicts indifference between that action and other foregone actions.
The praxeological conception of indifference between actions is naturally suggested by the subjective theory of value expounded by Carl Menger, which stresses that goods attain value—and therefore equality or inequality of value—only through their serviceability to our needs. According to Menger (2007):
In the value of goods, …we always encounter merely the significance we assign to the satisfaction of our needs—that is, to our lives and well-being. If I have adequately described the nature of the value of goods, if it has been established that in the final analysis only the satisfaction of our needs has importance to us, and if it has been established too that the value of all goods is merely an imputation of this importance to economic goods, then the differences we observe in the magnitude of value of different goods in actual life can only be founded on differences in the magnitude of importance of the satisfactions that depend on our command of these goods. (pp. 121–22)
This suggests that a praxeological conception of indifference between actions must be understood in terms of equality of the magnitude of importance of the satisfactions of needs obtained by these different actions. That is, we are indifferent between two actions when we judge that there is no difference in the magnitude of the satisfactions of needs obtained from those actions (the actual needs may be different, but the magnitude of the satisfactions from these needs must be equal). Similarly, we are indifferent between two goods when we judge that there is no difference in the magnitude of the satisfactions of needs that depend on our command of those goods.
In addition to a praxeological conception of indifference, the subjective theory of value can also be used to obtain a praxeological conception of homogeneity. This approach was recently expounded in Machaj (2009) where the author explains:
How can we define homogeneity in this framework? It’s very easy—two objects are homogeneous if they both can serve the same end. If so, it follows these are two units of the same supply, because they are capable of satisfying the particular need. From the point of view of an actor’s particular need they are homogeneous and interchangeable or equally serviceable. It does not have anything to do with psychological considerations or physical characteristics, but rather with the possibilities of action….
This solution rejects the neoclassical concept of indifference and saves the concept of homogeneity. … All this solution offers is the concept of homogeneity in the Mengerian tradition without falling into the murky waters of psychology. (pp. 234–35; some emphases removed; spelling corrected)
Under this approach, homogeneity and indifference are both praxeological and are directly related in praxeological terms. Different goods are homogenous if command of those goods allows the satisfaction of the same needs. Since value is derived solely from this satisfaction, this means that homogeneity implies indifference, though the converse is not true (i.e., it is possible to be indifferent between goods that are not homogeneous).The fuller quotation of this part of Machaj (2009) shows that he uses indifference and homogeneity interchangeably, and thereby defines indifference between goods as homogeneity. In fact, indifference between goods is a more general relation, since two goods may serve different needs, but may do so in such a way that the magnitudes of the satisfactions of those different needs are equal. In this case, a person would be indifferent between goods that are not homogenous.
Now for the tricky part: While the praxeological conception of indifference and homogeneity might seem perfectly natural for followers of the Austrian school, it implies that choices can be made between indifferent alternatives, something which flies in the face of the preference theory maintained by many eminent Austrian school economists. It is clearly possible for different goods to be equally serviceable to our needs, and for us to judge them so. Moreover, it would seem to be possible to make choices between these goods (later we will consider and refute an argument denying this). But if this is the case, then a praxeological conception of indifference and homogeneity implies that choice between indifferent alternatives is possible—in fact, it would appear to occur very often.
STRICT AND NON-STRICT PREFERENCE ORDERINGSThe possibility of choice between indifference outcomes is accommodated within the general framework of standard mathematical expositions of preference and action. These presentations use the concept of a “preference ordering” on a set of possible outcomes of action, where this ordering is interpreted as meaning that certain outcomes are regarded as “no worse than” other outcomes, with respect to the ex ante preferences of the decision maker.Throughout this paper, I leave out discussion of uncertainty as to the outcome of the actions, or other complicating factors, which do not change the nature of the argument. For the purposes of the discussion of indifference and preference, a reference to the “outcomes” of an action is a reference to the ex ante expected outcomes, from the point of view of the actor, with all uncertainty and other complicating factors taken into account. Action by the decision maker then establishes the existence and direction of these relations, in that it establishes that the outcome of the chosen action is no worse than the outcomes of the actions which were foregone—this is the law of “revealed preference”.
Under this approach, the primary relation established by action is the “no worse than” relation, which is the absence of a strict preference contradicting the action taken. This relation is an example of a non-strict preference ordering (also sometimes called a weak preference) in that it includes the possibility that the decision maker is indifferent between the chosen action and one or more foregone actions. Strict preferences and indifference between outcomes are then regarded as derivatives of this primary relation, and can be explained in terms of this relation (the standard mathematical presentation of this subject is given in the Appendix).
One plausible alternative to this non-strict preference approach, and the one adopted by many eminent Austrian school economists, is to treat action as demonstrating a strict preference for the chosen end (also sometimes called a strong preference). That is, to take an action in pursuit of some end as meaning that the outcome pursued is regarded as strictly “better than” other outcomes which were not pursued, again with respect to the ex ante preferences of the decision maker. This position denies the possibility of choice between actions in cases where the actor is indifferent between the outcomes.
THE AUSTRIAN SCHOOL APPROACH TO INDIFFERENCEIt is unclear whether the strict preference approach is the established Austrian school viewpoint or not. Mises (1998) does not appear to explicitly consider the distinction between strict and non-strict preferences in his analysis of human action, saying only that “[s]trictly speaking the end, goal, or aim of any action is always the relief from a felt uneasiness” (p. 93).It is not surprising that Mises did not analyze this distinction, given that it became most obvious during the later rise of the foundations of mathematical economics in the late fifties and early sixties (see, e.g., Debreu 1959). It was in these mathematical systems that the derivation of indifference from preference orderings, and the distinction between strict and non-strict orderings became most clear. Some incidental remarks that could be interpreted as support for the strict preference approach are found in Mises (1980), though these remarks are ambiguous and are also obiter dicta.In arguing against Irving Fisher’s indifference analysis, Mises talks about an example of an individual faced with a choice of goods who “...finds it impossible to decide between the two, i.e. he values both equally” (p. 56). This could be interpreted as a statement of the strict preference approach, or it could be interpreted merely as meaning that the inability to decide implies indifference, but is not necessarily implied by it. Moreover, in the context of the argument (a critique of cardinal utility) it is not clear whether Mises had the distinction between strict and non-strict preferences in mind at all. What is certain is that he is less clear on the subject than Rothbard, who confronts the distinction explicitly. Whatever Mises view of the matter, the strict preference viewpoint has been adopted by some later Austrian school economists. In particular, Rothbard (1997) explains the theory of action and indifference as follows:
Indifference can never be demonstrated by action. Quite the contrary. Every action necessarily signifies some choice, and every choice signifies a definite preference. Action specifically implies the contrary of indifference…. If a person is really indifferent between two alternatives, then he cannot and will not choose between them. Indifference is therefore never relevant for action and cannot be demonstrated in action. (p. 87)
This strict preference conception of human action has also been explicitly adopted in Hoppe (2005) and Block (2009a) in debate over preference and indifference, with both authors referring with approval to the Rothbardian view.
As we have seen, the denial of the possibility of choice under indifference contradicts the use of a praxeological conception of indifference and homogeneity. This opens up the question of whether or not indifference is a tool that can properly be used in the Austrian school’s theory of economics at all. Rothbard is in no doubt about the answer, saying: “[t]here is …no role for the concept of indifference in economics or in any other praxeological science” (Rothbard 2004, p. 307). But this presents a potential problem: that of forming the notion of homogeneity, and the consequent notion of “units of a commodity.” Nozick (1977) criticizes the Austrian school for their allegedly implicit use of indifference in this task (see also Caplan 1999):
…the Austrian theorists need the notion of indifference to explain and mark off the notion of a commodity, and of a unit of a commodity. … Without the notion of indifference, and, hence, of an equivalence class of things, we cannot have the notion of a commodity, or of a unit of a commodity; without the notion of a unit (“an interchangeable unit”) of a commodity, we have no way to state the law of (diminishing) marginal utility. (pp. 370–71)
This critique presents a serious challenge to Austrian school economists who adopt the strict preference view. If it is correct, it requires that they either reverse their position on indifference, or abandon the notion of homogeneous goods and the entire marginalist revolution of Menger.
Nozick’s critique has been taken up in previous analysis in Block (1980), Hülsmann (1999), Hoppe (2005), and in recent debate in Block (2009a) and Hoppe (2009). It receives further attention in Block (2009b) where the author rejects the praxeological conception of indifference and homogeneity, admitting that “If homogeneity is praxeological, if it is really equally serviceable, then Nozick and the critics are correct; Austrians must jettison either the law of diminishing marginal utility, or, embrace indifference” (pp. 69–70).
While the responses contained in these papers have been useful in clarifying some ways in which one can proceed from the strict preference approach, the result, as this paper will argue, has been to construct a rather strange interpretation of indifference and choice, consisting of assertions about choice and action that are contrary to the plain meaning of the terms and contrary to the Mengerian causal-realist approach which exemplifies the Austrian school.
It is the purpose of this paper to argue that the root of the problem is that the strict preference approach adopted by Rothbard and subsequent Austrian school economists is mistaken and the non-strict preference approach is correct—that is, that people can and do choose between alternatives to which they are indifferent. This view leads to a praxeological conception of preference and indifference under which neither is the primary relation established directly from action. Instead the primary praxeological category established by action is a judgment of non-preference for one action over another, as is used as the basis for standard mathematical models of preference and indifference. Strict preference and indifference can then both be derived through consideration of various combinations of non-preference, and can both properly be regarded as praxeological relations. While non-preference is observed directly, strict preference and indifference cannot be inferred solely from observed actions and must instead be inferred counterfactually.
EQUALLY OPTIMAL MUTUALLY EXCLUSIVE ACTIONSTo establish this claim, let us first consider the basic process by which hypotheses can be tested, and accepted or rejected. The essence of this process is built on the fact that contradictions do not exist in reality, so that any contradictory finding manifests an error. Thus, if one begins with several mutually exclusive hypotheses, and the law of non-contradiction, one can deductively eliminate false hypotheses by determining when these hypotheses contradict known facts of reality.
In the case of preference and indifference, we must therefore ask: does a choice of a particular action contradict the possibility that the actor is indifferent between the action taken, and some action foregone? Rothbard clearly thinks that it does; in remarking on the use of indifference maps in contemporary mathematical economics, he says, “The crucial fallacy is that “indifference” cannot be a basis for action” (Rothbard 2004, p. 307, emphasis removed). Hoppe (2005) agrees with this view, and further elaborates on the reasons, saying that “…any attempt to explain why one chooses to do x rather than y with reference to indifference rather than preference strikes one as a logical absurdity, a ‘category mistake’” (p. 87).
Now, it is certainly true that indifference cannot “be a basis” for action and cannot explain the action; this much is freely admitted by Machaj (2009) in his exposition of the praxeological conception of homogeneity. It is also true that an attempt to explain a choice by reference to indifference is absurd. But this does not rule out the possibility of choice under indifference, so long as there is some other explanation for the choice, some other basis for the action. If this can be established, then we avoid this alleged “category mistake.”
To see that this is possible, consider the situation in which there are two or more actions which are regarded by the actor as equally optimal actions—that is, the actor is indifferent between the outcomes of these actions, but strictly prefers any of those outcomes to the outcomes of any other available actions. In such a situation, a choice of one of the equally optimal actions is required in order to avoid the other, less preferred alternatives. To adopt the words of Mises, the aim of the action is “…the relief from a felt uneasiness,” the uneasiness in this case being the alternative less preferred outcomes of the other available actions.
Thus, in such a case, the actor will take one of the equally optimal actions. Because there are several of these actions and they are mutually exclusive, there is no choice but to forgo one (or more) of these actions in order to take another, notwithstanding indifference between them. Here the explanation for the chosen action is not by reference to indifference, but rather, by reference to preference—the preference for any one of these actions over all the available alternatives.
To take an example used in Hoppe and Block’s debate on indifference, suppose that a mother sees her two young sons Peter and Paul drowning, and has time to rescue only one of them. In this situation she has three choices: rescue Peter, rescue Paul, or do not rescue either of them. Put in terms of the consequences of her actions, these three choices amount to:
A Paul drowns;
B Peter drowns; or
C Peter and Paul both drown (the conjunction of A and B).
Now, since parents do not want their children to die, it is clear that A and B will each be preferred to their conjunction, C. If the mother loves her sons equally and is indifferent between outcomes A and B then the options of rescuing Peter or rescuing Paul are equally optimal—both are preferred to the other available alternative. In this case, despite her equal love for her sons, the poor distressed mother will nonetheless be forced to rescue either Peter or Paul, in order to avoid the deaths of both of them.
One important special case of a decision problem involving equally optimal actions is the case where the actor is indifferent to all the available actions (and there is more than one), including the action of “doing nothing.” For example, a medieval convict shackled to a cell wall, may be completely indifferent between the available actions of “doing nothing” and “rocking side to side.” If this is the case, then he simply must take one action or another, not because the outcomes of these actions are preferred to some other outcome, but because this exhausts all the possible actions available to him, including “inaction.” Here the explanation for the chosen action is not by reference to indifference, but rather, by reference to impossibility—it is simply not possible to choose an action outside the class of equally optimal actions.
WAYS OF GETTING AROUND THE PROBLEM OF EQUALLY OPTIMAL ACTIONSThe case of equally optimal actions which are preferred to some alternative, or which exhaust all available actions, is very problematic to the strict preference viewpoint, which holds that choice under indifference is impossible. Indeed, if not rebutted, it presents a fatal case against the strict preference approach.
Interpreted mathematically, the problem of equally optimal actions is represented by the following decision problem. Suppose we have a decision space (S, ≽) consisting of a set of available actions S and a non-strict preference ordering ≽ which induces an indifference relation ∼ and a strict preference ordering ≻ (see the Appendix for more details; also Takayama 1985, pp. 175–79). The problem of equally optimal actions occurs when the decision space (S, ≽) is such that:
a. There exist some actions a,b∈S such that a∼b and a≽c for all c∈S (this also implies that b≽c for all c∈S).
Under this condition, actions a and b would be equally optimal actions. To see why this would be fatal to the strict preference approach, we note that this approach asserts that the chosen action x∈S is such that x≻y for all other actions y∈S. But this is contradicted by the above condition, which implies that either x≼a or x≼b (or both).
It is clear that the strict preference approach must, in one way or another, deny the possibility that such a decision problem can ever exist. Now, since the decision problem in question is formed by the structure of a decision space composed of two elements (the set of available actions and the preference relation), there are only two ways of doing this. One is to deny that the preference relation ≽ can be structured so as to obtain an equally optimal action problem. The other is to deny that the set of available actions S can be structured so as to obtain an equally optimal action problem. Of course, there may be any number of particular arguments asserting these general conditions. However, all arguments against the existence of equally optimal action problems must fall within one or both of these categories.
Rothbard (2004) denies the possibility of equally optimal actions as follows:
Since indifference is not relevant to human action, it follows that two alternatives for choice cannot be ranked equally on an individual’s value scale. If they are really ranked equally, then they cannot be alternatives for choice, and are therefore not relevant to action. Hence, not only are alternatives ranked ordinally on every man’s value scale, but they are ranked without ties; i.e., every alternative has a different rank. (pp. 309–10)
Looking at this statement, we can see that Rothbard is making the following two assertions (assuming comparability of all actions):
b. If S is such that a,b∈S then ≽ must be such that a≁b; and
c. If ≽ is such that a∼b then S must be such that a∉S or b∉S or both.
Of course, these are actually two ways of expressing the same assertion:
d. The decision space (S, ≽) is such that a≁b for all a,b∈S.
Rothbard’s assertion is slightly stronger than is required to deny the equal optimality condition. He not only denies the equal optimality condition, but also the possibility that the decision maker can be indifferent between any of the available actions. This is sufficient, but not necessary, to avoid condition (a) and therefore to save the strict preference approach from the problem of equally optimal actions.
Having considered the general methods by which one may attempt to avoid equally optimal action problems, we are now in a good position to consider some possible resolutions for this problem which are put forward in Block (1980) and Hoppe (2005) and are further debated in Block (2009a) and Hoppe (2009). Hoppe and Block’s positions represent the two methods by which the existence of the problem of equally optimal actions can be denied. One is to deny that the preference relation can be structured so as to obtain an equally optimal action problem (Block’s approach). The other is to deny that the set of available actions can be structured so as to obtain an equally optimal action problem (Hoppe’s approach). In the former case, it is assumed that the choice itself induces a change in the preference structure, so that there are no longer equally optimal actions. In the latter case, the indifference between the equally optimal outcomes is used to deny that they can properly be regarded as different choices, so that there are again no longer equally optimal actions.
STRICT PREFERENCE INDUCED AS A RESULT OF CHOICEBlock (1980) holds that indifference between different actions can exist prior to the choice between them, but, as soon as a choice from the class of equally optimal actions is made by the actor, some preference between the individual actions must be formed, in order to choose one of the actions over the other. In an example involving the sale of one pound of butter from a supply of one-hundred units, Block says:
Before the question of giving up one of the pounds of butter arose, they were all interchangeable units of one commodity, butter. They were all equally useful and valuable to the actor. But then he decided to give up one pound. No longer did he hold, or can he be considered to have held, a homogeneous commodity consisting of butter pound units. Now there are really two commodities… [—the butter that is retained, and the butter that is given up]. (Block 1980, pp. 424–25).
This approach means that the preferences between the units of butter change during the course of the transaction, not as a result of any change in the owner’s view of the serviceability of these units, not as a result of any disparity in their purchasing power or their ability to satisfy his wants, but solely as a result of the necessity of choice, brought about only by the introduction of a more preferred alternative (selling a unit of butter). Under this view, the units of butter were homogeneous before the choice, but are not homogeneous after the choice.Block’s further elaborations on the subject make things all the worse. He explains that the “indifference” in this situation is a psychological, rather than a praxeological or economic category, claiming that this alone is sufficient to establish homogeneity of goods and the law of diminishing marginal returns (Block 1980, p. 425). Of course, this would appear to establish the law of diminishing marginal returns, not as an economic law, but as a psychological phenomenon, something that has been strongly denied by Austrian school economists (e.g., Rothbard 2004, p. 73). But Block is having none of this—he elaborates on his views, saying: Homogeneity is, properly, at least in the context of diminishing marginal utility, a thymological, not a praxeological category. ... It is satisfied when goods are indistinguishable chemically, or physically, not praxeologically. ...it is my view that decreasing marginal utility is praxeological, and, for this law to not logically imply illicit indifference, supply cannot consist of equally serviceable units; rather, it must be (thymologically) composed of physically or chemically identical units. (Block 2009b, p. 70) But there are many problems with this view of homogeneity. The first problem is that it still fails to explain how the preferences can change due to the decision to give up a pound of butter. Surely, if the units of butter were physically indistinguishable before the transaction, then they must remain so after the instant of choice. Secondly, unless “physically distinguishable” has some special watered-down meaning, this requirement is incredibly strong. The requirement would rule out homogeneity in almost all cases in which an actor scrutinizes goods with any semblance of rigor. It would rule out homogeneity of even such simple things as coins or monetary bills of the same denomination, and maybe even pounds of butter, since these items will inevitably have some physical imperfections that distinguish one “unit” from the other. Even physical differences which are totally irrelevant to the actor then become a basis for a break with homogeneity, so long as he notices them. If the actor notices that a particular dollar bill has a crease in the top left corner and another one does not, then they are no longer homogeneous. He probably will not care about this difference, and will regard both bills as equally serviceable for the satisfaction of his needs, but now we are again in the realm of praxeological indifference and homogeneity.
To this author, this kind of reasoning seems unconvincing, in that it violates the causal-realist approach and reverses the causal relationship between preference and choice—it posits choice as the reason for a change in preference, and not the other way around. Now, while it is true that the praxeological approach uses the notion of preference as an explanatory instrument for actual human action, so that preference is secondary to action in this sense, the actual causal relation between wanting and doing must surely not be made topsy-turvy in order to try to support the strict preference theory.
The approach of positing choice as the cause of preference cuts forcefully against the grain of the causal-realist method adopted by the Austrian school. Indeed, it runs completely contrary to the causal-realist explanation of the subjective value of goods given in Menger (2007). If goods obtain their value only from their capacity to satisfy our needs, then this requires that any strict preference between goods must follow from some difference in the magnitude of the satisfactions that depend on command of those goods. Under the causal-realist approach, if the actor is genuinely indifferent between each pound of butter prior to the sale, it is difficult to see why his preferences between the units of butter should change during the course of the transaction, unless there has been some underlying change in the satisfactions that can be derived from command of these different units of butter. The mere introduction of another more preferred alternative, if it does not change the relative satisfactions that can be gained from the different units of butter, would not seem to meet this criterion.As far as the relative preference between the units of butter is concerned, the introduction of the trade would be an “irrelevant alternative” (see Ray 1973), since it does not affect the ultimate satisfactions that depend on command of the units of butter (i.e., each unit of butter still allows the same ultimate satisfactions) and therefore must not affect the preference (or indifference) between them. Contrarily, in Block’s argument, the new alternative of exchange for another good is allowed to affect the preferences between the units of the sold good.
It is important to note that Block’s suggestion of a change in preferences being induced by the act of choice is not contingent on any greater scrutiny being applied to the evaluation of the units of butter once the necessity of choice is evident. So long as the person need not choose between the units of butter, he may make a meticulous comparison of them and conclude his own indifference no matter how conscientiously they are examined and appraised. He may consider them equally serviceable as a unit of payment and equally serviceable in satisfaction of all his wants, so long as he does not currently prefer to make such a payment. But, should he then be put in a position where it is preferable to give up one unit—in payment or otherwise—and he therefore chooses to do so, now—voila—a phenomenon occurs in which his preference between them is altered.
AMALGAMATING MUTUALLY EXCLUSIVE ACTS INTO A SINGLE “CHOICE”Another possible solution to the problem of equally optimal actions is given by Hoppe (2005) following the work of Searle (1984). Unlike Block, Hoppe rejects the view that a choice between equally optimal actions induces a strict preference and instead holds that indifference between outcomes may remain even when a particular action is taken, and another foregone. However, he denies that this constitutes a “choice between” the actions. Instead, his approach in such a case is to interpret the action as a choice of the conjunction of the various specific actions which are equally optimal, amalgamating them into a single chosen action. Hoppe (2005) explains the situation of the drowning children as follows:
…a mother who sees her equally loved sons Peter and Paul drown and who can only rescue one does not demonstrate that she loves Peter more than Paul if she rescues the former. Instead, she demonstrates that she prefers a (one) rescued child to none. On the other hand, if the correct (preferred) description is that she rescued Peter, then she was not indifferent as regards her sons. (p. 91)
Put in terms of the above taxonomy of actions, Hoppe is saying that, if the mother is indifferent between A and B, then rescuing Peter demonstrates a preference for the exclusive disjunction of A and B (one child drowning) over the conjunction of A and B (both children drowning). In other words, what you regard as the “chosen action” depends on how you frame the choices.Rothbard makes a similar argument (though nowhere near as well developed) when he states: If it is a matter of indifference for a man whether he uses 5.1 or 5.2 ounces of butter for example, because the unit is too small for him to take into consideration, then there will be no occasion for him to act on this alternative. He will use the butter in ounce units, instead of tenths of an ounce. (Rothbard 2004, p. 307)
Hoppe’s explanation of the situation is an ingenious way of attempting to rescue the strict preference approach from the problem of several equally optimal and mutually exclusive actions. Hoppe is claiming that, although the mother rescues Peter, she did not actually choose outcome A. Since she was indifferent between A and B, she could not choose A, and forgo choosing B. Rather, she chose outcome “A or B” even though she actually happened (for whatever reason) to do the specific action that led to outcome A. Thus, by her action of rescuing Peter, she shows that she prefers outcome “A or B” to outcome “A and B”. To Hoppe, the preferred description of the action is that the mother is “rescuing one of her sons,” not “rescuing Peter.”
This argument is grounded in the fact that actions have both an external-behaviorist and internal-mentalist aspect (Hoppe 2005, pp. 89–90; Searle 1984, pp. 57–58). Two actions can be different even if they are behaviorally identical, so long as the intentions of the actor are different in both cases. To take an example used in Hoppe’s analysis, a walk to Hyde Park may be behaviorally identical to a walk in the general direction of Patagonia, though they are not the same action. Similarly, two different behavioral acts can be regarded as the same action if the intentions of the actor are the same in both cases. Thus, a walk to Hyde Park beginning with the left foot, then the right foot, etc., is the same action as a walk to Hyde Park beginning with the right foot, then the left foot, etc., so long as the actor does not have any particular intention as to which foot to put forward first.
To understand the implications of this kind of approach, observe that Rothbard only claims that a person cannot “choose between” actions if he is indifferent between them. He does not say that he cannot do one specific thing, and not another. This leaves open the possibility that he could choose the action which is the conjunction of all the equally optimal actions (between which he is indifferent). If Hoppe is correct, and this action is properly to be regarded as a choice of the conjunction, rather than a choice of a particular equally optimal act, then this would indeed remove the problem presented by equally optimal mutually exclusive actions.
While there is no a priori logical contradiction in Hoppe’s approach, his attempt to rescue the strict preference approach from the problem of equally optimal actions is a gargantuan task. It is not at all enough for Hoppe to establish that specific acts can be properly described in this amalgamated way. To avoid the problem of equally optimal actions, it requires him to show that all cases where a person faces mutually exclusive equally optimal actions should be assessed by regarding the conjunction of these actions as the proper description of the action. Moreover, this must be the case—according to the criteria he adopts—on an examination of the actual external behavior and the internal mental processes of the person in question.
While the present author agrees with Hoppe’s view that the proper description of an action depends on the intention of the decision maker, it is highly dubious (on this very basis) to assert that all cases of mutually exclusive equally optimal actions should be assessed as yielding a single preferred action which is the conjunction of these distinct acts. Just as a causal-realist approach to subjective value destroys Block’s argument, so too a causal-realist approach to the subjective framing of the set of available actions destroys Hoppe’s argument. It is only by a process of inferring what aspects of the action were in the mind of the actor, and what aspects were not, that we can then say that the choice to move the left foot first, and then the right, or the choice to rescue Peter, and not Paul, was part of the action.So then, let us consider the case of a mother who is indifferent between her drowning children, on the basis of her internal mental processes. In such a situation, it is almost unthinkable that her mind would not turn to the choice between rescuing Peter, versus rescuing Paul, notwithstanding her equal love of both of them. These acts would certainly not be regarded by her as one action, with no choice between the two, even if she were completely unable to see any difference in the degree of satisfaction these two “goods” afford her. In fact, a major reason that this particular dilemma would be so stressful to the mother is the fact that she would inevitably turn her mind—even if only for an instant—to the question of which child to rescue and which to allow to die. If the issue were framed in her mind as a choice between one dead son or two, then it would be a trivial decision problem, at which she would not feel even the slightest pressure or difficulty. But surely her conception of the problem would not be thus. It is highly unlikely to be properly described as a choice to rescue “one son” as opposed to the one she actually does rescue. On seeing her children drowning, and knowing her limited time, she will inevitably turn her mind—in the small time she has—to the question of which to save and she will make a choice. She will go left or she will go right. She will dive into the water, not with the intention of rescuing “one son,” but with the intention of rescuing Peter. From both an external-behavioral and an internal-mentalist perspective, she has chosen to rescue Peter, not Paul. Indeed, if she did not do this—if she intended only to rescue “one son”—then her action would surely be plagued by indecision and delay. She would brace to dive into the water, but her cognitive processes would not be able to tell her whether to dive left or right—to Peter or to Paul. She would stand on the riverbank, shifting from foot to foot, thinking, “I’ve decided—I’ll rescue one of my sons... um, one of my sons.” To dive in, to choose a direction, she would need more than this. She would need to really decide—Peter or Paul? Who lives and who dies? When the media arrive at the riverbank to report on the incident, she will not tell them “I swam into the river to rescue one unit of child, but the other unit drowned.” No! Even if it is genuinely the case that she loves her sons equally, she will say, “I swam into the river to rescue Peter, but my darling son Paul drowned!” Years later, the poor woman would look back on her action ex post and think: “Did I make the right choice? Should I have rescued Paul instead? Has Peter had a good life, and how does it compare to what Paul would have done had he been alive today?” She would not, unless she was deranged or in serious denial, think that she had merely made the choice to rescue “one son.” Nor could she follow the strict preference approach of Rothbard and say, with a straight face, “I really didn’t have a choice of which to save; after all, I loved them both equally!” Of course, some may object to this whole line of argument, on the basis that “choice” and “preference” have special meanings in economics, which are not necessarily congruous with the ordinary usage of the terms employed by a distressed mother. If so, then we must surely ask whether such an esoteric use of terms is necessary to obtain a sensible theory. Ceteris paribus, we should prefer a theory which avoids artful interpretations of ordinary words in ways that are contrary to their common meaning.
Hoppe’s position does not demonstrate the impossibility of choice under indifference. Instead, Hoppe takes this as the starting point for his analysis, and uses it to deny any possibility that equally optimal actions can be regarded as distinct choices. Although he refers in detail to the internal-mentalist aspects of action, his merging of optimal actions into a single choice does not appear to follow from any genuine assessment of the internal mental processes of actual people; it applies a capite ad calcem in all equally optimal action problems, mental processes be damned! Thus, just as Block’s approach is contrary to a causal-realist assessment of preference, Hoppe’s approach is contrary to a causal-realist assessment of the framing of decision problems.
This approach could perhaps be rescued semantically by being careful to define “indifference” and “choice” in a way that ensures that never the twain shall meet. The problem with this is that it imposes a serious restriction on the way in which decision problems can be described, a restriction which bears little resemblance to a causal-realist assessment of decision framing or the ordinary meaning of choice.To give a simple example of the disparity between the ordinary meaning of choice and the Hoppean approach, suppose that an economist following this approach tries to order dinner at a Chinese restaurant, and that he is indifferent between his two favorite dishes, the Peking Duck and the Szechwan Beef. The following exchange occurs: Waiter: What would you like tonight, sir? Economist: I’ll have the Peking Duck, please. Waiter: The duck is an excellent choice, sir. It is an especially succulent dish. Economist: Wait right there! I didn’t choose the Peking Duck; I chose the Peking Duck or the Szechwan Beef! I like them both equally. Waiter: Oh, I’m sorry, sir. I thought you said you were ordering the Peking Duck. Economist: I did. Waiter: So you want to change your order? Economist: No, I will have the Peking Duck. Waiter: Oh, okay, so you’re choosing the Peking Duck. Economist: No, I’ve already told you: I choose the Peking Duck or Szechwan Beef. Waiter: But which would you like, sir? Economist: I like them both equally. Waiter: Okay, so which do you choose? Economist: I choose the exclusive disjunction of the Peking Duck and the Szechwan Beef! Waiter: Do you mean you want them both? Economist: Of course not! I’m not hungry enough to have two dinners! There are diminishing marginal returns on these things, you know. Waiter: I’m sorry, sir. My English is not so good. Perhaps you could tell me again which you are choosing. Economist: Look here, it’s perfectly simple! I choose the Peking Duck or the Szechwan Beef, but not both. Now bring me the Peking Duck immediately! Waiter: You don’t want the Szechwan Beef? Economist: I want them both equally. Waiter: I’m a little bit confused, sir. Perhaps I could give you half-and-half—would that be alright? Economist: I am indifferent. Make it half-and-half if you want. Waiter: I don’t usually add extra choices to the menu, sir, but I want to make sure you get what you want. Economist: You didn’t add an extra choice! You just changed the nature of an existing choice. Now, I choose the Peking Duck or the Szechwan Beef or half-and-half. Waiter: Oh dear. I’m getting more confused, sir. You see, my English is not so good. I have only been in this country for twenty-six years. I will go and get a manager. Who is at fault here, the waiter or the economist? (If this exchange reminds the reader of an episode of The Three Stooges then perhaps this should give us pause before adopting the Hoppean approach.)
Another, smaller problem with Hoppe’s approach is that it makes the available actions depend on the preferences of the actor, which complicates our description of action. If an actor judges that there are twenty different behavioral options available in a given situation, then Hoppe could not take this as the number of choices. Instead he would be forced to conclude that there are at most twenty choices available and that the actual number of available choices, and their content, depend on the preferences of the actor. Thus different actors, confronted with the same situation, and facing the same constraints, have different “choices” available to them.Continuing the Chinese restaurant example, the exchange continues as follows: Waiter: Good evening again Sir. I’m sorry about before. Please let me offer you a glass of wine on the house to apologize. We have a large number of choices of wine tonight Sir. Economist: Hmm. I’ve been looking at your wine list—you only have twelve choices. Waiter: Perhaps you didn’t look at all the pages Sir. We have over fifty different selections, including many excellent foreign and domestic wines. Economist: I’ve done that. There are only twelve choices. Waiter: Perhaps your copy of the wine list is defective Sir. I’m terribly sorry. Here, let me give you my copy. Economist: Hmm. This looks exactly the same to me. I still see only twelve choices. Waiter: I’m sorry, sir. If you just look here, you’ll see that they’re numbered: one to fifty. See? Economist: Yes, I see that. That’s the number of wines, not the number of choices. Perhaps there are fifty choices for other diners. But for me there are only twelve. Waiter: I’m sorry, sir. Perhaps I wasn’t clear. You can have any wine you like—there are no restrictions. Economist: Thank you. I understand that. Waiter: May I recommend the Montedam Shiraz—it would make an excellent choice. Economist: I can’t—that’s not a choice available to me. Look, I don’t want to get into all this again. Just take my word for it: I only have twelve choices, and that isn’t one of them. Waiter: I’m sorry, sir. As I said, my English is not so good. I am usually much better at this, but perhaps I am not being clear. You can have any wine on the wine list—even the Shiraz. I don’t want to restrict you in any way. Economist: Yes, yes, I already told you, I understand that. I think the best choice here is the exclusive disjunction of the Curtis Hill Merlot, the Di Georgio Cabernet Savignon and the Yalumba Rose. I am going to choose that. Waiter: Oh dear. I think I am going to have some trouble again. I will get the manager. I am very sorry, sir.
It would certainly be mistaken to claim that that all people are bisexual, on the basis that all select partners from the class of “men and women.” To do this would be to infer indifference between different options from the fact that a choice is made from a class of options. The error in the Hoppean approach is the converse of this: to infer the narrowing of the choice frame from the fact of indifference.This does not mean that Hoppe would make the claim that all people are bisexual—his approach is the opposite of this. In fact, his approach only looks at a partner choice this way in cases where a person is indifferent between a male or female partner, in which case the person surely is bisexual. The point here is that by amalgamating decisions indiscriminately in all equally optimal action problems, he must surely contradict the actual decision framing of some people. Hoppe’s analysis of indifference and choice is certainly compelling and innovative. But it is ultimately at odds with the plain meaning of choice and the causal-realist approach to decision framing. If applied indiscriminately to all equally optimal actions the assessment of choice framing is unconvincing.
FIXING THE PROBLEM: NON-STRICT PREFERENCE AND THE LAW OF REVEALED PREFERENCEIt is quite easy to fix all these problems by accepting the possibility of choice under indifference. Rather than reinventing the meaning of ordinary words to try to avoid the problem of equally optimal actions, Austrian school economists can simply accept the full implications of the praxeological conception of indifference and homogeneity, accepting with it the possibility of choice under indifference.
Contrary to Rothbard and other Austrian school economists who have followed his approach, an action does not demonstrate a definite preference between ends. Indeed, the appellation “law of revealed preference” is misleading, if taken in the strong sense. Human action does not actually reveal strict preferences—instead, it reveals inconsistency with some strict preference possibilities. If a person takes action A, but could have taken action B instead, and didn’t, then this reveals that the ends of action B were not strictly preferred to the ends of action A—after all, if action B were strictly preferred to action A then action B would have been taken. Now, it could be that the person prefers action A to action B, or it could be that he is indifferent between the two. Both are logically consistent with the action taken, and must be so, in order to avoid the problems presented by equally optimal actions. Thus, the law is, more accurately stated, a “law of revealed non-preference” if preference is interpreted in the strict sense. It reveals only that any preference possibilities that would have led to a different action must not be correct.
Of course, if there were a situation in which all but one strict preference possibility were found to be inconsistent with the observed action or some counterfactual analysis, then that would indeed reveal this particular strict preference to be correct, through a process of elimination. But it is only by this process—not by any more direct method—that a particular strict preference can be revealed. That is, it is through the revealing of the absence of strict preferences that we gain information about other strict and non-strict preferences.
Continuing the above example, suppose that the mother rescues Peter, allowing her son Paul to drown. This action is inconsistent with the possibility that she strictly prefers Peter drowning to Paul drowning. It is also inconsistent with the possibility that she strictly prefers both of her children drowning to Paul drowning. This is all that is revealed by the action of rescuing Peter. This action is therefore consistent with two possible preference explanations vis-à-vis Peter and Paul: either the mother strictly prefers Peter to Paul, or she is indifferent between the two, but prefers (strictly or non-strictly) to have only one of her sons die than both of them.
The non-strict preference ordering embodied in this explanation is sufficient to derive the notion of indifference and strict preferences between outcomes. This is because any non-strict ordering relation induces a corresponding equivalence relation and strict ordering relation (see Appendix). Unlike the derivation of indifference from strict preferences, this result does not require any assumption of the comparability of all possible outcomes, a property that should be particularly pleasing to Austrian school economists who are apt to stress the fact that preferences are an explanatory tool for action rather than a set of comprehensive orderings ever-present in the human mind (see e.g., Mises 1998, pp. 94–95).
INDIFFERENCE AS A PRAXEOLOGICAL CATEGORYUnder the non-strict preference approach, a choice of a particular action demonstrates that this action is no worse than the available alternatives, assessed in terms of the ex ante judgment of the actor. Thus, the “no worse than” relation is established directly from action—it is the primary praxeological relation embodied in action.
The relationship between this non-strict preference and indifference is simple. If the actor regards outcome A as “no worse than” outcome B and also regards outcome B as “no worse than” outcome A then the actor is indifferent between outcomes A and B (the converse also applies). Thus, indifference can be established as a derivative of the primary praxeological relation —it is also a praxeological relation.This does not mean that we need to define indifference as a derivative of non-strict preference; we have already seen that indifference can be defined directly in praxeological terms (as can strict and non-strict preference). It simply means that we can relate indifference to the primary praxeological relation if we want to. The reason to do this is that our direct inferences from observed actions are about non-strict preferences (the primary relation) and any inference about indifference or strict preference will be derivative to this (secondary relations).
Of course, it is never possible to observe indifference manifested in action according to revealed preference. For this would require an actor to choose A over B, and also choose B over A in the same exact context (even at the same time). Clearly this cannot occur, since these two actions are mutually exclusive. However, this is no objection to the formation of the praxeological category of indifference, since these relations still hold from an examination of the nature of human action, not the observation of any particular action. In other words, since we know from action that the “no worse than” relation can exist, this logically implies that the indifference relation also exists, even though we never observe it in action!Machaj makes a similar point when he discusses the fact that indifference and homogeneity must be described in terms of what is unseen as well as what is seen (see Machaj 2009, p. 233). This point should not be taken to mean that we cannot infer indifference; it simply means that we cannot observe it in action and any such inference must involve some assumption or belief about counterfactual action.
Under the non-strict preference approach, the resulting preference ordering directly induces an equivalence relation which is properly interpreted as indifference. This approach is therefore sufficient to establish the notion of indifference and the notion of homogeneous goods, without any of the attendant problems raised against the strict preference approach in this paper. The best interpretation of these is praxeological, following the subjective theory of value in Menger (2007).
EXPLAINING THE CHOICE BETWEEN ECONOMICALLY IRRELEVANT ALTERNATIVESLest there be any possible misunderstanding, it is important to note that the non-strict preference approach, resting on the praxeological interpretation of indifference, does not explain why the actor chooses the particular equally optimal action that is chosen. However, it does explain the fact that one of the equally optimal actions will be chosen, and that this necessitates some selection between the equally optimal actions. Under this view, the particular choice from among equally optimal actions is a matter that is outside the domain of praxeology and economics. It is an economically irrelevant choice in that it does not affect any of the satisfactions anticipated to be gained from action. The explanation of the particular choice from among equally optimal actions, if such is thought to be necessary at all, must arise from some other source, whether this is psychology, neuroscience, or some other field.
Even with this limitation, the non-strict preference approach is still markedly superior to the strict preference approach adopted by Rothbard and later Austrian economists. Where the non-strict preference approach merely limits its explanation of action to economically relevant choices, and does not seek to explain economically irrelevant choices, the strict preference approach says that the latter choices are not possible at all! Where the non-strict preference approach easily accommodates equally optimal action problems, the strict preference approach denies their existence. Where the non-strict preference approach allows Austrian economists to follow the subjective theory of value to its logical conclusion and adopt praxeological indifference and homogeneity, the strict preference approach sees even the most ardent Austrian methodologists drop praxeology like a hot potato and instead appeal elsewhere for their theory of diminishing marginal returns.
4 CONCLUDING REMARKSIt is this author’s view that the non-strict preference approach is the only approach that is compatible with the causal-realist view of economics personified by Carl Menger, as well as an analogous causal-realist view of the subjective framing of decision problems. In light of problems in attempts to avoid equally optimal action problems, the strict preference approach adopted by Rothbard and others seems to require contortions that render it unrealistic as a description of action.
The praxeological conception of indifference and homo-geneity which leads to the non-strict preference ordering is perfectly natural for Austrian school economists. It follows directly from the subjective theory of value. For the rest, we can let Block do the talking:
Once we concede that two units of anything are equally serviceable in the view of the economic actor, we might as well fold our tents and go home as far as warding off the charge of consorting with indifference is concerned. (Block 2009b, p. 69)
This author is at a loss to understand the desire of Austrian school economists to avoid weakening the preference ordering to non-strict preferences. This approach allows them to easily avoid the difficulties—and the resulting contortions to escape—in optimal action problems. It also allows them to interpret both preference and indifference as praxeological relations, consistent with the causal-realist approach and consistent with Menger’s excellent explanation of the theory of value. While Nozick might gloat a bit from beyond the grave, this would seem to be, not a defeat for Austrian economics, but a triumph of its praxeological method.
APPENDIXStrict and Non-Strict Preference Orderings
Suppose we have a set S of outcomes of various possible actions. On the set S we have a preference ordering ≽ which is the “is no worse than” relation (i.e., a≽b means that outcome a is no worse than outcome b). This is a binary relation that is both reflexive and transitive:
Reflexivity: a≽a for all a∈S.
Transitivity: a≽b and b≽c implies a≽c for all a,b,c∈S.
The preference ordering ≽ induces an equivalence relation ∼ which is the “is no worse or better than” relation. If a≽b and b≽a then we say that a∼b which means that outcome a is no worse or better than outcome b (i.e., the decision maker is indifferent between a and b). This is a binary relation that is reflexive, symmetric and transitive (i.e., an equivalence relation):
Reflexivity: a∼a for all a∈S.
Symmetry: a∼b implies b∼a for all a,b∈S.
Transitivity: a∼b and b∼c implies a∼c for all a,b,c∈S.
Having defined this equivalence relation, the preference ordering ≽ is, by definition, anti-symmetric with respect to the equivalence relation (i.e., a non-strict ordering):
Anti-symmetry: a≽b and b≽a implies a∼b for all a,b∈S.
The preference ordering ≽ also induces a strict preference ordering ≻ which is the “is better than” relation. If a≽b is true but b≽a is false we say that a≻b, which means that outcome a is better than outcome b. This is a binary relation that is non-reflexive, asymmetric and transitive (i.e., a strict ordering):
Non-reflexivity: a≺a is false for all a∈S.
Asymmetry: a≺b contradicts b≺a for all a,b∈S.
Transitivity: a≺b and b≺c implies a≺c for all a,b,c∈S.
All of this can be derived directly from the decision space (S, ≽). However, it can only be derived from (S, ≽) with an assumption of comparability of all actions:
Comparability: For all a,b∈S we have either a≼b or b≼a or both.
Volume 14, Number 2; Summer 2011
This paper deals with the meaning and the limits of the subjective theory of value. Economists deploy this theory in such various areas as utility, marginalism, knowledge and expectations . Yet, despite its wide spread use in economics, the meaning of subjective value remains equivocal and imprecise. This paper seeks to provide a more accurate praxeological interpretation of subjective value by anchoring it on preferences that are effectively demonstrated in action. This praxeological approach appears to be particularly pertinent for explaining the misuses of subjectivism in relation to utility and marginalism, and in showing the limits of various attempts to extend subjectivism to knowledge and expectations.
Volume 6, No. 1 (Spring 2003)Neoclassical utility functions are an invalid means of analyzing consumer behavior for three reasons: first, and most important, because such functions, and their attendant rankings, are cardinal, not ordinal in nature; second, because, with respect to the set of bundles relevant to actual human beings, such functions are not continuous and, therefore, not differentiable; and third, because such functions do not correctly, consistently, and properly include dimensions/units.
Volume 14, Number 1; 53-62. Spring 2011
Boettke, Leeson and Subrick (Boettke and Leeson 2004; Leeson and Subrick 2006) describe institutional robustness as the ability of a given system of social organization to stand up to the test of the so-called “hard cases,” i.e., hypothetical scenarios under which the ideal assumptions concerning, e.g., information and motivation possessed by the members of a given society are relaxed. In this paper I employ the methodology used by these authors in order to undermine their contention that the best-case version of socialism is based on benevolence and the worst-case version of liberalism is grounded in selfishness. My argument contends that the pursuance of self-interest is a beneficial and robustness-enhancing force in both of these systems. Moreover, I delineate several dimensions of motivation other than the one associated with the spectrum of benevolence and selfishness, and suggest that their relationship with the question of institutional robustness is worthy of further exploration. Finally, I endeavor to show that with regard to each of these dimensions worst-case liberalism, unlike best-case socialism, proves stable and robust.
Volume 14, Number 2; Summer 2011
This short note is a contribution to the solution of the problem of indifference in Austrian economics (“Nozick’s problem”). The problem is divided into two questions: (i) Can the stock of a commodity be defined without a reference to indifference? (ii) What is the praxeological interpretation of the fact that one unit of a homogenous stock is chosen over another? It is argued that the answer to the former question is negative; in the answer to the latter question it is demonstrated that indifference can already be included in the description of choice alternatives and strict preference ordering on the set of these alternatives can thus be preserved.
Volume 15, Number 4 (Winter 2012)
In response to Block and Barnett (2012), this paper clarifies some misunderstandings about the concept of transitivity and shows its relation to rationality, asynchronicity of choice, and indifference analysis. It is demonstrated that Block and Barnett, contrary to their self-interpretation, do not in fact attack transitivity but the assumption of stable preferences. It is argued that the stability of preferences assumption cannot be easily dismissed.
Volume 15, No. 2 (Summer 2012)
Transitivity in economics maintains that if a is preferred to b, and b to c, then a must also be preferred to c. The problem with this is that these three decisions are made at different points of time, and tastes may have changed in the interim. The difficulty with a rejection of transitivity (which underlies indifference curve analysis) is a reductio ad absurdum, based upon the “money pump.” The present paper rejects this attempt at a reductio.
Volume 4, Number 1 (Spring 1983)Richard Ebelling interviews G.L.S. Shackle about his time at the London School of Economics and his views on economics as a science.
Volume 10, Number 3 (Spring/Summer 1989)Don Bellante discusses the fallacies of government intervention into the labor market, and how an Austrian approach provides insight into these fallacies.
Volume 4, Number 1 (Spring 1983)Richard Ebelling interviews G.L.S. Shackle about his time at the London School of Economics and his views on economics as a science.
Volume 9, Number 1 (Fall 1987)James Buchanan is interviewed on his recent award of the Nobel Prize in Economics.
The rise of behavioral economics has long been seen by statists as a body blow to libertarianism. By arguing that people are irrational consumers who are easily manipulated, behavioral economics seems to argue for state intervention to save us from ourselves. In his best-seller Predictably Irrational, behavioral economist Dan Ariely claims that irrational consumers invalidate arguments in favor of the free market, namely those that argue that free consumer choice leads to the most efficient and productive economy. Since consumers are irrational, Ariely claims, we need the government to step in and regulate the economy.
For many, more government is a reasonable conclusion from Ariely’s premise of consumer irrationality. If consumers can’t rationally select the goods and services they need, then perhaps government can choose more wisely for them. But when you look deeper, behavioral economics provides a convincing indictment of the political system.
Behavioral economists claim that consumers cannot rationally pick products in the free market. But if that’s the case, what makes us qualified to pick the elected officials who promise to run our lives for us? Within Ariely’s analysis, two issues — the power of “free” and the concept of herding — point out how the premise of consumer irrationality undermines any faith in the concept of electoral politics.
The Word “Free”Behavioral economists argue that consumers lose their minds when we’re confronted with the word “free.” In Predictably Irrational, Ariely argues that free, “is an emotional hot button — a source of irrational excitement.” To prove his claim, he cites an experiment where consumers were first asked to choose between a $0.01 Hershey’s kiss and a $0.30 Lindt truffle. Consumers chose the Lindt by big margins, because at $0.30 a Lindt truffle is a steal. But when the experimenters lowered the price of each product by $0.01, so the Lindt became $0.29 and the Hershey’s kiss became free, the number of consumers choosing the Hershey’s more than doubled.
According to Ariely, the lure of getting something for free short-circuited peoples’ rationality and caused them to choose a worse product, just because it was free.
Before we go on, we must note that Ariely’s conclusion that our love of “free” is irrational ignores the idea of subjective value. If consumers get a certain thrill from obtaining a “free” product, then consumers are simply making the rational calculation that the value of the thrill exceeds the value of the Lindt chocolate. Ariely defines the excitement created by the word “free” as irrational, but the excitement is simply part of the calculation made by consumers. For Ariely, the value of a product only counts if it can be calculated in dollar figures, but of course, we know this is not true.
Whether we call it “irrational” or not, though, there’s little doubt that the term “free” has a huge bearing on peoples’ mental calculations. But if people are as obsessed with “free” as Ariely claims, why then can we be qualified to vote? How can we as consumers be trusted to choose between politicians who offer us free healthcare, free welfare benefits, a free pristine environment, or free money? Faced with a reasonable, smart politician who promised us government services we would have to pay for, and a less qualified politician who lied and promised us free government, Ariely’s experiment suggests that consumers would irrationally choose the latter. But irrational political consumption undermines any argument for a big, democratically-elected government because it rejects the ideal that we’ll elect the best and brightest to lead us.
HerdingBehavioral economists also stress the concept of herding: people attach value to something that other people attach value to. Ariely brings up the example of restaurant lines. If you see five people waiting in a line outside a restaurant, you might think, “wow, that restaurant has five people waiting to get in; it must be great!” You might get in line. The next person to come by, seeing now six people outside the restaurant, will then think the same thing. Both of you get in line, but neither of you knows if the food inside is even any good. Consumers line up, not because they know they want the product they’re lining up for, but because the product is popular.
To the extent that this concept is real, it too is an argument against big representative government. It implies that voters will choose their candidate not according to who is best but according to who is most popular. People will vote for Obama because their friends did, but their friends may have voted for Obama because of the herding factor as well. According to behavioral economics, we could expect plenty of people to vote for Obama (or Romney, or any other candidate) without having any good reason to do so.
Irrational VotersA functional republic relies on a rational, smart electorate to choose its leaders. That’s why so many people trust big government — they trust the purifying effects of the electoral process, and trust that the best and brightest will win voters’ trust and be elected to office. From there, the best and brightest can wisely manage the country and the lives of its citizens.
This ideal, as anyone familiar with Congress knows, is more than a little ridiculous. But the interesting thing is that behavioral economists like Ariely, who publicly advocate for more democratic government, reveal just how ridiculous it is. If consumers are as irrational as Ariely argues, they’re likely to pick politicians who don’t represent their best interests or don’t have coherent ideas. Why would we trust such men and women to run our lives?
Knowing that electoral politics brings to office not the best and brightest but merely the best at appealing to irrational voters, shouldn’t we want to restrict their power? Shouldn’t we trust them with less influence over our lives, not more?
The insights of behavior economics create what is essentially a Catch-22 for statists who attempt to use it. If Ariely’s definition of rationality is wrong and the Austrians are right, then it is impossible to plan an economy and obtain efficient results from government policy. On the other hand, if behavioral economics is right, then social democracy can be shown to be the product of an irrational political system.
I’m not endorsing behavioral economics. Like most fields of study, it has some gems and some flaws. But if Ariely’s observations on the power of “free” and the problems of herding have anything to teach us, it is that the modern democratic process is inherently flawed, and that libertarianism and even anarchism may be the more rational choices.
Archived from the live Mises.tv broadcast, this lecture was presented by Jeff Herbener at the 2013 Mises University, hosted by the Mises Institute in Auburn, Alabama, on 22 July 2013. Includes an introduction by Mark Thornton.
[Excerpted from The Economics of Liberty (1990), edited by Lew Rockwell] Astrologers, palmists, and crystal-ball gazers are scorned while professional economists are heralded for their scientific achievements. Yet the academics are no less mystical in trying to predict the direction of interest rates, economic growth, and the stock market.
Forty years ago, Thomas Dewey was defeated by Harry Truman, stunning the political experts and journalists who were certain Dewey was going to win. While questions about “scientific” polling techniques naturally arose, one journalist focused on the heart of the matter. In his November 22, 1948, column in Newsweek, Henry Hazlitt said the “upset” reflected the pitfalls of forecasting man’s future. As Hazlitt explained:
The economic future, like the political future, will be determined by future human behavior and decisions. That is why it is uncertain. And in spite of the enormous and constantly growing literature on business cycles, business forecasting will never, any more than opinion polls, become an exact science.
We know how well economists forecasted the eighties: from the 1982 recession and the employment boom to the Crash of 1987, no major forecasting firm came close to predicting these turns in the market. And following the Crash, virtually every professional forecaster revised his economic forecasts downward, all because the historical data suggested that the stock market was a reliable barometer of future economic activity. The economy then continued to expand and the stock market eventually reached new highs.
After President Eisenhower’s heart attack on September 24, 1955, the stock market experienced a massive drop. The stock market later recovered as the president recovered; like 1987, 1955 turned out to be one of the statistically best in economic history.
Despite the sorrowful record, most economists remain die-hard advocates of forecasting. Most have spent years in college and graduate school learning the tools of their trade, and can’t bring themselves to admit their own entrepreneurial errors. As one investment advisor put it: “No matter how many times they fail, their self-assurance never weakens. Their greatest (or only) talent is for speaking authoritatively.”
Of their errors, the forecasters contend that it’s only a matter of time before they master the techniques. Though that day will never arrive, economic forecasting remains an integral part of the economics mainstream. The original motto of the Econometric Society still holds sway: “Science is Prediction.”
Whether one uses a ruler to extend an economic trend into the future, or a sophisticated econometric model with dozens of equations, the problem is still the same: there are no constant relations in human affairs.
Economics, unlike the natural sciences, deals with human actions, plans, motivations, preferences, and so on, none of which can be quantified. Even if it were possible to quantify these things, changing tastes (and all the factors that affect tastes) would make the data almost instantaneously useless to the forecaster. And then there are the millions of “unimaginable” things, like Eisenhower’s heart attack, which constantly crop up, influencing people in unpredictable ways.
Economic statistics (i.e., history) do not imply anything about the future. Because data show the relation between price and supply to be one way for one period of time doesn’t mean that it cannot change. As Mises pointed out, “external phenomena affect different people in different ways” and “the reactions of the same people to the same external events vary.”
Some economic forecasters like to argue that economic forecasting is not unlike predicting the weather (and should also be equally difficult). Not only is the nature of these two problems entirely different, but one can reasonably expect that as scientific methods become more sophisticated, weather prediction could theoretically approach perfection. This is because there are constant relations among physical and chemical events. By experimenting in the laboratory, the natural scientist can know what these relations are with a high degree of precision. However, human society is not a controlled laboratory. This fact makes the forecaster’s job of accurately predicting future events impossible.
Forecasters try to get around this problem by linking events in historical chains, and randomly guessing that if one variable reoccurs, then the others will necessarily follow. But this is a sophisticated version of the logical fallacy, post hoc ergo propter hoc (after this, therefore, because of this). This has led major forecasters to seriously study astrological patterns and to build mathematical models that correlate weather patterns with business cycles. Once the forecaster throws out economic logic, anything could have caused anything else, and all variables in the universe are open to study. One mainstream forecasting theory for investors, for example, is based on the rate at which rabbits multiply.
Does this mean we can know nothing about the future? No, the best forecasters are successful businessmen, whose entrepreneurial judgment allows them to anticipate consumer tastes and market conditions. As Murray N. Rothbard points out:
The pretensions of econometricians and other “model-builders” that they can precisely forecast the economy will always flounder on the simple but devastating query: “If you can forecast so well, why are you not doing so on the stock market, where accurate forecasting reaps such rich rewards?”
Forecasting gurus, instead, tend to disdain successful entrepreneurs.
The myth that economists can predict the future is not just harmless quackery, however. Central planners use the same theories to direct the economy. Yet by setting production goals with the data collected by the planners themselves, they destroy the very process that directs free-market production.
Central planners try to overcome uncertainty by substituting formulas for entrepreneurial judgment. They believe that they can replace the price system with commands, but they miss the whole purpose of individual action on the free market. As Ludwig von Mises said, they make “not the slightest reference to the fact that the main task of action is to provide for the events of an uncertain future.” In that sense, central planners are no different from professional forecasters.
Don’t expect unemployment among forecasters, however. Many have cushy jobs with the Congress, the White House, and virtually every agency of the U.S. government, and will happily issue predictions to no end.
In the Austrian view, on the other hand, economists have three functions: to further our understanding of the free market, to identify possible consequences of government policies, and to counter economic myths.
Economic forecasting has nothing to do with these objectives. In fact, by presenting itself as the only scientific dimension of economics, forecasting has helped discredit the whole discipline, and fueled an exodus of economists from the more mundane academic world to the arena of state control and coercion, to the detriment of every American.
"If it ain't Menger or his direct student Eugene [sic] Von BB, it ain't Austrian. Sorry #Mises : respectfully, too many mistakes were made."~ August 10 tweet by Sandeep Jaitly
Last week the Keiser Report, hosted by Max Keiser, featured a segment with Sandeep Jaitly, a follower of Antal Fekete and the author of the above tweet. Now, Jaitly doesn't seem like the worst fellow in the world, so I don't relish criticizing him, but saying Mises made too many deviations to be considered an Austrian economist is really too much.
On subjectivism, on reverse imputation, on "cost of production," on method, on marginal utility, on the origin of money — on everything we remember Menger for, in other words — Mises was a Mengerian, and thus an Austrian. One would hardly suppose there could be any controversy in this at all.
Jaitly's tweet evidently piqued Keiser's curiosity. What, he asked, are these Misesian mistakes?
"His mistakes were too great to elaborate on on the show," Jaitly replied, and proceeded to list a few (see below). But after saying Mises's mistakes "were too great to elaborate on," he went on to say,
It's not insulting or denigrating what von Mises has done. He was certainly the greatest economist of the 20th century. It's just that he made a slight few errors of observation. That's all.
So were Mises's alleged errors too great even to be able to discuss, or were they "a slight few errors of observation"? If the latter, how could such slight errors justify expelling Mises from the Austrian canon? And if, as Jaitly concedes, Mises really was "the greatest economist of the 20th century," what does it say about the Austrian School to which Jaitly claims to belong that the century's greatest economist didn't qualify as an Austrian?
Keiser went ahead and promoted this episode as discussing the "real Austrian economics of Carl Menger versus the fake Austrian economics of Ludwig von Mises."
According to Jaitly, Mises's first error was that he "didn't look back to Menger's original axiom, which is that value is not outside your own consciousness [i.e., value is subjective]." Jaitly, then, is saying that Menger embraced the concept of subjective value, and that Mises rejected, or "didn't look back to" it.
Exactly the opposite is true. If anything, so many times does Mises insist that value is subjective that he may have feared he was trying the reader's patience. Robert Wenzel, in his own critique of Jaitly, chose an illustrative quotation from Mises perhaps at random: "Value is not intrinsic, it is not in things. It is within us; it is the way in which man reacts to the conditions of his environment."
Quotations like this could be multiplied many times over. I cannot fathom what Jaitly could have had in mind.
In fact, while Jaitly claims Menger as the believer in subjective value as against the deviationist Mises, the truth is the very opposite: in chapter 5 of Epistemological Problems of Economics, Mises actually criticized Menger for being insufficiently subjectivist.
Jaitly further contends that "Mises didn't like to admit that interest was a market phenomenon. He sort of wanted to imply that it's a natural consequence of not having a present good."
This claim is so at odds with Mises's words that one is left breathless at its sheer daring. Mises never denied that interest is a market phenomenon. The whole point of his business-cycle theory is that deviation from market rates of interest by means of artificial credit expansion leads to malinvestments that culminate in a bust.
Mises does not say interest is "a natural consequence of not having a present good." Merely not having something yields no natural consequence. Mises says people prefer a good in the present to the same good in the future, such that they would opt for the future good only at a premium. This premium reflects their time preference, or their discount of the future. Interest rates that arise on the market reflect these time preferences of individuals in society.
To say that Mises did not believe interest was a market phenomenon because its origins lay in individuals' time preferences is like saying he didn't believe prices were a market phenomenon because their origins lay in individuals' subjective valuations. In each case, the market takes a subjective factor (individuals' value scales in the case of prices, and individuals' time preferences in the case of interest) and gives it objective expression — market prices in the former case, and the interest rate in the latter case.
Finally, Jaitly claims that Mises confuses "the thing that occupies an object with the object itself," and gives as an example "Mises thinks that a promise to gold is the same as the object of a promise to gold."
Finding this point rather opaque, I ran it by a friend, who came back to me with
As near as I can make out, Jaitly thinks that Mises believed that gold is valued intrinsically instead of as a means to an end. This appears to be what he has in mind by saying that a "promise to gold," i.e., a commitment to provide gold, is the same as the object, or end, for which this commitment is made.
I find no evidence that Mises ever said or believed such a thing, and Keiser, doubtless as confused as his audience over this claim, doesn't follow up on it either of the times Jaitly tries to raise it.
(There is some disagreement as to what Jaitly meant here; Bob Murphy takes a different view, while Bob Wenzel insists that readers and critics shouldn't have to engage in textual somersaults to dig out nuggets of truth from one unclear and confusing statement after another.)
Keiser then wanders far from his comfort zone with what he believes to be a smackdown of libertarianism itself:
This idea of "value does not exist outside of mankind's consciousness" — this is pretty much the opposite of Objectivism, which is Ayn Rand's philosophy, to which many American libertarians adhere, and they cite von Mises as their justification. So this idea of Objectivism is diametrically opposed to the true Austrian School of economics. So that would be a fundamental flaw in any so-called libertarian's philosophy.
Keiser evidently thinks that because Austrian economists use the word "subjective" a lot, while Randian philosophers call themselves "Objectivists," there is a fatal contradiction at the heart of the whole libertarian project.
Before getting to the substantial reply to this particular piece of confusion, here are its most obvious difficulties:
Rand herself emphatically rejected the libertarian label.
Most libertarians are not Objectivists. (So if Objectivism were flawed, libertarianism would be left untouched.)
Libertarianism is committed at root to only one principle: nonaggression. Theories of value, important as they are, are extraneous to libertarianism. So again, no problem.
Rand was not speaking about technical economics, or about economics at all, when she called her philosophy Objectivism.
When economists say they believe in subjective value, they are not saying anything particularly controversial. If we are going to understand how the prices of classical music CDs are formed, for example, it is fruitless to engage in debates over whether Beethoven was objectively superior to Mozart. This would tell us nothing at all about why their recordings sell at the prices they do. What matters for price theory are people's subjective preferences for one or the other; after all, it is individuals, not disembodied standards of musical quality, who actually buy the CDs and thereby contribute to making their prices what they are.
Likewise, someone may well believe that the Confessions of St. Augustine or Ayn Rand's Introduction to Objectivist Epistemology would be more worthwhile reading than a book by Tom Clancy. But such a judgment does not help us understand the prices of these goods, unless the St. Augustine admirer thinks the quality of his book means its price deserves to be $1 million. Prices aren't formed this way, thank goodness.
I cannot imagine a sensible Objectivist, understanding the sense in which economists mean the term "subjective value," objecting to the idea.
Now returning to Jaitly: "Gold does not have intrinsic value per se. It has value because it satisfies human ends.… It doesn't have value in and of itself."
This is certainly true, but any knowledgeable libertarian, and certainly any Austrian economist one might name, already knows this.
Keiser then raises the subject of externalities, pollution in particular. The failure to incorporate such external costs of production into market prices, he says, is "a major failure by libertarianism."
It isn't a failure of libertarianism, actually. For one thing, "Mr. Libertarian," Murray Rothbard, made quite an important contribution to our understanding of externalities of that sort. For another, one of the central themes of Austrian economics is economic calculation, which lies at the heart of Keiser's objection.
Economic calculation is the means by which we attain higher-valued ends with lower-valued means, within the division of labor. Prices freely arrived at through market exchange help us, by means of profit-and-loss calculation, determine whether the value of our output exceeds the value of our input. More specifically, economic calculation makes it possible for our production activities to be carried out at the lowest cost in terms of opportunities foregone — i.e., all those other processes, producing a different pattern of consumer goods, in which the factors of production might otherwise have been employed.
Economic calculation is falsified to the extent that the state involves itself in the economy. Because the state acquires its resources through coercion rather than voluntary exchange, its expenditures and revenues lack the economizing feedback of profit and loss. As a result, its economic decisions — what to produce, in what amount, where, on what terms, using what inputs, etc. — are necessarily arbitrary.
The state can obscure economic calculation in other ways as well: when it owns and operates a business firm, when it owns a natural resource, or when it fails to enforce property rights and thereby falsifies costs. The latter two cases are examples of what Keiser has in mind.
But the problem here is the hampering of the market, not the alleged blindness of Austrian economists. Private ownership, which is precluded by state intervention, would encourage the preservation of the capital value of resources, as opposed to their immediate consumption or destruction. Furthermore, polluters in a genuine market economy would be held liable for their activity, not "regulated" according to some arbitrary level of acceptable emissions.
That does not mean a world of zero pollution, by the way, an outcome not even Keiser himself would favor: the ambulance rushing him to the hospital, heaven forbid, would be stopped in its tracks by the authorities. But it does mean a configuration of resources that takes all costs, including environmental ones, more explicitly into account. The Austrian literature is replete with discussion of the significance for human welfare of extending the unhampered market and its corollary, economic calculation, into as much of the world of exchange as possible. Austrians do not simply throw up their hands and claim that environmental damage ought to be ignored.
Quite satisfied with the segment, Keiser concludes: "I hope the so-called libertarians like Lew Rockwell watch and learn."
I'm not sure why Keiser considers himself qualified to evaluate people's claims to be libertarians, but I am sure that Lew wouldn't have a whole lot to learn from this muddle of confusion. In the meantime, rest assured that Mises really was an Austrian economist after all, and immerse yourself in his work by visiting the Mises Institute and my self-study program at LearnAustrianEconomics.com.
The above was originally posted on LewRockwell.com. Keiser responded to it with a post called "Tom Woods' Blunders." For a split second I wondered if maybe I had overlooked or misstated something. Then I saw his post.
It begins,
Tom Woods ramblings are lengthy …
Translation: I haven't the foggiest idea how to answer Woods. If I say his reply to me is "lengthy" and "rambles," that will cover for the fact that I can't reply to 95 percent of it. Oh, and 15 minutes of bashing Mises and libertarians on the most uncomprehending grounds is not rambling or lengthy.
but I wanted to zero in on this bit:
In the following passage, taken from Tom Woods response to Sandeep Jaitly's interview on "Keiser Report," Tom Woods rationalizes the failure of his fundamentalist ideology and 'economic calculation' by wedging a lot of intellectual dishonesty into this quote: "Private ownership, which is precluded by state intervention, would encourage the preservation of the capital value of resources."
The idea that private interests preserve the capital value of resources ('unless they are interfered with by the state') produces a superior economic outcome over the public interests preservation of capital value of resources is the type of pseudoscience, faux-Austrian claptrap that gives rise to economic dictatorialism, completely blind to the actual consequences of its actions. What Woods is advocating here is in effect central planning, but the 'right kind' of central planning by the 'right people'; the complete opposite of what Austrians say they are supposedly in favor of and a complete contradiction of what Menger was trying to elucidate before the Mises crowd came along and poisoned the water.
I'll be a sport and overlook the lack of any argument or analysis here; we are evidently expected to accept Keiser's ex cathedra pronouncement without demanding such coarse elements as reason or evidence.
Here are Keiser's points, stripped of the viciousness that was absent from the tone of my own piece, along with my replies:
(1) It is silly and "fundamentalist" to think private owners might take better care of resources than the state.Evidently the whole tragedy-of-the-commons problem has been solved by Max Keiser; with such contributions to the human race, it almost seems petty of me to continue the exchange.
I think, though, he hasn't really solved this problem. Max would have to believe that people who rent cars treat those cars just as well as they treat their own cars. In Keiserland, people take rental cars for oil changes and maintenance, and repair dings and scratches.
On my planet, people do not take the same care of things they do not own as they do of goods they do own. The same goes for any resource: what private owner would want to destroy the long-term capital value of a mine, or a herd of animals, in order to enjoy one fleeting year of profits? Who would kill all the animals this year, leaving none for next year? What incentive exists to do such a thing?
(2) He thinks private ownership is a form of "central planning."(This guy has his own show?)
Central planning involves
the direction of resources in the absence of property rights, ororders handed down to resource owners by non-owners.Neither applies in the case of the ownership and use of a resource owned by someone with legitimate property title.
It of course is not a question of having the "right people" in charge. I am not saying that my people would do a better job of managing resources than Max's people; that Max even thinks in these terms makes him appear juvenile and uncomprehending.
The issue is that only private owners can operate within the realm of economic calculation, and only private owners have an interest in keeping the resource generating a stream of returns over time. Why would a politician, serving a two-year term, care at all about such a thing? You'll note how politicians, having no particular reason to care about future prosperity and interested only in immediate electoral returns, have looted a certain resource called the population of the United States. Keiser wants these people in charge of more resources.
(3) Without acknowledging that on every point I overturned his guest's bizarre and unsupportable claim that Mises was a non-Austrian deviationist from the plumb-line Menger, he closes with further reference to this alleged difference between the two.Max, here's my challenge to you. Where does Menger say the state, with its politicians' limited time horizons, is better able to preserve the capital value of resources than legitimate property owners? Where does Menger say that economic calculation within the division of labor is not a good way for society to economize?
You are saying Mises has deviated from Menger in holding the position he does. You have no idea what you are talking about. Give me chapter and verse from Menger.
If you can't, then admit you're in over your head, and apologize to your viewers for that ridiculous segment and for this crazy claim about Menger and Mises.
So far, Keiser has refused to answer my challenge. Not even one reference from Menger (whom I have a funny feeling Keiser may not have read, believe it or not) has been forthcoming. Instead it's been a barrage of insults delivered via Twitter. These are intended to distract people from his failure to answer me. And although Keiser will no doubt continue on with his ungentlemanly language — hardly dignified for a man his age — I've posted my final word on the whole matter here.
[Understanding the Dollar Crisis (1973)]
There was once a Russian school child whose cat had a family of kittens. When asked to write a paper for her class, the child wrote about the mother cat and the kittens. The next day she read her paper to the class. In it she told about how these kittens were born. There were five of them and they were all good little Communists. The teacher liked the paper, and when, a week later, one of the Moscow inspectors visited the school, the teacher, proud of her pupil, asked the child to read it again. The child read the paper. When she came to the part about the kittens she said there were five kittens and two of them were Communists. The teacher was quite surprised. The child had previously said all five were Communists; so the teacher asked the child why she had changed it. "Well," the little girl said, "three of them have opened their eyes."
One of the things we are trying to do in these lectures presented by the Centro de Estudios sobre la Libertad is to open the eyes of people who have heard so much about the promises of socialists and government interventionists to use political power to improve the economic situation of the poor, the sick, the young, the aged, and all others with whom they seek popularity. Actually, the only way for governments to improve the economic condition of their citizens is to provide equal protection of life, property, and the marketplace for everyone, while peacefully adjudicating disputes which might otherwise lead to frictions and infractions of the peace. Using the force of government to take from some to provide special privileges for favored groups will never improve the general welfare. Governments that play favorites sow the seeds of their own destruction and reduce the production of both the poor and the rich.
For each of us, life is a problem of how to use our limited means to produce more of the things that provide us and our loved ones with the greatest possible satisfaction. We daily strive to satisfy our most important wants before we try to satisfy those we consider less important. In short, we constantly seek to improve our situation by exchanging something we have for something we prefer. The prime function of government is to provide an atmosphere in which more and more mutually beneficial exchanges can take place.
Division of LaborAs individuals we cannot produce all the things we want. So we tend to specialize, and produce things that other people want. We then exchange the products of our efforts in the marketplace for the things that we want. This involves what economists call the division of labor.
In his great book, The Wealth of Nations, Adam Smith, the founder of English classical economics, tells how we can all have more if we specialize and trade. As mentioned in our previous lectures, it is our value scales that direct us in making our choices of how to use our limited means to attain more of the things we want most.
If man finds it easier to get what he wants by specializing his contributions and trading his specialties with those who produce what he wants, he will do so. He will take the easiest way he knows to improve his situation. Consequently, civilized men have resorted to specialization in production and the subsequent trading of the specialties they have produced. Such trading necessitates the use of a medium of exchange, or money. In our fifth lecture, we shall be dealing with that very serious part of the market problem. But it is money prices that we are talking about now. Most people are confused about prices. They seem to think that prices are set by producers and sellers, that they add up their costs and then add something more for their profit. This is how most people think prices are set.
Actually, the successful businessman looks for something that the people want, something he thinks he can produce for less than people will pay for it. So in the final analysis it is the values businessmen believe people have in their minds that determine what goods they will make, and how much they will make of each particular scarce good.
This question of what to make is one of the important problems that the socialists neglect. Marx thought there was no such problem. So did Lenin. They thought the only businessmen you needed were bookkeepers to keep the accounts. Nobody had to decide what needed to be produced. This was supposedly evident to everyone. The masses needed more food, more clothing, and more housing. For Marx and other socialists, the choice of what to make was no problem at all.
But this, of course, is not so. We cannot make everything people want. The most important decisions in this world are those that determine what should be made and what should not be made. These decisions seek to determine what things give the greatest human satisfactions, so that our scarce means of production are not wasted making things that people do not want as much as other things that could have been made with the available supplies of labor and raw materials.
In a market society, individual subjective values allocate the available supply of every scarce good so as to satisfy human wants in the descending order of their importance, whereby the particular want last satisfied is the one with the marginal utility. From beginning to end, price, and thus economic calculation, is the product of subjective valuations. Price is the result of the reciprocal impact of the subjective values placed on the good and on money by all interested parties. The resulting market prices must benefit all who exchange.
As we have said before, but should never forget, all life is a series of choices whereby we try to exchange something we have for something else that we prefer. The fewer the obstacles placed in our way in the form of higher costs, taxes, or other governmental interventions, the more exchanges we can make for the mutual advantage of all the participants.
The Economic ProblemWe are constantly faced with the economic problem. The economic problem is, of course, the problem of human beings, the problem of life. This problem is how to employ our available means in such a way that no important want is left unsatisfied because the means for attaining it were used to satisfy a less important want. Such a misuse of scarce means would provide less human satisfaction. It would be wasting valuable wealth. Acting man wants to know how to use what he has to provide the greatest attainable human satisfactions. This is the problem that concerns all of us. This is the problem that the market solves.
In trying to get what we want, we are directed by our ideologies. Ideologies are our ideas about how we think society operates. Sometimes we are influenced directly by an ideology. If we believe certain actions will produce the results we want, we take those actions. Ideas, as we stressed in the first lecture, are very important. But sometimes in our social activities, an ideology influences us indirectly. We follow certain procedures which by themselves we do not consider very helpful, because we do not want to offend those around us. We go along with certain widely held myths, certain popular prejudices, or certain accepted folkways, rather than take the actions we consider most efficient. We do this because we have to live with our fellow men and cannot always do things that we ourselves might consider best.
For a good to have value it must assure the satisfaction of a need or want of some human being. Thus, if that good did not exist, there would be some human want that would have to go unsatisfied. Every loss of an economic good means that there is one less human satisfaction attained. Goods can have a direct value, that is a use value, to us. Or they can have an indirect value, that is an exchange value, which means they have a use value to someone else. In that case, we can exchange them for something which has a use value to us.
In the marketplace it is the use value or the exchange value, whichever is greater, that determines our choice of actions. When we see something that is more valuable to us than its market price, we buy. When we have something that is more valuable in the market than it is to us, we sell. We do not trade for the fun of it. Otherwise we might trade back and forth all day long. We consider every exchange, every transaction, beforehand, and we continue exchanging up to the point or limit beyond which we do not expect to gain any further.
Trade Increases WealthSince all men are eager to satisfy their more important wants, those which are higher on their value scales, before they satisfy their less important wants, those which are lower on their value scales, they trade whenever they can find anyone who has opposite or contrary views on the relative values of two goods or services. By an exchange transaction, each good or service moves to that person who places the higher value on it. The wealth of each party is thus increased. They have both gotten a psychic profit, that is, a gain that they themselves consider a profit. This psychic profit cannot be measured, but it is a very real increase in satisfaction in the minds of the parties participating in the exchange. Market exchanges are not equal exchanges. They are unequal exchanges, from which both parties expect to gain.
So trade is productive of value. In a market economy goods are constantly moving from those who place a lower value on them to those who place a higher value on them. This is a fact of economic life that is not taken into consideration by mathematical economists. They seem to think that economic goods have a certain fixed value, usually based on the cost of production. They calculate this value as an unchanging fact, not realizing that when a good shifts from one person or place to another its value has been increased. The physical goods have greater value when they are owned by people for whom they can provide greater satisfaction.
It is the unequalness of the use and exchange values of different people that leads to exchange. These differences cannot be measured, only compared. They are in the mind. They are psychic. It is always a matter of greater or less. If the value of what you expect to receive is not greater for you than the value of what you will have to give up, then there is no trade. The differing use and exchange values of different individuals result in the emergence of prices — market prices. There are no other kinds of prices, only market prices.
Most scarce goods have many uses, or a use value for many people. The economic problem is to allocate them so as to give more human satisfaction to all concerned. Voluntary exchange is the only possible way in which all can benefit. It is the only system that allocates each scarce item to that use or person where it has the highest relative value. It is the only system that tends to minimize waste and maximize human satisfaction.
How Men Act in the MarketIn life we are faced with two questions as we go to the marketplace. These questions are whether or not to exchange, and if so, on what terms. The answers can be simple. There are three rules or postulates for answering these questions:
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Man will exchange only if he can exchange for an advantage.
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Man will exchange for a greater advantage, in preference to an exchange for a lesser advantage. If you can buy something for 250 pesos, you are not going to pay 275 pesos. You will always take that price which gives you the greatest advantage. Of course, sometimes it is not merely a matter of money. It may be primarily a matter of convenience. You may pay a slightly higher price for something in your neighborhood rather than take the time to go downtown, where you might get it for a few pesos less. Or you might pay a little more to a person or group you wanted to help, considering the difference a charitable contribution.
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Man will exchange for a small advantage in preference to not exchanging at all.
These three rules or postulates provide all the answers we need to solve the problems we face in the marketplace. Can you get an advantage? You can. Okay, you exchange. If you can get a greater advantage, you take it in preference to a lesser one, but you will take a small advantage in preference to no advantage at all. You are trying to improve your situation as best you can from your point of view.
Now here are a number of rather simple problems to show how prices evolve and how our value scales contribute to their emergence. Here we are going to assume that you have a use value for several objects you do not own, and that this value scale is:
1st — A
2nd — B
3rd — C
4th — D
Then you learn that you can exchange a "D" for an "A." This is new information, information you did not have when you had this original value scale. This new information changes your value scale and it becomes now:
1st — A
2nd — D
3rd — B
4th — C
5th .….… a second D
A "D" has gone up to second place, not because of its use value but because of its exchange value. You can exchange it for an "A." The fact that you have to take the trouble to exchange it to get the "A" places it below the "A." The second "D" would be valued for the use value of a "D."
So your value scales change as you get new information. You find out that you can buy something cheaper at another place, or you find that something unexpected has happened, or you learn that something new has been invented. You then have a new situation and it calls for a new value scale.
Simple BarterTable 5 presents a slightly more complicated, but still very simple, situation. These problems illustrate the principles that determine how prices are formed and how they are constantly being changed. We start here with an assumption that Smith has four horses. They appear in the first column. In the second column we have his value scales for horses and cows. If he had only four animals he would prefer first a horse, second a cow, third a second horse, and fourth a second cow.
Señor Black, in the third column, has four cows, and his value scale for horses and cows, in the last column, is in this order: first he would like a cow, second a horse, third a second cow, and fourth a second horse.
These two men meet. What happens? One owns four horses. The other owns four cows. When they come together, they soon find out that Smith will gladly trade his fourth horse for a cow. And Black will gladly trade his fourth cow for a horse. They make the exchange. They have both improved their holdings of these two kinds of animals.
In fact, they will go further, in a second step — Step B. Smith will gladly trade his third horse for a second cow, while Black will gladly trade his third cow for a second horse.
Table 5. SIMPLE BARTERMr. SMITH Mr. BLACKhas 4horses:his valuescale forhorses &cows: has 4cows:his valuescale forhorses &cows:1st H1st H 1st C1st C2nd H2nd C 2nd C2nd H3rd H3rd H 3rd C3rd C4th H4th C 4th C4th HSTEP A: Smith will gladly trade 4th horse for a cow.Black will gladly trade 4th cow for a horse.
STEP B: Smith will gladly trade 3rd horse for a 2nd cow.Black will gladly trade 3rd cow for a 2nd horse.
STEP C: No further trades of mutual advantage possible.
Then, they both have improved their situations and satisfied their value scales so far as this problem goes. Under these assumptions, no further trades are possible, because there is no advantage to be gained from any other transaction. They have each satisfied their value scales. If their value scales changed, you would have another problem, another situation. So much for that.
Satisfying a Value ScaleNow we go into another more complicated problem, shown in table 6. We assume here that Smith has six horses and Black six cows. In the column on the left we assume that they both have the same value scales. First they would like a horse, second a second horse, third a first cow, fourth a second cow, fifth a third horse, sixth a fourth horse, and down on to the bottom of the column, as you can see.
These two gentlemen come together. What happens? Now looking at these value scales we find that, in the existing situation, Smith has his 1st, 2nd, 5th, 6th, 7th, and 8th preferences, while Black has his 3rd, 4th, 9th, 10th, 11th, and 12th preferences. Under those circumstances, these two gentlemen meet. What happens?
Table 6. MORE COMPLEX BARTERValue Scaleof bothMr. Smith (S) has 6 horses (H)Mr. Black (B) has 6 cows (C)1st1st HS has his 1st, 2nd, 5th, 6th, 7th and 8th preferences;2nd2nd HB has his 3rd, 4th, 9th, 10th, 11th and 12th.3rd1st C Smith trades 6th H for Black's 6th C.4th2nd C 5th3rd HThen Smith has 5 horses and 1 cow:6th4th Hhis 1st, 2nd, 3rd, 5th, 6th and 7th preferences. Black has 5 cows and 1 horse:7th5th Hhis 1st, 3rd, 4th, 9th, 10th and 11th preferences.8th6th HSmith trades 5th H for Black's 5th C.9th3rd C 10th4th CThen Smith has 4 horses and 2 cows:his 1st, 2nd, 3rd, 4th, 5th and 6th preferences.Black has 4 cows and 2 horses:his 1st, 2nd, 3rd, 4th, 9th and 10th preferences.11th5th C12th6th CSmith would not gain, so no further trades with this value scale.
If the 5th preference on the value scale were a cow, one more trade would give each his first 6 preferences.
They certainly will be happy to make an exchange. So Smith trades his sixth horse for Black's sixth cow. Then we have a situation in which Smith has five horses and one cow. Now he has advanced his situation to the point that he has his 1st, 2nd, and 3rd (thanks to the trade), as well as his 5th, 6th, and 7th preferences. He has given up his eighth preference to obtain his third preference. He has improved his situation by getting the third item on his value scale in exchange for one that was lower down, in eighth place.
On the other hand, Black now has five cows and one horse. He has gotten his first preference and continues to have his 3rd, 4th, 9th, 10th, and 11th preferences. He has exchanged his 12th preference for his first preference. He, too, has certainly improved his situation from his own point of view.
Under these given conditions, it is also profitable for both of them to make another trade. Smith gladly trades his fifth horse for Black's fifth cow. Then Smith has four horses and two cows. He now has his 1st, 2nd, 3rd, 4th, 5th, and 6th preferences. He has exchanged his 7th preference for his 4th preference. He now has all of his first six preferences. He cannot improve his satisfaction with only six animals.
On the other hand, Black has four cows and two horses. He has his 1st, 2nd, 3rd, 4th, 9th, and 10th preferences. He has exchanged his 11th preference for his 2nd preference. He has his first four preferences, but he does not have his 5th, 6th, 7th, or 8th preferences. He would like to improve his situation further, but in the market you cannot improve your situation, you cannot have a transaction, unless both parties expect to gain. Since Smith could not gain from another trade, there will be no further trades with this value scale. Under these assumptions we have reached the end of the trading.
However, if the 5th or 6th preference on this value scale shifts to a cow, one more trade would give each of them their first six preferences. So this shows that as Value scales change, the possible trades change. Value scales affect everything that can occur in the marketplace. Each person tends to trade up to the point beyond which he cannot gain any more. But he has to find somebody else who will also gain, or there will be no transaction.
We have been talking about barter, the exchange of goods for goods. In a market economy we usually exchange goods for money or vice versa. Now we want to consider exchanges with the use of money, getting into what we call prices. A price can be defined as a quantity of money.
A Böhm-Bawerk ContributionMuch of the material for this lecture has been adapted from the works of Böhm-Bawerk. He was not only one of the greatest economists ever, but he was also a teacher of my great teacher, Mises. Böhm-Bawerk found it useful to compare the formation of prices to the breaking of waves and surf on the sea coast. Both are complex phenomena that seem to be completely "without rule or regularity," yet they are both subject to the strict operation of immutable laws.
When waves break on a rockbound coast, the path every drop of water follows may seem haphazard, but, given the essential data, the laws of physics can explain where every particle goes. Given the force of each wave, given the exact shape and resilience of the coast, and given the velocity and the direction of each gust of wind, there could only be one possible result. The laws of physics could then tell us where every drop of water must fall.
Likewise in economics, if we could know the ever-shifting value scales of every individual, and the available supplies of goods and services in the marketplace, then economic laws, the laws of human action, could tell us where every price would have to fall. Of course, in real life we cannot know the ever-changing value scales of all people. We can find them out in part, but only by reference to market exchanges.
When you go into a store, you do not usually tell the shopkeeper how much you might be willing to pay for a desired good. You try to find out the lowest price for which you can buy it. So when we participate in market transactions we seldom reveal how high we might go for the goods on our value scale. Therefore these values are seldom evident. But value scales determine all actions in the marketplace.
In developing man's understanding of economics, the British classical economists reduced everything to supply and demand. They took supply and demand as given. When they talked about supply and demand, they advocated that the businessman should strive to buy low and sell high. That is good business. But they did not go back to what creates supply and demand. This is a contribution of the Austrian School of economics.
Consumers Determine PricesAs I mentioned in my first lecture, science traces cause and effect by going back and back and back until one cannot go back any further. The Austrian economists demonstrated that you can go back behind supply and demand, and find out what it is that leads to both of them. Demand is determined by the value scales of consumers, while supply is determined by businessmen seeking to foresee, as accurately as they can, the future value scales of consumers. In the end, it is the value scales of consumers that determine both demand and supply and thus the prices of all goods and services sold in the marketplace.
Supply and demand are vague shibboleths that do not provide enough information. The central factor that explains price is found entirely in the subjective values of men. Market competition forces the pricing process into a zone between the subjective values of the border or marginal pairs, where the quantity offered for sale exactly equals the quantity there is a desire to buy at the market price. At that price, supply and demand are bound to be equal. You cannot buy more than are sold, but the price has to be one that benefits all who buy or sell.
Isolated ExchangeNow I'm going to present a few problems using money. You will pardon me if I use dollars here. It makes little difference which monetary unit is used. The first is a case of isolated exchange. (See table 7.) There are just two men involved. Farmer Brown needs a horse. A horse is worth more to him than $300 — that is, he will pay for a horse up to, but not more than, $300. If he has to pay more, it will not be worthwhile for him to buy it. Neighbor Smith has a horse with a use value to him of only $100.
These two men meet. What happens? Naturally it is to the advantage of both of them to make an exchange. We posed the essential questions earlier: whether or not they should exchange, and if so, at what terms. We have determined that these men should exchange. The question then becomes, at what price will the horse be sold.
Given this situation, will they trade? If so, at what terms? Every price from $100 to $300 is possible. The actual price within that range will depend upon the bargaining abilities of the two men. But a price below $100 is impossible. Smith would not sell for less, because the horse is worth that much to him. At a lower price he would use the horse rather than sell it. A price over $300 would not lead to a transaction because the horse is not worth sufficiently more than $300 for Farmer Brown to pay the higher price. So the price must fall between $100 and $300.
There is a rule that applies. It is not my opinion. It is not what I think it should be. It is a fact. It is an economic law. It is how men operate. The rule is that the price must fall between the buyer's subjective value and the seller's subjective value. Any other price is impossible. This seems simple and I hope it is understood. The price must benefit both parties.
Table 7ISOLATED EXCHANGE
Farmer Brown needs a horse. A horse is worth more than $300 to him, but not enough more for him to pay more than $300.
Neighbor Smith has a horse with a use value to him of $100.
Will they trade? If so, at what terms?
Every price between $100 and $300 is possible. The actual price, within that range, will depend on the bargaining abilities of the two men.
RULE: The price must be between the buyer's Subjective Value and the seller's Subjective Value.
One-Sided Competition among BuyersWe move on to a little bit more complicated problem. We take now an example of one-sided competition among buyers. And the question is: Who will buy and within what price range? (See table 8.) Smith has a horse, as before, with a use value to him of $100. As before, a horse is worth more than $300 to Brown. But this time we also have a Mr. Carey for whom a horse is worth just a bit over $200. Who buys Smith's horse? And what will be the price range?
Given this situation, Brown will buy at a price between $200 and $300. Any other price is unthinkable. If the price were below $200, Brown would have competition from Carey. If the price were over $300 the horse would not be worth it to him. So the only sale that can take place, given these assumptions, is between the prices of $200 and $300.
Table 8ONE — SIDED COMPETITION AMONG BUYERS
QUESTION: Who will buy and within what price range?
ASSUME: Smith has a horse with a use value to him of $ 100.
A horse is worth just over $300 to Brown.
A horse is worth just over $200 to Carey.
Brown will buy at a price between $200 and $300.
ASSUME FURTHER: A horse is worth more than $260 to Dell.
Brown will buy between $260 and $300.
ASSUME FURTHER: A horse is worth more than $320 to Ely.
Ely will buy at a price between $300 and $320.
RULE: The potential buyer who places the highest value on the good gets it at a price below his own valuation and above the highest value of all his competitors.
Now assume another man, Señor Dell, comes along. He wants to buy a horse, and a horse is worth more than $260 to him. What does this do to the situation? Who will buy the horse, and what price will he pay?
Mr. Brown will buy the horse, but he will have to pay more than $200 under these circumstances. He will have to outbid Mr. Dell. He will have to pay a higher price than $260, but of course he will still not pay more than $300.
Now assume further that another gentleman, Mr. Ely, comes along. For him a horse is worth more than $320. Now what happens? What is the answer to the question of who will buy and within what price range? It should be obvious by now that Mr. Ely will buy the horse. What price will he pay? He has to outbid our friend Mr. Brown. So he will have to pay more than $300, but he will not pay more than $320.
Now, these are not my opinions. This is not how I say it should be. But this is how men act. They try to get what they want at the best price they can, and they do not pay more than the good is worth to them. The rule for this type of exchange is that the potential buyer who places the highest value on the good gets it at a price below his own valuation and above the highest value placed on the good by any of his competitors.
What we are saying is simply that the market allocates scarce goods to those who place the highest values on them, to those prepared to make the greatest sacrifice to attain them. Here we have had competition on one side, competition among multiple buyers for one horse.
One-Sided Competition among SellersNow, we move to the very opposite situation, one-sided competition among sellers. (See table 9.) There is one buyer and there are many potential sellers. The question here is, who will sell and within what price range? Potential buyer Brown places a subjective use value of $300 on a horse. Potential seller Fort places a subjective value of $140 on his horse, while Green places a subjective use value of $200 on his, and another potential seller, Mr. Hall, has a subjective use value of $250 for his horse. Who will sell the horse to Mr. Brown, and within what price range?
It should now become obvious that it is not a question of my opinion. Every one of us should come to the same conclusion, because this is a matter of how all men act. It is an application of economic law.
Mr. Brown will buy the horse as cheaply as he can. He will not pay $200 if he can get a horse for less than $200. So, based on these assumptions, he will pay less than Mr. Green is asking. Mr. Fort will sell his horse to Mr. Brown at a price between $140 and $200. Any other price is unthinkable.
Moving on, we assume further that another gentleman, a Mr. Jate, wants to sell a horse. He places a subjective value of $180 on his horse. What does this do to the situation? It reduces the price that Mr. Fort will be able to ask. He will still sell his horse to Mr. Brown. But now it will NOT be between $140 and $200, but, according to his bargaining ability, between $140 and $180.
Table 9ONE-SIDED COMPETITION AMONG SELLERS
QUESTION: Who will sell and within what price range?
ASSUME: Potential Buyer Brown places a subjective value (S/V) of $300 on a horse.
Potential Seller Fort with a Subjective Value of $140.
Potential Seller Green with a Subjective Value of $200.
Potential Seller Hall with a Subjective Value of $250.
Fort will sell at a price between $140 and $200.
ASSUME FURTHER: Potential Seller Jate with a S/V of $180.
Fort will sell at a price between $140 and $180.
ASSUME FURTHER: Potential Seller Korn with a S/V of $120.
Korn will sell at a price between $120 and $140.
RULE: The potential seller who places the lowest subjective value on the good sells it at a price above his own valuation and below the lowest subjective value of all his competitors.
We assume another gentleman comes along, a seller, Mr. Korn, who places a subjective use value of $120 on his horse. Applying the same reasoning, Mr. Brown wants a horse, which is worth more than $300 to him, but he still doesn't want to pay any more than he has to. He puts these men into competition bidding against each other. The bidding goes down below the previous high price of $180. Mr. Brown can now buy a horse at a price between $120 and $140.
The rule here is that the potential seller who places the lowest subjective value on the good sells it at a price above his own subjective valuation and below the lowest subjective value placed on the good by any of his competitors. And so a horse moves from the potential seller who places the lowest value on a horse to the man who places the highest value on one. That is how the market works.
These problems have been relatively simple. The value of money is a factor in all of these. This too is not constant. The value of money is always shifting. As the values of horses and money shift, the value scales of people shift. They get different ideas about what is to their advantage. But they only trade when they expect to gain. In these examples we have assumed that their value judgments remain constant until the transactions are completed. The prices that resulted were formed under the impact of the entire quantity of horses on the value scales of all present at the market. All the competing suppliers and buyers had a chance to act to improve their situation according to their value scales as the market conditions permitted. Competition forced every successful buyer and seller to set his price with full regard to the relative subjective values of all concerned.
Bilateral CompetitionNow we come to an example of bilateral competition, as I call it. (See table 10.) This is a more complex situation, in which there is competition between both multiple buyers and multiple sellers for a limited quantity of goods, in this case, 13 taxi cabs.
Table 10. BILATERAL COMPETITION(Problem posed)
Assumed subjective valuation of similar taxis
Owners of 13 taxis Potential BuyersAce's1st$4,000 Law's3rd$2,750Bag's1st3,800 Moon's2nd2,920Cod's1st3,750 Nid's2nd3,080 Ace's2nd3,600 Law's2nd3,130Dove's1st3,500 Ott's1st3,400Eby's1st3,450 Pry's2nd3,550 Bag's2nd3,380 Moon's1st3,680Ace's3rd3,360 Law's1st3,780Fork's1st3,330 Pry's1st4,100 Gay's1st3,250 Nid's1st4,250Ace's4th3,050 Bag's3rd2,800 Dove's2nd2,600 Part 1 — How many sold? Within what price range?
Part 2 — Assume (a) sales tax of $50; (b) 10% tax.
In the column on the left-hand side are the owners of 13 taxicabs or taxis. Seven men own these 13 taxis; four of them are owned by Mr. Ace. In the next column we have the assumed subjective values these owners place on their taxis, that is, the figures below which they would not sell the taxis. If they can get a higher price for any one of the taxis than the figure shown in this column, they will sell that cab. On the right-hand side, we have some potential buyers and the highest prices they would pay, the subjective valuations they place on owning a taxicab. If they can get taxicabs for these figures, they will buy. If they cannot, they will not buy.
There are 13 cabs. We shall assume they are identical cabs with no material differences that need to be taken into account. The potential buyers and potential sellers all come together at one time and place. There are potential bidders here, ten, I believe. The questions are: How many of the cabs will be sold? How many will not be sold? And within what price range will the sales be made?
The answer is rather simple. There are many ways you can go about getting it. You can be quite complex and start the bidding low. Of course, no one will offer to sell a taxi for $2,600. If Mr. Dove tries to get, say, $2,700 for his second one, he will have every one of these ten potential buyers bidding for it. They are not going to let it be sold for $2,700. They are going to bid it up. As they bid it up, Mr. Bag comes in when it gets to a price above $2,800. Before then, Mr. Law's demand has dropped out. As the bidding goes higher, other cabs become available, and other potential cab buyers drop out. This goes on until you get into a price range where the number of cabs offered for sale and the number of potential buyers who will buy become equal.
Or you can start with the top. Mr. Ace would be glad to sell his top cab for $4,150 to Mr. Nid. But he is not going to get $4,150 because Mr. Nid is not going to pay $4,150, when all these other cab owners are competing to sell one for less. Competitive bidding will bring the price down, making fewer cars available for sale as it drops below the points in the left-hand column. At the same time, competition will increase the number of the potential buyers as it drops below points in the right-hand column. This will go on until the price reaches the price range where again the number offered for sale equals the number potential buyers will buy.
In this marketplace, we assume all these cabs are similar. There are no known differences, no dents in the fenders as in real life. There will be one price at which the owners will exchange all the cabs that are exchanged. The question is: How many will be exchanged and at what price? The answer is simple.
The best and easiest way to find the answer is to apply what I have already said about the market. This is the fact that the market allocates all scarce goods to those who place the highest values on them. You have 13 taxicabs. You have 23 desires for the taxicabs. Who ends up with the taxicabs? Those who place the 13 highest values on them.
So all you have to do is to find out quickly which are the 13 highest values. The answer to this problem is that six taxicabs will be sold, and the price will be between $3,360 and $3,380. All three methods reach the same result. No other answer or price is thinkable. (See table 11.)
At a lower price, Mr. Ace would not sell his third cab. At a higher price, Mr. Bag would try to sell his second cab. There would be seven potential sellers, but there would not be seven potential buyers. There would thus not be equality between the number offered for sale and the number that would be bought. The bidding would go on until that number was equal, because would-be sellers can never sell more than potential buyers will buy.
Table 11.So the subjective values of the market participants limit the price range, and the market allocates the scarce taxis to those who place the highest values on them. The 13 who place the highest values on them are those above the line on the left side and those below the line on the right side. When the transactions are completed, these parties are the ones who are going to own cabs. Given this assumed state of the market, the people on the left below the line do not value cabs enough to keep them, while the people on the right above the line do not value cabs enough to buy them.
If there were a 14th cab, one more desire for a cab could be satisfied. If there were 15 cabs, two more desires could be satisfied. But the reality of life on this earth is that there is a scarcity of the things men want, and the economic problem is to decide who gets these scarce goods and who must go without.
Law of PriceIn the market economy, this decision as to who gets the limited number of taxicabs, who goes without, and what the price will be, is determined by the Law of Price. The Law of Price is not opinion. It is not what I think it should be. Nor is it a law I would like the government to pass. It describes how men act, in a market situation, each man trying to improve his situation as best he can from his point of view. It is, however, just as immutable as any law of physics.
Under bilateral competition, market prices must fall within a range between upper and lower limits that are determined by the available supply and the subjective values of the interested parties. The upper limit is set by the subjective valuations of the lowest successful bidder and the lowest excluded potential seller, whichever is lower. The lower limit is set by the subjective valuations of the highest successful offerer and the highest excluded potential buyer, whichever is higher.
Prices are determined by the subjective valuations of the two marginal pairs, and must fall within the range between the middle two of these four valuations. Valuations above and below these middle two marginal pair valuations have no effect on the market price.
Now let us look at table 11 again and run through this Law of Price with the figures before us. According to the Law of Price, under bilateral competition, market prices must fall within a range between an upper limit and a lower limit. The upper limit is set by the lower of the pair with the X in the squares. Of those two, the lower one is the $3,380 figure. That is the upper limit.
The lower limit is set by the higher of the pair with the X in the circles. In this case, the higher is the $3,360. So the price has to fall between these middle two, $3,360 and $3,380.
At any other price, there would not be equal numbers willing to buy and willing to sell. This is not my opinion. It is how all men act. They will not buy unless they expect to improve their situation by getting something they value higher than they value the sum of money they pay for it. They will not sell unless they value the money received higher than they value the good they offer for sale. Every participant expects to gain from every transaction, and there must be a buyer for each unit sold. Likewise, men will not pay more than market conditions demand; nor will they sell for less than competitive market conditions compel potential buyers to pay.
Effect of TaxesNow we shall try to show what happens when the government places a tax on the transaction. First we shall assume a sales tax of $50 on every sale of a taxicab. That means you have to add $50 to the subjective value each potential seller places on his taxicab. He will have to get at least that much before he improves his situation by selling. What happens with this problem?
Under the assumed conditions, only five cabs would be sold, and the price would be in the range from $3,350 to $3,360. With the tax included, this price range would be from $3,400 to $3,410. (See table 12.)
Table 12. BILATERAL COMPETITION(Second part of problem answered)
Effect of Taxes
Assume sales tax added to sales price of each taxi in table 11.
If a flat rate of $50 per taxi: If a 10% sales tax rate:5 taxis will be sold at aprice of $3,350–3,360;with tax included,$3,400–3,410.
4 taxis will be sold at$3,250–3,330;with tax included,$3,575–3,663.
If the tax were 10 percent of the sales price, only four cabs would be sold, and the price range, with the tax included, would be between $3,575 and $3,663.
Now we have seen what would happen to the price. It goes up. We have also seen what would happen to the number of transactions. Fewer cabs are sold. This means that under the first assumption, the $50 tax, one taxicab has to remain with a man who places a lower value on it than another man, a potential buyer, does. Because of the tax, the taxicab cannot be transferred to the potential buyer who places a higher value on it, but for whom it is not worth the extra $50 he must now pay.
When the tax goes up as high as 10 percent of the sales price, two taxicabs have to remain with men who place a lower value on them than would be the case in a market where the taxes did not exist. So sales taxes stand in the way of transactions that would increase the satisfactions of both potential buyers and potential sellers.
Of course, those taxes might be necessary for the market to operate. In that case they are a necessary cost of doing business. But when they are just an interference with the market, or a tax to provide a subsidy for some privileged group, rather than an expense for the equal protection of all, they must diminish the satisfactions of the people operating in the marketplace. Every transaction prevented reduces the satisfaction of a potential buyer and a potential seller. In addition, it results in a rearrangement of market conditions in a manner that must reduce the highest potential satisfaction of human beings.
This is how prices come about. They emerge from the concatenation of the subjective values of all the people participating in the marketplace, each one trying to improve his situation as best he can from his own point of view. Except for the valuations of the middle marginal pair, changes in the valuations of the other parties have no influence, as long as they do not cross the price range of the middle marginal pair. If one of the potential buyers below the line was willing to pay up to $10,000 for a cab, it would have absolutely no influence on this particular situation, because he will not in fact pay more than he needs to pay, that is, the market price.
Remember that price must benefit all who trade. You do not trade unless you expect to benefit. Price must also allocate the available units to those who place the highest value on them. And every interference with free-market prices is an interference that must diminish the human satisfaction of moral persons. It leaves things where they are worth less than they would have been worth if the market had been free to transfer them to those placing the highest value on them.
The same is true of laws that do not directly affect price, but do directly affect what you can trade, the hours during which you can trade, or where you can trade. All such laws reduce transactions and must therefore reduce human satisfactions.
Economic CalculationWe have been talking about consumers' goods, or things that people seek for their own use satisfactions. Let us go into the more complicated part of the market — producers' goods, or goods that are eventually used to make consumers' goods. When valuing producers' or capital goods, men transfer values of consumers' goods to their factors of production, that is, to the various things that are needed to make the consumer goods. It is thus the market value of consumers' goods that determines the value of labor, machines, and raw materials. For this, economic calculation is necessary.
Under socialism, economic calculation is not possible. Without a market, socialists cannot calculate what goods will give the most satisfaction, or the most efficient way to make whatever they decide to make. Since the government owns and controls all the factors of production, there can be no competitive market bidding for scarce materials to decide how they should be allocated. This is a function of prices in a market economy. But there is no market for raw materials or other factors of production in a socialist or communist society.
In a socialist or communist society, those who want to find out whether steel is more expensive than aluminum or some other metal have to buy a newspaper from a country that has a market. Even then, the prices in that paper will reflect the relative values of that country's market and not those within the borders of the socialist area, where supply and demand conditions may be very different. Socialists have no other way of knowing relative values. They must rely on the opinion of some bureaucrat, someone with authority. Without competitive prices, planning production is like trying to solve a puzzle without an answer. Because it monopolizes raw materials, the government receives no help from competitors in determining relative values.
In our market calculations we grade, prefer, and set aside. Values are ordinal and comparative. Now let's take an example of what happens in the market with one of the factors of production. Take iron, for example.
The price of iron originates in the businessmen's appraisal of the consumers' subjective valuations of iron products, products of which iron is a part. After all, businessmen cannot sell their products unless consumers consider them a bargain. So their ideas of consumers' valuations determine how high they will go in bidding for iron and the other factors needed to make their product.
The available supply of iron, like that of taxicabs, always goes to the highest bidders, those who expect their use of the iron will bring the highest price from consumers. Of course, the larger the quantity offered for sale, the fewer the potential buyers who are disappointed. Money is the common denominator for calculating the most profitable uses of the limited supply, that is, the best-paid uses, the highest prices on the market.
The available iron is sold to the highest bidders, with the marginal buyer determining its price and thus the cost to all buyers, even those who might have been willing to pay more. The competition of sellers drives prices down on all iron products. If there are high profits, there will soon be more suppliers competing. General market bidding thus allocates all the available supplies of all factors of production so as to satisfy the highest not yet satisfied consumer wants. High market prices for a product induce businessmen to increase production of that product, while low market prices cause businessmen to use the factors of production to make other consumers' goods for which they expect prices to be higher.
Market Effect of SavingsWhenever additional savings are available, these new savings start a bidding for the factors of production needed to supply the highest not yet satisfied wants on consumers' value scales. This bidding raises costs, including wages, and ultimately results in more production, which tends to lower prices and squeeze or eliminate profits.
If the cost of some factor of production is too high for businessmen, it means there is another use for it for which consumers are expected to pay a higher price. Prices are expressions of relative scarcity in relation to demand. Values are not quantities but arrangements in order of importance in satisfying human wants. Adding values, like adding love, is crazy. We can only compare them.
As consumers' value scales change, the kinds of wealth produced must change. Market prices are the indicators that direct businessmen to change their production. Businessmen tend to produce units of every article up to the point at which they expect consumers to pay all costs of production, including interest. A profitable industry tends to expand to that point; an unprofitable one tends to shrink to that point. Thus consumers, by their buying or non-buying at or above the cost of production, determine how much should be produced in every branch of industry.
There prevails upon the unhampered market a tendency for consumers to encourage production in every industry up to that point at which the marginal producer or producers make neither a profit nor a loss. Flexible market prices are the means for revealing that point to producers. Any outside interference with freely flexible prices must misdirect production and lead to diminished satisfaction of consumers.
Subjective Values Determine PricesAs stated in the beginning, it is the subjective values of individuals which allocate the available supply of every good, so as to satisfy human wants in the descending order of their importance, whereby the particular want last satisfied is the one with the marginal utility. From beginning to end, prices, and thus economic calculations, are the products of subjective valuations. They are the results of the reciprocal impact of the subjective values placed on the goods and those placed on a quantity of money by all interested parties. Every price must benefit all who exchange.
There is nothing automatic or mysterious in the operation of the market. The only forces determining the continually fluctuating up-and-down state of the market are the value judgments of interested individuals, and their actions as directed by their value judgments. The ultimate factor in the market is the striving of each man to satisfy his needs and wants in the most economical way possible or known to him. The supremacy of the market is in fact a supremacy of the consumers. Interfering with the market interferes with the satisfactions of consumers.
QUESTIONS AND ANSWERSEffect of Consumers' Values on ProducersQ. What you have explained is all right for products which already exist. But does it apply to those that don't exist — to new ones?
A. Certainly it does! As I have said, people's wants are never fully satisfied. There are always some things they want that they do not have. When there are new savings in a market society, the saver becomes an investor. He tries to invest his savings in a way that will produce more goods. What goods? Those goods next lower on consumers' value scales, for which their needs have not yet been satisfied. These are the goods that businessmen expect consumers will pay more for in the future than their current cost of production. When he produces these new goods, he has got to bid for labor. He has got to bid for raw materials. Thus he pushes those wages and prices up to take the labor and raw materials away from other uses. Then he produces goods that have to be sold in competition with all existing goods. With more goods and no change in the quantity of money, prices are lower than they would have been, and everyone gets more for his own limited amounts of money. To answer the question more specifically, every businessman must pay attention to consumers' values — to what consumers want and will pay. This may mean producing larger quantities of presently available goods or entirely new items not previously available. In either case, more human wants are satisfied. If a businessman does not pay attention to consumers' wants, he will soon be out of business.
Morality of SpeculationQ. The majority of people consider speculation immoral. What do you have to say about that?
A. Calling speculation "immoral" is saying that all men are immoral, because we are all speculators. It is even a speculation to cross the streets in Buenos Aires — or New York. No one knows the future. We have to speculate. All of our choices and actions are speculations.
It is true that many consider immoral those "terrible" people who make money speculating. Do you know that you cannot make money speculating unless you serve society? If you speculate on the future and do not serve society, you lose. The normal process for successful speculation is to buy something cheap at one period and sell it high at a later period. Speculators make a profit when they can do this. But when they buy, they have no assurance that it is going to be higher later. It could be lower and then they lose. Try it in the stock market sometime and you will find out.
If the speculators buy something when its price is low, they are buying it when it is in relatively large supply and, because the price is low, people are using it as a cheap good. If they sell it later at a higher price, it is because it is then scarcer in relation to the demand for it. It is, therefore, worth more and serves human uses that are more valuable. So what the speculator does to earn his money is to buy the good when it is cheap and store it for when he hopes it may be more expensive. If this is something that is needed for life, like the grain in the story of Joseph in the Bible, when the seven plenteous years were followed by seven years of famine, the service to society becomes evident. Those who save goods when there is a plentiful supply and make it available when there is a famine, or no other supply, are speculators who make money by serving society. If, on the other hand, there is, later on, a larger supply, the speculator has to sell his stored supply at a cheaper price, pay for the warehouse, pay interest on his investment, and thus he loses. A speculator can make money only when he serves society. A speculator is a person who tries to foresee the future situation and prepare for it. Only if he sees and acts relatively more effectively than other people in satisfying human wants, does he make a market profit from his speculation. Serving society is never immoral.
On Effects of Intrinsic Value and QualityQ. What do you have to say about the influence of intrinsic value? And about the influence of quality?
A. Those are really two different questions. In economics, there is no such thing as intrinsic value. This is a very common error, particularly concerning the precious metals, including gold. Nothing has value in the market unless it satisfies some human want or need. The value of something is in a person's mind. It is not in the product. Of course, the physical qualities of a good contribute to its usefulness to men. However, it is only when men can see a use for a scarce good that it has value.
Now, of course, the quality of a good is an essence of its value. Rotten eggs have little value. There are people who will pay more for a higher quality. But the seller can charge a higher price for a higher quality only if people want the higher quality. Most of us, of course, prefer higher quality. We do not go around in rags. We buy suits that are made to fit us. We buy suits that look better on us than simple lengths of cloth that we could wind around us to keep us warm, and we pay more for them. It is the consumers who determine both the values and the qualities that are found in the market.
Competition and MonopolyQ. What happens to the Golden Rule when there is no perfect competition, that is to say, under oligopoly and monopoly?
A. First, about this "perfect competition," we could spend a whole evening on the fallacies embraced by that idea. There is no such thing as perfect competition. But in a market society there is always competition. In one sense everything in the market is in competition with everything else for the consumers' dollars.
We could spend another couple of evenings on the question of competition and monopoly. Actually, the only monopolies we have to fear are those that are monopolies because they have a special privilege from a government. If there is freedom to compete in the marketplace, you can maintain a monopoly only as long as you are superior to every prospective competitor. In a free-market society, you do not have a monopoly unless you are doing something better than any other person or group of persons could do it.
In one sense, we are all monopolists. We each have a monopoly on our own services. The man who is the best prize fighter, the champion of the world, has a monopoly on that title. The opera singer who can sing the highest note has a monopoly and gets the highest price. The man who owns the only gasoline station in a community has a monopoly. In a free-market society, if anyone can do better, he is free to compete.
The problems of monopoly get down to the question of monopoly prices. No one has to pay a monopoly price unless he is satisfied that doing so improves his situation. In a free market anyone should be able to compete, if he thinks he can compete.
Most of our monopoly problems come from special privileges granted by law. The answer there is always to take away the special privilege. With equality before the law, which was mentioned in one question following the first lecture, there is no significant monopoly problem. Everybody should have an equal right to compete. Then those who give consumers the greatest satisfaction will be the ones who succeed. If they get fat, lazy, and rich from their success, then somebody else will come along, compete, and knock them down. In a free market, newcomers are constantly trying to replace the giant firms on the top.
One of the worst effects of the New Deal in my country and of welfare state processes in other countries is that they keep at the top those who are already there. Interventionism tends to protect them from the competition of those at the bottom who would like to replace them.
For example, it is now impossible in my country to do what Henry Ford did forty years ago. What Henry Ford did was to employ men to make more automobiles for more people, who bought them all at prices that they considered bargains. He paid the workers higher wages than they could get anywhere else. He made these automobiles for the masses and became rich. What did he do with his wealth? He plowed it back into more or bigger factories, hiring still more men to make still more cars.
Today, with present tax rates, the government takes a good part of all profits, including more than half of the profits made by corporations. As a result a businessman in the United States can no longer expand as fast as Henry Ford could. He therefore cannot compete as easily against the giants already at the top. So these laws, supposedly directed against the top people, are more against the new, smaller, struggling competitors. They prevent newcomers from competing with those already on the top as efficiently as they could if they were permitted to keep and plow back into the business more of their early profits.
Calculation under CommunismQ. Considering the actual value scales existing in Communist Russia, must not the Communists calculate economic values on the basis of the cost of production?
A. They have no cost of production, or rather, their cost of production is the sweat and blood of their people. It is an order: You do this, or you do that, or you do something else. They cannot calculate market costs because they have no market to tell them costs. Their calculations have to be based on the judgments of a czar, the czar of each particular industry.
Some ten years ago, I put together an article that was largely quotations from Russian papers, Pravda and others. It related several interesting incidents, which indicated that these papers were not entirely happy with the operation of their own Russian Soviet system. It seems there was one industry that had to move goods from the north to the south on the Volga River. So they built a fleet of boats to move these goods from the north to the south, and the boats returned north empty. There was also another industry that had to move goods from the south to the north. So this industry built another fleet of boats that returned south empty.
Now in a market economy, there would be common carriers, or advertising that would bring the two industries together. In either case, the market economy would not waste its scarce labor and its scarce materials by building two fleets of ships to do what one could do.
Another interesting article was about the Soviet railroad organization. It was paid to carry things on the railroads. The railroads had some tank cars. If they moved oil in one direction, they got paid for it. If they came back empty, they did not get paid for it. So on the return trips they would fill up the tank cars with water. That way they got paid for the return trip. How can you calculate costs under such a system? There are many examples of such uneconomic actions. I shall cite one in a later talk. It concerns a trade agreement arranged between East Germany and the Soviet Union that resulted in a suicide.
The communists have no means of calculation unless they look outside the country to market economies. Then they have the relationship of supply and demand that exists within the other country. The communist system, because it has no economic calculation, has to be inefficient. Communists can never be forerunners. They must always be followers. When people understand this, they will no longer be afraid of them as an economic power. If communism were a good and strong economic system, we should adopt it. But the communists are not strong. They are weak. They are now trying to copy capitalistic production methods, but they cannot do so while the government controls and allocates all the factors of production. Without markets, they are blind as to real costs.
Christianity and CapitalismQ. Do you think that Protestantism has helped free-market principles?
A. Well, I am a very staunch believer that free-market principles are in full harmony with Christian principles and that the free market is the only economic system that is consistent with Christian or Judeo-Christian principles. I must say that in recent years the organized churches, both the Protestant and the Roman Catholic, have not been in harmony with free-market teachings, nor have they been in harmony with what I must hold are the principles taught in the Bible. The organized churches have largely accepted the welfare state ideology so popular today. This ideology has changed the original meaning of the Ten Commandments. I could give you quite a speech on that. However, I want to make just this one point. There is the Commandment which in English is only four words: "Thou shalt not steal." Today, most of our people think that it has been expanded to eight words. They think it is: "Thou shalt not steal except by majority vote." They seem to think that any stealing done by majority vote is all right.
Except when necessary for defense, neither capitalism nor Christianity approves of the use of force or coercion. The fundamental principle of the free market, voluntary social cooperation for mutual advantage, is in full conformity with Judeo-Christian teachings.
Antitrust Law InterventionsQ. What do you think about the antitrust laws?
A. How many weeks can we have to answer that? Antitrust laws are like all other interventions. They help certain interests and they hurt others. They always hurt the consumers. In my country the antitrust laws originated because the government had given privileges to certain industries, and the companies, particularly the railroads, used these privileges to enrich themselves at the expense of the consumers. By law, the railroads were handed monopoly privileges that protected them from competition. Once they had this monopoly, they raised rates above those that would have attracted competition; but no competitor could come in to lower them. Then the people and the government said, "We have to control these greedy monopolies!" This led to the creation of the so-called antitrust laws.
Most of the antitrust laws are aimed at trying to undo the damage created by earlier government laws. I have written an article on this subject, particularly with relation to labor unions. It is entitled, "Is Further Intervention a Cure for Prior Intervention?"First published in On Freedom and Free Enterprise: Essays in Honor of Ludwig von Mises, ed. by Mary Sennholz. (Princeton, New Jersey, D. Van Nostrand Co., Inc., 1956. Reprinted separately by the Foundation for Economic Education, Inc., Irvington-on-Hudson, N.Y.). My answer is "No." Marx wanted such interventions because, as he correctly stated in the Communist Manifesto, they will make matters worse, create a demand for more and more intervention, until they result in overturning the capitalistic system. This is what is happening in many countries today. When people think the remedy for anything they do not like is another law, you get more and more laws until there is no freedom left. Every one of these governmental interventions makes matters worse from the point of view of those who advocate them. Try and think of one that does not.
Are High Prices Helpful?Q. Do you think that the producer who sells his product at high prices benefits the community?
A. Yes, if he can get them. If the high prices mean a high profit, he is soon going to have competitors who will gradually bring the price down pretty close to the actual costs of production. Let me cite an example that has been before the world just recently, the case of the few doctors who are able to transplant human hearts. Suppose you only allowed them to charge $100 per operation, and they could only perform one operation a week, and there was need for many more. Who would be selected, and how many young doctors would train to learn that operation, if $ 100 once a week were all they could make? On the other hand, if they were allowed to charge the highest price they could get, the market would select their customers. If that price were really high, many young doctors would want to learn to perform that very intricate operation. In a short period of time, more doctors would be able to perform the operation; the price would come down and more people could benefit from that type of operation, if it could help them.
The remedy for high prices is prices high enough to attract competition. When you lower prices by law, you not only fail to attract new producers, but you also make it unprofitable for marginal producers to continue in business. So production goes down, and consumers are provided with less satisfaction.
We have seen that in my country in connection with the question of rent control. During World War II, they said we had to take care of the poor people and keep rents low. So they froze rents then in effect across the nation. Wartime inflation raised the costs of construction. What happened? Nobody built any houses for rent, not even after the war, when construction materials were again available for peacetime uses. Did that help the boys who came back from the war, married, and started new families? No. It only created a still greater shortage of rental housing.
What was the political solution? Another law — public housing. First, there was public housing for politically selected low-income families. Now it is public housing for politically selected middle-income families. Like the public schools a century earlier, it may be public housing for all incomes before long. In Russia, you take the housing the government assigns you. In Sweden, married couples sign up for space on a waiting list. By the time they get something they are ready for divorce.
On Politics and PovertyQ. How do you explain the fact that today, although we live in a free-market economy, every day there are fewer rich and every day more and more poor?
A. I do not know where the questioner lives! In my country and other countries of the Western civilization, we have had more and more wealth under relatively free-market economies. It is only where government intervention results in capital consumption that there is less wealth produced. Marx certainly never envisioned the automobiles you have running around the streets here. He thought that before the end of the 19th century people were going to be starving, and that then they would rise up, throw off their chains, and create a dictatorship of the proletariat.
Now the automobiles that you have in Buenos Aires are not for the rich only. Those who are really poor today are poor largely because government intervention keeps them from competing for jobs. I, of course, am no authority on your economy, but I do know that in my country the poor, and particularly the Negroes, are kept poor because the labor unions can legally keep them out of jobs. We shall be saying more on this subject in the next lecture. It is the interventionist laws that prevent the poor from getting on the bottom rung of the ladder so that they can start the climb up. The stress of poverty is greatest when production goes down, and this usually occurs as a result of government interferences with a market economy.
We may not have a free-market economy but we do have a market economy. We have what my great teacher calls a hampered market economy. It is hampered. Its operations are hindered by governmental interferences. Under this situation we all have less. Both the rich and the poor have less, but the poor suffer more. The rich can get along comfortably with a little less, but many of the poor cannot take that less. Most government intervention is intended to help the poor at the expense of the rich, but, short of a dictatorship, it is always at the expense of everyone, including the poor.
Speculators and ScarcityQ. Do you agree that a speculator can artificially create scarcity so as to sell at a high price?
A. No, I would not agree that he can artificially create scarcity except in a very, very temporary local situation. We had a case in New York. Some of you may remember that a couple of years ago our electricity went off late one afternoon, and remained off for some 15 hours. People were caught in elevators. Everything was dark. Radios and TVs were silent. No one knew why. The only news I could hear was the radio in my automobile, and the local stations were going off the air. All of our electricity had gone off. There was a scarcity of electricity, to put it mildly. Those people who had flashlights and candles to sell were in a position to make a nice little profit. But if those flashlights and candles had not been there, the people could not have had them. People can make these profits only when they foresee the future better than their competitors. In a free society everybody has the right to be a speculator. If you think the price of cotton is going to double by next year, buy it now. Sell it next year. You have as much right to do it as anybody else. But what if you do, and the price goes down? This is the chance the speculator takes. If someone destroys his own property to raise prices, he is going to invite competition, so that any gain will be short-lived.
Price ControlsQ. What are the consequences of imposing maximum and minimum prices?
A. Imposing a maximum price — that is, holding prices below those of the market — means that the marginal producer will not cover his costs and will go out of business. Imposing a minimum price — that is, holding prices above those of the market — has the opposite effect. It means that more will be produced than can be sold at the minimum price.
Mises tells the story of how they like to introduce these maximum prices by putting them on something that is very much needed, say milk for babies. The poor people need cheap milk. So we lower the price of milk by law. And what do the people who have the cows do? They use the milk to make cheese and ice cream, which are not under price control. So to keep the price of milk down you have to apply the price controls to cheese and ice cream. The controls then must be applied to the expenses of the dairy industry, and eventually from one product to another, until you get to the point that Hitler reached in Nazi Germany.
Establishing minimum prices, by which the government guarantees a higher-than-free-market minimum price to producers, as we have done in our farm programs in my country, means that you soon have surpluses piling up in warehouses. The taxpayers then have to pay subsidies to the farmers, storage, and higher interest charges, as well as higher prices for their food and cotton goods. In fact, all over the world new areas are now growing cotton and taking our former markets away from us. The free market would direct those now producing the surpluses to make something else that consumers prefer rather than more of the goods for which prices are held artificially high.
The maximum prices reduce production and the availability of the goods. The minimum prices increase production beyond what people want at prices that cover the marginal cost of production. Then the product has to be warehoused or destroyed. In your neighboring country, Brazil, they simply burned their surpluses of coffee.
Existence of a Free-Market EconomyQ. In the United States, do you have a free-market economy, and if so, tell us since when?
A. The free-market economy is like Christianity. It is a goal to move toward but human beings never quite attain it. We have never had a completely free economy in the United States. It was only relatively freer than any that had ever existed in the world before. It protected private property and brought us great capital accumulation, on which we are now living. The nearer you approach to the free-market economy, the higher the standard of living will be.
Product Durability vs. Higher SalesQ. Would you be so kind as to discuss briefly the soundness of a policy of manufacturing goods that do not last too long, thus insuring a continuing demand, creating manufacturing volume, and thereby reducing both costs and selling prices?
A. Well, a manufacturer's purpose is, of course, to maximize his profits. He has to compete with businessmen who may have different ideas of production. It is always the consumers who will decide which manufacturer gets the profits. I am the son of a Britisher and this question led to debates I used to have with my father about automobiles. As a Britisher, he defended the Rolls Royce, which did not change its models every year, had higher quality, and lasted almost a lifetime. In the United States, we change our automobile models almost every year in some way. The consumers then decide which of the two they will buy, the one that will wear out quickly, or the one that lasts a longer time.
[product:0]
The same thing is true of styles. In my country, as in other countries, the women's wear industry has persuaded women to change their styles almost every year so the industry will have more sales. They are now trying to do it with the men. Clothing manufacturers would like us to throw our clothes away because they are out of style rather than because they are worn out. Any business can attempt this, but the final decision is always made by the consumers as they spend their money. So in the long run, the manufacturer has no choice; he must provide what the consumers will buy.
Right to Destroy WealthQ. Has the producer the right to destroy the products he produces?
A. The question is: Does he own them? If he has paid for them, he has the right to do that; and I suppose he has the right to commit suicide too. If you have something of value and want to destroy it without harming anyone else, that is your right. But if it has a market value, there is no inducement to destroy it.
This article is excerpted from Understanding the Dollar Crisis (1973).
[This essay is based on a paper presented at the April 1979 national meeting of the Philadelphia Society in Chicago. The theme of the meeting was "Conservatism and Libertarianism."]
Libertarianism is the fastest growing political creed in America today. Before judging and evaluating libertarianism, it is vitally important to find out precisely what that doctrine is, and, more particularly, what it is not. It is especially important to clear up a number of misconceptions about libertarianism that are held by most people, and particularly by conservatives. In this essay I shall enumerate and critically analyze the most common myths that are held about libertarianism. When these are cleared away, people will then be able to discuss libertarianism free of egregious myths and misconceptions, and to deal with it as it should be on its very own merits or demerits.
Myth #1: Libertarians believe that each individual is an isolated, hermetically sealed atom, acting in a vacuum without influencing each other. This is a common charge, but a highly puzzling one. In a lifetime of reading libertarian and classical-liberal literature, I have not come across a single theorist or writer who holds anything like this position.
The only possible exception is the fanatical Max Stirner, a mid-19th-century German individualist who, however, has had minimal influence upon libertarianism in his time and since. Moreover, Stirner's explicit "might makes right" philosophy and his repudiation of all moral principles including individual rights as "spooks in the head," scarcely qualifies him as a libertarian in any sense. Apart from Stirner, however, there is no body of opinion even remotely resembling this common indictment.
Libertarians are methodological and political individualists, to be sure. They believe that only individuals think, value, act, and choose. They believe that each individual has the right to own his own body, free of coercive interference. But no individualist denies that people are influencing each other all the time in their goals, values, pursuits, and occupations.
As F.A. Hayek pointed out in his notable article, "The Non Sequitur of the 'Dependence Effect,'" John Kenneth Galbraith's assault upon free-market economics in his best-selling The Affluent Society rested on this proposition: economics assumes that every individual arrives at his scale of values totally on his own, without being subject to influence by anyone else. On the contrary, as Hayek replied, everyone knows that most people do not originate their own values, but are influenced to adopt them by other people.John Kenneth Galbraith, The Affluent Society (Boston: Houghton Mifflin, 1958); F.A. Hayek, "The Non-Sequitur of the 'Dependence Effect,'" Southern Economic Journal (April, 1961), pp. 346–48.
No individualist or libertarian denies that people influence each other all the time, and surely there is nothing wrong with this inevitable process. What libertarians are opposed to is not voluntary persuasion, but the coercive imposition of values by the use of force and police power. Libertarians are in no way opposed to the voluntary cooperation and collaboration between individuals: only to the compulsory pseudo-"cooperation" imposed by the state.
Myth #2: Libertarians are libertines: they are hedonists who hanker after "alternative lifestyles." This myth has recently been propounded by Irving Kristol, who identifies the libertarian ethic with the "hedonistic" and asserts that libertarians "worship the Sears Roebuck catalogue and all the 'alternative life styles' that capitalist affluence permits the individual to choose from."Irving Kristol, "No Cheers for the Profit Motive," Wall Street Journal (Feb. 21, 1979).
The fact is that libertarianism is not and does not pretend to be a complete moral or aesthetic theory; it is only a political theory, that is, the important subset of moral theory that deals with the proper role of violence in social life.
Political theory deals with what is proper or improper for government to do, and government is distinguished from every other group in society as being the institution of organized violence. Libertarianism holds that the only proper role of violence is to defend person and property against violence, that any use of violence that goes beyond such just defense is itself aggressive, unjust, and criminal. Libertarianism, therefore, is a theory which states that everyone should be free of violent invasion, should be free to do as he sees fit, except invade the person or property of another. What a person does with his or her life is vital and important, but is simply irrelevant to libertarianism.
It should not be surprising, therefore, that there are libertarians who are indeed hedonists and devotees of alternative lifestyles, and that there are also libertarians who are firm adherents of "bourgeois" conventional or religious morality. There are libertarian libertines and there are libertarians who cleave firmly to the disciplines of natural or religious law. There are other libertarians who have no moral theory at all apart from the imperative of non-violation of rights. That is because libertarianism per se has no general or personal moral theory.
Libertarianism does not offer a way of life; it offers liberty, so that each person is free to adopt and act upon his own values and moral principles. Libertarians agree with Lord Acton that "liberty is the highest political end" — not necessarily the highest end on everyone's personal scale of values.
There is no question about the fact, however, that the subset of libertarians who are free-market economists tends to be delighted when the free market leads to a wider range of choices for consumers, and thereby raises their standard of living. Unquestionably, the idea that prosperity is better than grinding poverty is a moral proposition, and it ventures into the realm of general moral theory, but it is still not a proposition for which I should wish to apologize.
Myth #3: Libertarians do not believe in moral principles; they limit themselves to cost-benefit analysis on the assumption that man is always rational. This myth is of course related to the preceding charge of hedonism, and some of it can be answered in the same way. There are indeed libertarians, particularly Chicago School economists, who refuse to believe that liberty and individual rights are moral principles, and instead attempt to arrive at public policy by weighing alleged social costs and benefits.
In the first place, most libertarians are "subjectivists" in economics, that is, they believe that the utilities and costs of different individuals cannot be added or measured. Hence, the very concept of social costs and benefits is illegitimate. But, more importantly, most libertarians rest their case on moral principles, on a belief in the natural rights of every individual to his person or property. They therefore believe in the absolute immorality of aggressive violence, of invasion of those rights to person or property, regardless of which person or group commits such violence.
Far from being immoral, libertarians simply apply a universal human ethic to government in the same way as almost everyone would apply such an ethic to every other person or institution in society. In particular, as I have noted earlier, libertarianism as a political philosophy dealing with the proper role of violence takes the universal ethic that most of us hold toward violence and applies it fearlessly to government.
Libertarians make no exceptions to the golden rule and provide no moral loophole, no double standard, for government. That is, libertarians believe that murder is murder and does not become sanctified by reasons of state if committed by the government. We believe that theft is theft and does not become legitimated because organized robbers call their theft "taxation." We believe that enslavement is enslavement even if the institution committing that act calls it "conscription." In short, the key to libertarian theory is that it makes no exceptions in its universal ethic for government.
Hence, far from being indifferent or hostile to moral principles, libertarians fulfill them by being the only group willing to extend those principles across the board to government itself.For a call for applying universal ethical standards to government, see Pitirim A. Sorokin and Walter A. Lunden, Power and Morality: Who Shall Guard the Guardians? (Boston: Porter Sargent, 1959), pp. 16–30.
It is true that libertarians would allow each individual to choose his values and to act upon them, and would in short accord every person the right to be either moral or immoral as he saw fit. Libertarianism is strongly opposed to enforcing any moral creed on any person or group by the use of violence — except, of course, the moral prohibition against aggressive violence itself. But we must realize that no action can be considered virtuous unless it is undertaken freely, by a person's voluntary consent.
As Frank Meyer pointed out,
Men cannot be forced to be free, nor can they even be forced to be virtuous. To a certain extent, it is true, they can be forced to act as though they were virtuous. But virtue is the fruit of well-used freedom. And no act to the degree that it is coerced can partake of virtue — or of vice.Frank S. Meyer, In Defense of Freedom: A Conservative Credo (Chicago: Henry Regnery, 1962), p. 66.
If a person is forced by violence or the threat thereof to perform a certain action, then it can no longer be a moral choice on his part. The morality of an action can stem only from its being freely adopted; an action can scarcely be called moral if someone is compelled to perform it at gunpoint.
Compelling moral actions or outlawing immoral actions, therefore, cannot be said to foster the spread of morality or virtue. On the contrary, coercion atrophies morality, for it takes away from the individual the freedom to be either moral or immoral, and therefore forcibly deprives people of the chance to be moral. Paradoxically, then, a compulsory morality robs us of the very opportunity to be moral.
It is furthermore particularly grotesque to place the guardianship of morality in the hands of the state apparatus — that is, none other than the organization of policemen, guards, and soldiers. Placing the state in charge of moral principles is equivalent to putting the proverbial fox in charge of the chicken coop.
Whatever else we may say about them, the wielders of organized violence in society have never been distinguished by their high moral tone or by the precision with which they uphold moral principle.
Myth #4: Libertarianism is atheistic and materialist, and neglects the spiritual side of life. There is no necessary connection between being for or against libertarianism and one's position on religion. It is true that many if not most libertarians at the present time are atheists, but this correlates with the fact that most intellectuals, of most political persuasions, are atheists as well.
There are many libertarians who are theists, Jewish or Christian. Among the classical-liberal forebears of modern libertarianism in a more religious age there were a myriad of Christians: from John Lilburne, Roger Williams, Anne Hutchinson, and John Locke in the 17th century, down to Cobden and Bright, Frédéric Bastiat and the French laissez-faire liberals, and the great Lord Acton.
Libertarians believe that liberty is a natural right embedded in a natural law of what is proper for mankind, in accordance with man's nature. Where this set of natural laws comes from, whether it is purely natural or originated by a creator, is an important ontological question but is irrelevant to social or political philosophy.
As Father Thomas Davitt declares,
If the word "natural" means anything at all, it refers to the nature of a man, and when used with "law," "natural" must refer to an ordering that is manifested in the inclinations of a man's nature and to nothing else. Hence, taken in itself, there is nothing religious or theological in the "Natural Law" of Aquinas.Thomas E. Davitt, S.J., "St. Thomas Aquinas and the Natural Law," in Arthur L. Harding, ed., Origins of the Natural Law Tradition (Dallas, Tex.: Southern Methodist University Press, 1954), p. 39.
Or, as D'Entrèves writes of the 17th century Dutch Protestant jurist Hugo Grotius,
[Grotius's] definition of natural law has nothing revolutionary. When he maintains that natural law is that body of rule which Man is able to discover by the use of his reason, he does nothing but restate the Scholastic notion of a rational foundation of ethics. Indeed, his aim is rather to restore that notion which had been shaken by the extreme Augustinianism of certain Protestant currents of thought. When he declares that these rules are valid in themselves, independently of the fact that God willed them, he repeats an assertion which had already been made by some of the schoolmen.A.P. d'Entrèves, Natural Law (London: Hutchinson University Library, 1951). pp. 51–52.
Libertarianism has been accused of ignoring man's spiritual nature. But one can easily arrive at libertarianism from a religious or Christian position: emphasizing the importance of the individual, of his freedom of will, of natural rights and private property. Yet one can also arrive at all these self-same positions by a secular, natural-law approach, through a belief that man can arrive at a rational apprehension of the natural law.
Historically, furthermore, it is not at all clear that religion is a firmer footing than secular natural law for libertarian conclusions. As Karl Wittfogel reminded us in his Oriental Despotism, the union of throne and altar has been used for centuries to fasten a reign of despotism on society.Karl Wittfogel, Oriental Despotism (New Haven: Yale University Press, 1957), esp. pp. 87–100.
Historically, the union of church and state has been in many instances a mutually reinforcing coalition for tyranny. The state used the church to sanctify and preach obedience to its supposedly divinely sanctioned rule; the church used the state to gain income and privilege.
The Anabaptists collectivized and tyrannized Münster in the name of the Christian religion.On this and other totalitarian Christian sects, see Norman Cohn, Pursuit of the Millennium (Fairlawn, N.J.: Essential Books, 1957).
And, closer to our century, Christian socialism and the social gospel have played a major role in the drive toward statism, and the apologetic role of the Orthodox Church in Soviet Russia has been all too clear. Some Catholic bishops in Latin America have even proclaimed that the only route to the kingdom of heaven is through Marxism, and if I wished to be nasty, I could point out that the Reverend Jim Jones, in addition to being a Leninist, also proclaimed himself the reincarnation of Jesus.
Moreover, now that socialism has manifestly failed, politically and economically, socialists have fallen back on the "moral" and the "spiritual" as the final argument for their cause. Socialist Robert Heilbroner, in arguing that socialism will have to be coercive and will have to impose a "collective morality" upon the public, opines that: "Bourgeois culture is focused on the material achievement of the individual. Socialist culture must focus on his or her moral or spiritual achievement."
The intriguing point is that this position of Heilbroner's was hailed by the conservative religious writer for National Review, Dale Vree. He writes:
Heilbroner is … saying what many contributors to NR have said over the last quarter-century: you can't have both freedom and virtue. Take note, traditionalists. Despite his dissonant terminology, Heilbroner is interested in the same thing you're interested in: virtue.Dale Vree, "Against Socialist Fusionism," National Review (December 8, 1978), p. 1547. Heilbroner's article was in Dissent, Summer 1978. For more on the Vree article, see Murray N. Rothbard, "Statism, Left, Right, and Center," Libertarian Review (January 1979), pp. 14–15.
Vree is also fascinated with the Heilbroner view that a socialist culture must "foster the primacy of the collectivity" rather than the "primacy of the individual." He quotes Heilbroner's contrasting "moral or spiritual" achievement under socialism as against bourgeois "material" achievement, and adds correctly: "There is a traditional ring to that statement."
Vree goes on to applaud Heilbroner's attack on capitalism because it has "no sense of 'the good'" and permits "consenting adults" to do anything they please. In contrast to this picture of freedom and permitted diversity, Vree writes that "Heilbroner says alluringly, because a socialist society must have a sense of 'the good,' not everything will be permitted." To Vree, it is impossible "to have economic collectivism along with cultural individualism," and so he is inclined to lean toward a new "socialist-traditionalist fusionism" — toward collectivism across the board.
We may note here that socialism becomes especially despotic when it replaces "economic" or "material" incentives by allegedly "moral" or "spiritual" ones, when it affects to promoting an indefinable "quality of life" rather than economic prosperity.
When payment is adjusted to productivity there is considerably more freedom as well as higher standards of living. For when reliance is placed solely on altruistic devotion to the socialist motherland, the devotion has to be regularly reinforced by the knout. An increasing stress on individual material incentive means ineluctably a greater stress on private property and keeping what one earns, and brings with it considerably more personal freedom, as witness Yugoslavia in the last three decades in contrast to Soviet Russia.
The most horrifying despotism on the face of the earth in recent years was undoubtedly Pol Pot's Cambodia, in which "materialism" was so far obliterated that money was abolished by the regime. With money and private property abolished, each individual was totally dependent on handouts of rationed subsistence from the state, and life was a sheer hell. We should be careful before we sneer at "merely material" goals or incentives.
The charge of "materialism" directed against the free market ignores the fact that every human action whatsoever involves the transformation of material objects by the use of human energy and in accordance with ideas and purposes held by the actors. It is impermissible to separate the "mental" or "spiritual" from the "material."
All great works of art, great emanations of the human spirit, have had to employ material objects: whether they be canvasses, brushes and paint, paper and musical instruments, or building blocks and raw materials for churches. There is no real rift between the "spiritual" and the "material" and hence any despotism over and crippling of the material will cripple the spiritual as well.
Myth #5: Libertarians are utopians who believe that all people are good, and that therefore state control is not necessary. Conservatives tend to add that since human nature is either partially or wholly evil, strong state regulation is therefore necessary for society.
This is a very common belief about libertarians, yet it is difficult to know the source of this misconception. Rousseau, the locus classicus of the idea that man is good but is corrupted by his institutions, was scarcely a libertarian. Apart from the romantic writings of a few anarcho-communists, whom I would not consider libertarians in any case, I know of no libertarian or classical-liberal writers who have held this view.
On the contrary, most libertarian writers hold that man is a mixture of good and evil and therefore that it is important for social institutions to encourage the good and discourage the bad. The state is the only social institution which is able to extract its income and wealth by coercion; all others must obtain revenue either by selling a product or service to customers or by receiving voluntary gifts. And the state is the only institution which can use the revenue from this organized theft to presume to control and regulate people's lives and property. Hence, the institution of the state establishes a socially legitimatized and sanctified channel for bad people to do bad things, to commit regularized theft and to wield dictatorial power.
Statism therefore encourages the bad, or at least the criminal elements of human nature. As Frank H. Knight trenchantly put it,
The probability of the people in power being individuals who would dislike the possession and exercise of power is on a level with the probability that an extremely tenderhearted person would get the job of whipping master in a slave plantation.Journal of Political Economy (December 1938), p. 869. Quoted in Friedrich A. Hayek, The Road to Serfdom(Chicago: University of Chicago Press, 1944), p. 152.
A free society, by not establishing such a legitimated channel for theft and tyranny, discourages the criminal tendencies of human nature and encourages the peaceful and the voluntary. Liberty and the free market discourage aggression and compulsion, and encourage the harmony and mutual benefit of voluntary interpersonal exchanges, economic, social, and cultural.
Since a system of liberty would encourage the voluntary and discourage the criminal, and would remove the only legitimated channel for crime and aggression, we could expect that a free society would indeed suffer less from violent crime and aggression than we do now, though there is no warrant for assuming that they would disappear completely. That is not utopianism, but a common-sense implication of the change in what is considered socially legitimate, and in the reward-and-penalty structure in society.
We can approach our thesis from another angle. If all men were good and none had criminal tendencies, then there would indeed be no need for a state, as conservatives concede. But if on the other hand all men were evil, then the case for the state is just as shaky, since why should anyone assume that those men who form the government and obtain all the guns and the power to coerce others, should be magically exempt from the badness of all the other persons outside the government?
Tom Paine, a classical libertarian often considered to be naively optimistic about human nature, rebutted the conservative evil-human-nature argument for a strong state as follows: "If all human nature be corrupt, it is needless to strengthen the corruption by establishing a succession of kings, who be they ever so base, are still to be obeyed…" Paine added that "NO man since the fall hath ever been equal to the trust of being given power over all.""The Forester's Letters, III" (orig. in Pennsylvania Journal, Apr. 24, 1776), in The Writings of Thomas Paine (ed. M. D. Conway, New York: G. E Putnam's Sons, 1906), I, 149–150.
And as the libertarian F.A. Harper once wrote:
Still using the same principle that political rulership should be employed to the extent of the evil in man, we would then have a society in which complete political rulership of all the affairs of everybody would be called for.… One man would rule all. But who would serve as the dictator? However he were to be selected and affixed to the political throne, he would surely be a totally evil person, since all men are evil. And this society would then be ruled by a totally evil dictator possessed of total political power. And how, in the name of logic, could anything short of total evil be its consequence? How could it be better than having no political rulership at all in that society?F.A. Harper, "Try This On Your Friends," Faith and Freedom(January, 1955). p. 19.
Finally, since, as we have seen, men are actually a mixture of good and evil, a regime of liberty serves to encourage the good and discourage the bad, at least in the sense that the voluntary and mutually beneficial are good and the criminal is bad. In no theory of human nature, then, whether it be goodness, badness, or a mixture of the two, can statism be justified.
In the course of denying the notion that he is a conservative, the classical liberal F.A. Hayek pointed out,
The main merit of individualism [which Adam Smith and his contemporaries advocated] is that it is a system under which bad men can do least harm. It is a social system which does not depend for its functioning on our finding good men for running it, or on all men becoming better than they now are, but which makes use of men in all their given variety and complexity.F.A. Hayek, Individualism and Economic Order (Chicago: University of Chicago Press, 1948), reemphasized in the course of his "Why I am Not a Conservative," The Constitution of Liberty (Chicago: University of Chicago Press, 1960), p. 529.
It is important to note what differentiates libertarians from utopians in the pejorative sense. Libertarianism does not set out to remold human nature. One of socialism's major goals is to create, which in practice means by totalitarian methods, a New Socialist Man, an individual whose major goal will be to work diligently and altruistically for the collective.
Libertarianism is a political philosophy which says, Given any existent human nature, liberty is the only moral and the most effective political system.
Obviously, libertarianism — as well as any other social system — will work better the more individuals are peaceful and the less they are criminal or aggressive. And libertarians, along with most other people, would like to attain a world where more individuals are "good" and fewer are criminals. But this is not the doctrine of libertarianism per se, which says that whatever the mix of man's nature may be at any given time, liberty is best.
Myth #6: Libertarians believe that every person knows his own interests best. Just as the preceding charge holds that libertarians believe all men to be perfectly good, so this myth charges them with believing that everyone is perfectly wise. Yet, it is then maintained, this is not true of many people, and therefore the state must intervene.
But the libertarian no more assumes perfect wisdom than he postulates perfect goodness. There is a certain common sense in holding that most men are better apprised of their own needs and goals than is anyone else. But there is no assumption that everyone always knows his own interest best. Libertarianism rather asserts that everyone should have the right to pursue his own interest as he deems best. What is being asserted is the right to act with one's own person and property, and not the necessary wisdom of such action.
It is also true, however, that the free market — in contrast to government — has built-in mechanisms to enable people to turn freely to experts who can give sound advice on how to pursue one's interests best. As we have seen earlier, free individuals are not hermetically sealed from one another. For on the free market, any individual, if in doubt about what his own true interests may be, is free to hire or consult experts to give him advice based on their possibly superior knowledge. The individual may hire such experts and, on the free market, can continuously test their soundness and helpfulness.
Individuals on the market, therefore, tend to patronize those experts whose advice will prove most successful. Good doctors, lawyers, or architects will reap rewards on the free market, while poor ones will tend to fare badly. But when government intervenes, the government expert acquires his revenue by compulsory levy upon the taxpayers. There is no market test of his success in advising people of their own true interests. He only need have ability in acquiring the political support of the state's machinery of coercion.
Thus, the privately hired expert will tend to flourish in proportion to his ability, whereas the government expert will flourish in proportion to his success in currying political favor. Moreover, the government expert will be no more virtuous than the private one; his only superiority will be in gaining the favor of those who wield political force. But a crucial difference between the two is that the privately hired expert has every pecuniary incentive to care about his clients or patients, and to do his best by them. But the government expert has no such incentive; he obtains his revenue in any case. Hence, the individual consumer will tend to fare better on the free market.
Conclusion I hope that this essay has contributed to clearing away the rubble of myth and misconception about libertarianism. Conservatives and everyone else should politely be put on notice that libertarians do not believe that everyone is good, nor that everyone is an all-wise expert on his own interest, nor that every individual is an isolated and hermetically sealed atom. Libertarians are not necessarily libertines or hedonists, nor are they necessarily atheists; and libertarians emphatically do believe in moral principles.
Let each of us now proceed to an examination of libertarianism as it really is, unencumbered by myth or legend. Let us look at liberty plain, without fear or favor. I am confident that, were this to be done, libertarianism would enjoy an impressive rise in the number of its followers.
The fact that men are born unequal in regard to physical and mental capacities cannot be argued away, writes Ludwig von Mises.
This audio Mises Daily is narrated by Harold Fritsche.
[This article is excerpted from The Positive Theory of Capital, book 3, chapter 2, "Nature and Origin of Subjective Value."]
All goods without exception — indeed according to the very conception of them as "good" — possess a certain relation to human well-being. There are, however, two essentially distinct grades of this relation. A good belongs to the lower grade when it possesses the general capacity to subserve human weal. The higher grade, on the other hand, demands that a good should be more than merely a sufficient cause; it must be an indispensable condition of human well-being — a condition of such a kind that some gratification stands or falls with the having or wanting of the good. In the expressive vocabulary of everyday life we find a separate designation for these grades. The lower is called Usefulness, the higher Value. This distinction, already recognized in common speech, we must try to make as clear and well-marked as its fundamental importance for the whole theory of value deserves.
A man dwells beside a bubbling spring of water. He has filled his cup, and the spring goes on pouring out enough to fill a hundred other cups every minute. Another man is traveling in the desert. A long day's journey over glowing sand still divides him from the nearest oasis, and he has come to his last cup of water. What is the relation in each case between the cup of water and the well-being of its owner?
A single glance shows us that the relation is very dissimilar; but wherein lies the difference? Simply that, in the former case, we have only the lower grade of the relation we call well-being, that of usefulness; in the latter case we have the higher grade as well. In the first case, just as in the second, the cup of water is useful, that is, capable of satisfying a want, and, moreover, in exactly the same degree; for evidently the refreshing qualities of the water — the qualities on which its capacity to quench thirst is based, such as coolness, taste, etc. — are not in the least degree weakened by the fact that other cups of water chance to possess similar properties; nor, in the second case, are these refreshing qualities in the least augmented by the accidental circumstance that there is no other water near. On the other hand, the two cases become essentially distinct when considered with reference to the second grade. Looking at the former case we must say that the possession of the cup of water does not provide the man with one single satisfaction more, nor its loss with one satisfaction less, than he could have obtained without it. If he has that particular cup of water he can quench his thirst with it; if he has not that cup — well, he can quench his thirst quite as well with one of the hundred others which the spring puts freely at his disposal every minute of the day. If he likes, therefore, he may make that one cup the cause of his satisfaction by quenching his thirst with it; an indispensable condition of his satisfaction it cannot be; for his well-being it is dispensable, unimportant, indifferent.
It is quite otherwise in the second case. Here we must say that, if our traveller had not that one last cup, he could not quench his thirst; he must bear its pangs unassuaged, perhaps even succumb to them. In the cup of water then, in this case, we see not merely a sufficient cause, but the indispensable condition, the sine qua non of human well-being. Here it is of consequence, even of urgency; it possesses importance for his well-being.
Now it is not too much to say that the distinction here drawn is one of the most fruitful and fundamental in the whole range of our science. It does not owe its existence to the microscope nor to any hair-splitting distinctions of the logician. It has its life in the world of men, who know it and use it and take it as guide for their common attitude towards the world of goods, not only as regards the intellectual estimate they apply to these goods, but as regards their actual business transactions. About goods which are only useful the practical business man is careless and indifferent. The academic knowledge that a good may be "of use" cannot evoke any efficient interest in the good, in face of the other knowledge that the same use may be obtained without it. Such goods are practically naught as regards our well-being, and we treat them as such; we are not put about when we lose them, and we make no effort to gain them. Who would fret at, or make an effort to prevent, the spilling of a cup of water at the spring, or the escape of a cubic foot of atmospheric air? Where, on the other hand, the sharpened glance of the economic man recognizes that some satisfaction, well-being, gratification, is connected with a particular good, there the effective interest which we take in our own well-being is transferred to the good which we recognize as its condition; we see and value our own welfare in it; we recognize its importance for us as value; and finally, we develop an anxiety, proportioned to the greatness of that importance, to acquire and hold the good.
Thus, formally defined, value is the importance which a good or complex of goods possesses with respect to the well-being of a subject. Any addition to this definition, regarding the kind and reason of the importance, is, strictly speaking, not necessary, since goods can only have an effective importance for human well-being in one way, viz. by being the indispensable condition, the sine qua non, of some one utility which subserves it. In view of the fact, however, that in other definitions of value it is very often translated as an "importance," while the importance spoken of rests, erroneously, on a simple capability of utility, or, not less erroneously, on the necessity of expenditure of costs, or the like,See Conrad's Jahrbücher, vol. xiii. p. 11. we shall define it, un-ambiguously and exactly, as: That importance which goods or complexes of goods acquire, as the recognized condition of a utility which makes for the well-being of a subject, and would not be obtained without them.
All goods have usefulness, but all goods have not value. For the emergence of value there must be scarcity as well as usefulness — not absolute scarcity, but scarcity relative to the demand for the particular class of goods. To put it more exactly: goods acquire value when the whole available stock of them is not sufficient to cover the wants depending on them for satisfaction, or when the stock would not be sufficient without these particular goods. On the other hand, those goods remain valueless which are offered in such superfluity that all the wants which they are fitted to satisfy are completely supplied, and when, beyond that, there is a surplus which can find no further employment in the satisfaction of want, and which, at the same time, is large enough to spare the goods or quantities of goods that we are valuing without imperiling the satisfaction of any one want.
After what has been said as to the nature of value, it should not be very difficult to prove these propositions. When the supply of goods is not sufficient, and some of the wants which they are adapted to satisfy must remain unsatisfied, it is clear that the loss of even a single good involves the loss of a possible satisfaction, while the addition of a single good involves the acquisition of a satisfaction otherwise impossible; and it is clear, consequently, that some gratification or form of well-being depends on the existence of that good. Conversely, it is quite as clear that, if goods of any class are to be had in superfluity, there is no harm done if one of the goods be lost — since it can be immediately replaced from the superfluous stock, nor any utility got if another such good be added — since it cannot be employed in any useful way. Suppose, for instance, that a peasant requires 10 gallons of water per day, and no more, for general purposes — say, for his own drinking, for that of his family and servants, for watering his cattle, for cleansing, flushing, etc. — and suppose that the only spring within reach supplies no more than 8 gallons a day. It is quite evident that he cannot spare 1 single gallon from his water-supply without suffering, to a more or less sensible extent, as regards the wants and aims of his economy. Every gallon in this case is the condition of a definite sphere of usefulness. Even if the spring supplied just 10 gallons this would still be true. But if the spring supplied 20 gallons per day, it is just as obvious that the loss of 1 gallon would not do the slightest injury to our peasant. He can only employ 10 gallons usefully, and he must let the other 10 gallons flow away unused. If 1 gallon is spilled it is replaced from the overflow, and the only effect is that now the unusable surplus is reduced from 10 gallons to 9.
Now as it is the insufficient, or the barely sufficient, goods that are the objects of economical care — the goods we "economize" or endeavour to acquire and keep — while such goods as are to be had in superfluity are free to everybody, we may express the above propositions shortly in the following form: All economical goods have value; all free goods are valueless.Some very interesting phenomena of value may, in certain circumstances, be exhibited by free goods also. For the explanation of this see my Grudzüge, p. 15. In any case it must steadily be borne in mind that it is only relations of quantity that decide whether any particular good is merely capable of use, or is also the condition of a utility for us.Those numerous writers of whom Scharling is the latest instance (Conrad's Jahrbücher, vol. xvi. pp. 417 and 513, and particularly 424, 430, 651), who say that the distinguishing criterion of "economical" and "valuable" goods is difficulty of attainment, the necessity of expending labor, and the like, are giving a secondary ground of definition instead of the really decisive and primary one. It is only when and because we are suffering, or fear to suffer, loss of satisfaction from insufficient supply of goods that we decide, generally speaking, to submit to the hardships of acquiring them, to labor, and so on. Labor and hardship could not by themselves confer an economical character on goods were it not that, for the most part, another circumstance, and that the really decisive one, is also present; in other words, that those kinds of goods, which are difficult or troublesome to obtain, are, at the same time, the goods that remain scarce. That, however, it is not the difficulty but the scarcity that decides is vividly shown in those cases — not, I grant, very common — where the technical circumstances are of such a nature that the good can be got only, indeed, by conquering difficulties, but then in superfluous amount. When the peasant obtains good drinking water, e.g., by bringing it along a pipe to a house, it may occasion him a permanent expenditure of labor and costs for construction, upkeep, and management of the water-supply. But if this brings the water in greater quantity than he requires, it will not occur to the peasant, in spite of the labor, that he must "economize" the water.
Leland Yeager offers an illuminating discussion of a serious problem that has historically plagued monetary theory and continues to do so to this day: the failure to clearly distinguish between the individual and the overall viewpoints when analyzing monetary phenomena. I wish to emphasize particularly Yeager's insight that the source of this problem lies in the failure of monetary theorists to heed "the sound precept of methodological individualism," which dictates that bridges be constructed between the two viewpoints "by relating propositions about all economic phenomena, including the behavior of macroeconomic aggregates, to the perceptions and decisions of individuals." In detailing and critically analyzing the errors engendered by this confusion of viewpoints in monetary theory, Yeager has taught an elementary, yet much needed, lesson in the principles of economic reasoning and the dire consequences of neglecting them. I daresay this lesson would have been wholly unnecessary had economists attended more closely to the earlier lessons taught by Ludwig von Mises, certainly the foremost exponent and practitioner of methodological individualism in twentieth-century monetary theory.
Since I am in fundamental agreement with the thrust of Yeager's argument, I shall utilize one illustration in his discussion to elucidate an especially neglected contribution to monetary theory made by Mises in his consistent application of methodological individualism to the explanation of monetary phenomena. In this connection, I wish to focus attention on Yeager's treatment of the modern monetary approach to the balance of payments. I propose to show, first, that the valid and vitally important insight on which the monetary approach rests forms the basis of Mises's own elaboration of balance-of-payments theory and, second, that Mises's approach is not open to the objection that Yeager raises against the monetary approach, precisely because Mises firmly adheres to the precept of methodological individualism. This enterprise, it may be noted, has important implications for the contemporary formulation of the monetary approach as well as for doctrinal research into its historical antecedents. On the doctrinal side, it is a matter of setting the record straight. Several studies have appeared recently of the doctrinal roots of the monetary approach. With one minor exception,The exception is Thomas M. Humphrey, "Dennis H. Robertson and the Monetary Approach to Exchange Rates," Federal Reserve Bank of Richmond Economic Review 66 (May/June 1980), p. 24, wherein Mises is briefly mentioned as one whose contributions to the monetary approach have been largely overlooked. all of them have completely neglected Mises's contribution. Hopefully, greater familiarity with Mises's approach to the balance of payments, which so strongly anticipates the monetary approach, will spark a rethinking of the latter approach and lead to its reformulation on sounder methodological foundations.
The fundamental insight of the monetary approach is that the balance of payments is essentially a monetary phenomenon. The very concept of a balance of payments implies the existence of money; as one writer puts it, "Indeed, it would be impossible to have a balance-of-payments surplus or deficit in a barter economy."M.A. Akhtar, "Some Common Misconceptions about the Monetary Approach to International Adjustment," in The Monetary Approach to International Adjustment, eds. Bluford H. Putnam and D. Sykes Wilford (New York: Praeger, 1978), p. 121. This being the case, any endeavor to explain balance-of-payments phenomena must naturally focus on the supply of and demand for the money commodity. The monetary approach consists in the rigorous delineation of the implications of this simple yet powerful insight for the analysis of balance-of-payments disequilibrium, adjustment, and policy. As I shall attempt to demonstrate, Mises fully anticipated the modern monetary approach by explicitly recognizing these implications.
Mises grounds his balance-of-payments analysis on the insight that the balance of payments is a monetary concept. He states that, "If no other relations than those of barter exist between the inhabitants of two areas, then balances in favor of one party or the other cannot arise."Ludwig von Mises, The Theory of Money and Credit, new enl. ed., trans. H.E. Batson (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1971), p. 182. Mises thus conceives of money as the active element in the balance of payments and not as a residual or accommodating item that passively adjusts to the "real" flows of goods and capital:
The surplus of the balance of payments that is not settled by the consignment of goods and services but by the transmission of money was long regarded as merely a consequence of the state of international trade. It is one of the great achievements of Classical political economy to have exposed the fundamental error in this view. It demonstrated that international movements of money are not consequences of the state of trade; that they constitute not the effect, but the cause, of a favorable or unfavorable trade balance. The precious metals are distributed among individuals and hence among nations according to the extent and intensity of their demand for money.Ibid.
Mises uses his marginal-utility theory of money to explain the "natural" or equilibrium distribution of the world money stock among the various nations. Regarding the case of a 100 percent specie standard, he writes that
the proposition is as true of money as of every other economic good, that its distribution among individual economic agents depends on its marginal utility … all economic goods, including of course money, tend to be distributed in such a way that a position of equilibrium among individuals is reached, when no further act of exchange that any individual could undertake would bring him any gain, any increase of subjective utility. In such a position of equilibrium, the total stock of money, just like the total stocks of commodities, is distributed among individuals according to the intensity with which they are able to express their demand for it in the market. Every displacement of the forces affecting the exchange ratio between money and other economic goods [i.e., the supply and demand for money] brings about a corresponding change in this distribution, until a new position of equilibrium is reached.Ibid., pp. 183–84.
Mises goes on to conclude that the same principles that determine the distribution of money balances among persons also determine the distribution of money stocks among nations, since the national money stock is merely the sum of the money balances of the nation's residents.Ibid., p. 184. In thus building up his explanation of the international distribution of money from his analysis of the interpersonal distribution of money balances, Mises sets the stage for an analysis of balance-of-payments phenomena that conforms to the precept of methodological individualism.
Like the later proponents of the monetary approach, Mises envisages balance-of-payments disequilibrium as an integral phase in the process by which individual and hence national money holdings are adjusted to desired levels. Thus, for example, the development of an excess demand for money in a nation will result in a balance-of-payments surplus as market participants seek to augment their money balances by increasing their sales of goods and securities on the world market. The surplus and the corresponding inflow of the money commodity will automatically terminate when domestic money balances have reached desired levels and the excess demand has been satisfied. Conversely, a balance-of-payments deficit is part of the mechanism by which an excess supply of money is adjusted.
The role played by the balance of payments in the monetary-adjustment process is clearly spelled out by Mises in the following passage.
In a society in which commodity transactions are monetary transactions, every individual enterprise must always take care to have on hand a certain quantity of money. It must not permit its cash holding to fall below the definite sum considered necessary for carrying out its transactions. On the other hand, an enterprise will not permit its cash holding to exceed the necessary amount, for allowing that quantity of money to be idle will lead to loss of interest. If it has too little money, it must reduce purchases or sell some wares. If it has too much money, then it must buy goods.…
In this way, every individual sees to it that he is not without money. Because everyone pursues his own interest in doing this, it is impossible for the free play of market forces to cause a drain of all money out of the city, a province or an entire country.
If we had a pure gold standard, therefore, the government need not be the least concerned about the balance of payments. It could safely let the market take care of maintaining a sufficient quantity of gold within the country. Under the influence of free-trade forces, gold would leave the country only if a surplus of cash balances were on hand. Conversely it would always flow into the country if cash balances were insufficient. Thus, for Mises, the monetary-adjustment process ensures that gold money, like all other commodities, is imported when in short supply and exported when in surplus.Ludwig von Mises, On the Manipulation of Money and Credit, ed. Percy L. Greaves, trans. Bettina Bien Greaves (Dobbs Ferry, N.Y.: Free Market Books, 1978), pp. 53–54.
An implication of this view of the balance of payments as a phase in the monetary adjustment process is that international movements of money that do not reflect changes in the underlying monetary data can only be temporary phenomena. "Thus," writes Mises, "international movements of money, so far as they are not of a transient nature and consequently soon rendered ineffective by movements in the contrary direction, are always called forth by variations in demand for money."Mises, Theory of Money and Credit, p. 185.
Although Mises therefore does regard the long-run causes of balance-of-payments disequilibrium as exclusively monetary in nature, he does not make the error, which Yeager attributes to the more radical, global-monetarist proponents of the monetary approach, of identifying a balance-of-payments surplus with the process of satisfying an excess demand for domestic money or a deficit with the process of working off an excess supply of domestic money. Mises explicitly recognizes that changes occurring on the "real" side of the economy, for example, a decline in the foreign demand for a nation's exports, may well have a disequilibrating impact on the balance of payments, even in the absence of a change in the underlying conditions of monetary supply and demand. However, in Mises's view, such nonmonetary disturbances of balance-of-payments equilibrium are merely short-run phenomena. It is one of the functions of the balance-of-payments adjustment mechanism to reverse the disequilibrating flows of money that attend these disturbances and to restore thereby the equilibrium distribution of the world money stock, which is determined solely by the configuration of individual demands for money holdings.
If the state of the balance of payments is such that movements of money would have to occur from one country to the other, independently of any altered estimation of money on the part of their respective inhabitants, then operations are induced which re-establish equilibrium. Those persons who receive more money than they will need hasten to spend the surplus again as soon as possible, whether they buy production goods or consumption goods. On the other hand, those persons whose stock of money falls below the amount they will need will be obliged to increase their stock of money, either by restricting their purchases or by disposing of commodities in their possession. The price variations, in the markets of the countries in question, that occur for these reasons give rise to transactions which must always re-establish the equilibrium of the balance of payments. A debit or credit balance of payments that is not dependent upon an alteration in the conditions of demand for money can only be transient.Ibid., pp. 184–85.
The foregoing passage illustrates the difference between Mises and the global monetarists, who deny the possibility that international flows of money can proceed from nonmonetary causes. Their denial is tantamount to claiming that all international movements of money are necessarily equilibrating, since they are undertaken solely in response to disequilibrium between national supplies of and demands for money. As Yeager has pointed out, this line of reasoning leads to the outright and fallacious identification of balance-of-payments surpluses and deficits with the process of adjusting national money stocks to desired levels.
It is not difficult to pinpoint the source from which this erroneous line of reasoning stems: it is the tendency of the monetary approach to depart from the sound precept of methodological individualism and to focus on the nation rather than the individual as the basic unit of analysis. In so doing, it has naturally, although quite illegitimately, applied to the nation analytical concepts and constructs that are appropriate only to the analysis of individual action. In particular, the monetary approach attempts to explain balance-of-payments phenomena by conceiving the nation in the manner of a household or firm that is consciously aiming at acquiring and maintaining an optimum level of money balances. The concept of what Ludwig Lachmann has called "the equilibrium of the household and of the firm" is then invoked to describe the actions which the nation-household must and will undertake in the service of this goal.Ludwig M. Lachmann, Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy, ed. Walter E. Grinder (Kansas City: Sheed Andrews and McMeel, 1977), p. 117. As Lachmann explains, the concept of household-firm equilibrium is implied in the very logic of choice.Ibid., pp. 117, 189. An economic agent will always choose the course of action consistent with his goals and their ranking given his knowledge of available resources and of technology. His actions are, therefore, always equilibrating in the sense that they are always aimed at bringing about a (possibly only momentarily) preferred state of affairs.
In the context of the issues dealt with by the monetary approach, the implication of this analytical concept is that the nation will never alter the level of its stock of money unless it is dissatisfied with it, that is, unless there is an excess supply of or demand for domestic money. A further implication is that all international movements of money will be equilibrating, the result of deliberate steps undertaken by nations to adjust their actual money balances to desired levels. National payments, surpluses and deficits, then, are logically always associated with the adjustment of monetary disequilibrium. To argue that balance-of-payments disequilibria may arise, even temporarily, for reasons unrelated to monetary disequilibrium is to argue that the economic agent, in this case the nation, has taken leave of economic rationality. Why else acquire or rid oneself of money balances, if not as a deliberate act of choice aimed at securing a more preferred position? Thus the global monetarists are prepared to deny, for example, that a shift in relative demands from domestic to foreign products would create even a temporary deficit in the balance of payments in the absence of the development of an excess supply of domestic money.
This clearly illustrates the confusion that results when monetary theorists lapse into methodological holism and apply to hypostasized entities such as the nation concepts whose use is inappropriate outside the realm of individual action. The concept of household-firm equilibrium has meaning only within the framework of the logic of choice. And the logic of choice itself is meaningful only within the context of individual action.
By virtue of his thoroughgoing methodological individualism, Mises maintains a firm grasp on the all-important distinction between the equilibrium of the individual actor and interindividual equilibrium in his balance-of-payments analysis. This difference between Mises's approach and the monetary approach may be seen in their divergent analyses of the effects on the balance of payments of a change emanating from the "real" or "goods" side of the economy. Assuming an international pure specie currency and starting from a situation of monetary and balance-of-payments equilibrium, let us suppose that domestic consumers increase their expenditures on foreign imports and that this increase reflects increased valuations of foreign products relative to domestic products. Let us further assume that the overall demand for money balances remains unchanged and that no other changes in the real or monetary data occur elsewhere in the system.
Under these conditions, those proponents of the monetary approach who are inclined to identify balance-of-payments surpluses and deficits with the process of adjusting monetary disequilibrium would naturally deny any disequilibrating effect on the balance of payments, since the nation, by hypothesis, does not wish to alter its level of money balances but merely its mix of consumers' goods. The adjustment will thus proceed entirely in the goods sphere, with the nation simply increasing its exports of domestic products, which it now demands less urgently, to pay for the increased imports of the now more highly esteemed foreign products, while the level of its money balances remains unchanged.
For Mises, however, things are not simple, since the adjustment process does not consist of the mutually consistent choices and actions of a single macroeconomic agent. Rather, it involves a succession of configurations of mutually inconsistent individual equilibria representing numerous microeconomic agents who are induced by the price system to bring their individual actions into closer and closer coordination until a final interindividual equilibrium is effected.
As a consequence, in Mises's analysis there will indeed emerge an initial balance-of-payments deficit and corresponding outflow of money from the nation as domestic consumers shift their expenditures from domestic products to foreign imports. Now, from the point of view of these individual domestic consumers, this outflow of money is certainly "equilibrating" in the logic-of-choice sense, because it demonstrably facilitates their attainment of a more preferred position. Nevertheless, from the point of view of the economic system as a whole, far from serving to adjust a preexisting monetary disequilibrium, this flow of money disrupts the prevailing equilibrium in the interindividual distribution of money balances and is therefore ultimately self-reversing. Thus, the domestic producers of those goods for which demand has declined experience a shrinkage of their incomes, which threatens to leave them with insufficient money balances. On the other hand, the foreign producers, the demand for whose products have increased, experience an augmentation of their incomes and a consequent buildup of excess money balances. Without going into detail, suffice it to say that the steps undertaken by both groups to readjust their money balances to desired levels will initiate a balance-of-payments adjustment process that will reestablish the original, equilibrium distribution of money holdings among individuals, and hence among nations.
Mises thus arrives at the same long-run, comparative-static conclusion as the proponents of the monetary approach do, to the effect that the change in question will not result in any alteration in national money stocks. However, his focus on the individual economic agent leads him to analyze the dynamic macroeconomic process by which the comparative-static, macroeconomic result emerges.
Before concluding, I wish to briefly note two other important ways in which Mises anticipated the monetary approach. The first involves the global perspective of the monetary approach, which contrasts so sharply with the narrowly national focus of closed-economy macro-models typical of the various Keynesian approaches to the balance of payments. The monetary approach views the world economy as a unitary market with the various national commodity and capital submarkets fully integrated with one another and subject to the rule of the law of one price. As a consequence, arbitrage insures that a particular nation's prices and interest rates are rigidly determined by the forces of supply and demand prevailing on the world market.
The analytical importance of the global perspective, which has revolutionized modern balance-of-payments analysis, was grasped completely by Mises:
The mobility of capital goods, which nowadays is but little restricted by legislative provisions such as customs duties, or by other obstacles, has led to the formation of a homogeneous world capital market. In the loan markets of the countries that take part in international trade, the net rate of interest is no longer determined according to national, but according to international, considerations. Its level is settled, not by the natural rate of interest in the country, but by the natural rate of interest anywhere…. So long and in so far … as a nation participates in international trade, its market is only a part of the world market; prices are determined not nationally but internationally.Mises, Theory of Money and Credit, pp. 374–75.
I might add that Mises's individualist and subjectivist analytical focus enables him to deal more trenchantly than the writers on the monetary approach with the objection that the existence of internationally nontraded goods and services, for example, houses, haircuts, ice cream cones, severely limits the operation of the law of one price and thus undermines the unity of the world price level. The response of the proponents of the monetary approach, such as Jacob Frankel and Harry Johnson, is the empirical assertion that the elasticities of substitution between the classes of traded and nontraded goods approaches infinity in both consumption and production, a condition that places extremely narrow limits on the range of relative price changes between the two classes of goods.Jacob A. Frenkel and Harry G. Johnson, "The Monetary Approach to the Balance of Payments: Essential Concepts and Historical Origins," in The Monetary Approach to the Balance of Payments, eds. Jacob A. Frenkel and Harry G. Johnson (Toronto: University of Toronto, 1976), pp. 27–28.
Mises, on the other hand, disposes of the objection theoretically.Mises, Theory of Money and Credit, pp. 170–78. His argument is based on the important insight that the location of a good in space is a factor conditioning its usefulness and, therefore, its subjective value to the individual economic agent. For this reason, technologically identical goods that occupy different positions in space are, in fact, different goods. To the extent that the overall valuations and demands of market participants for such physically identical goods differ according to their locations, there will naturally be no tendency for their prices to be equalized. Mises is able to conclude logically, therefore, that the existence of so-called nontraded goods whose prices tend to diverge internationally does not constitute a valid objection to the worldwide operation of the law of one price in the case of each and every good and the corollary tendency to complete equalization of the purchasing power of a unit of the world money.
A final respect in which Mises can be considered as a forerunner of the monetary approach is in his analysis of the causes and cures of a persistent balance-of-payments disequilibrium. For Mises and for the monetary approach, a chronic balance-of-payments deficit can only result from an inflationary monetary policy that continuously introduces excess money balances into the domestic economy via bank-credit creation. The deficit and the corresponding efflux of gold reflects the repeated attempts of domestic money holders to rid themselves of these excess balances, which are being re-created over and over again by the inflationary intervention of the monetary authority. The deficits will only be terminated when the inflationary monetary policy is brought to a halt or the stock of gold reserves is exhausted. Tariffs and other protectionist measures will fail to rectify the situation, since they do not address the fundamental cause of monetary disequilibrium.
The connection between inflationist, interventionist monetary policies and chronic balance-of-payments disequilibrium is delineated by Mises in the following passage:
If the government introduces into trade quantities of inconvertible banknotes or government notes, then this must lead to a monetary depreciation. The value of the monetary unit declines. However, this depreciation in value can affect only the inconvertible notes. Gold money retains all, or almost all, of its value internationally. However, since the state — with its power to use the force of the law — declares the lower-valued monetary notes equal in purchasing power to the higher-valued gold money and forbids the gold money from being traded at a higher value than the paper notes, the gold coins must vanish from the market. They may disappear abroad. They may be melted down for use in domestic industry. Or they may be hoarded.…
No special government intervention is needed to retain the precious metals in circulation within a country. It is enough for the state to renounce all attempts to relieve financial distress by resorting to the printing press. To uphold the currency, it need do no more than that. And it need do only that to accomplish this goal. All orders and prohibitions, all measures to limit foreign exchange transactions, etc., are completely useless and purposeless. Mises, Manipulation of Money and Credit, p. 55.
In conclusion, Mises's contribution to balance-of-payments analysis should be hailed not only as a doctrinal milestone in the development of the monetary approach but, much more importantly, as a shining exemplar of methodological individualism in monetary theory.Limitation of space has precluded a discussion of Mises's analysis of the exchange rate. Suffice it to say that Mises anticipated the monetary approach to the exchange rate, both in his pathbreaking explanation of the purchasing-power-parity theory (which predated Cassel) and also in his integration of expectations into the explanation of short-run exchange-rate movements. Moreover, Mises brought his global perspective to bear in his insight that the exchange rate between national currencies is to be explained on the same principles as the exchange rate between parallel currencies circulating in the same nation.
[This article is excerpted from Money, Sound and Unsound, chapter 6: "Ludwig von Mises and the Monetary Approach to the Balance of Payments: Comment on Yeager." This essay originally appeared in Method, Process, and Austrian Economics: Essays in Honor of Ludwig von Mises, ed. Israel M. Kirzner (New York: D.C. Heath and Company, 1982), pp. 247–56.]
[image]"To what extent can we believe the conclusions of a model that assumes away the fundamental features of reality as we understand it?" If you are taking or have taken some of the typical courses in economics, it is quite likely that you asked yourself questions like the following: If an economic model is not like the real world, why should I trust the results of that model? One of the answers I would often get when posing this question goes something like this: Of course the model is not like the real world; it is not supposed to be like the real world. If it were, then it would not be a model!
This response can leave one feeling intellectually inferior or incapable of abstract thinking. One may get the impression that there is something obvious that he or she is missing. Sometimes, the answer would go a bit further: models are simplified representations of reality that we use to better understand that reality. This answer is somewhat more polite, but it still does not tell us how we determined which features of reality were not important enough to be included in the model. Building a model in this way also seems to imply that we already understand the elements of reality and how they are interrelated.
If none of these answers left you entirely comfortable with the currently predominant, Walrasian approach in economics, you may want to look into the works of some of the Austrian economists. Ludwig von Mises, Friedrich Hayek, and Murray Rothbard were the leading figures in this school of thought in the 20th century. Scholars like Mises, Hayek, and Rothbard showed that there are, in all likelihood, more robust descriptions of markets than those contained solely in mathematical general-equilibrium models.
Basic Principles of Austrian Economics The Walrasian and the Austrian approaches often come to similar conclusions when it comes to the desirability of markets, but they come to these conclusions using quite different paths. The advantage of the Austrian approach is precisely in the path it takes to come to its conclusions — it maintains several key principles that most of us would have a hard time disagreeing with:
Value is in the mind of an individual. It is then by definition subjective and directly unobservable to others.
Value is not a physical quantity. Thus, interpersonal comparisons of utility or value are inappropriate.
All economic activity is a consequence of individual humans acting on their values.
The Walrasian approach often assumes away these principles for the sake of mathematical tractability. This is where the crucial problem arises. To what extent can we believe the conclusions of a model that assumes away the fundamental features of reality as we understand it? This is actually the most common criticism of the neoclassical defense of markets.
You have probably heard many people blaming the current economic crisis on "market failure." Some would say that markets "failed" because real markets are different from the economists' "perfect" models. The logic is as follows: since we can't trust these market models, neither can we trust the actual markets. There is an error in this logic.
For example, if we had a theory that states that 2+2=5 and then we count 2 apples and 2 more apples and determine there are in fact 4, not 5, apples, this contradiction between our theory of addition and the empirical observation would not be an argument against using the operation of addition in our daily lives. Instead, we would go back to our theory of addition to determine where we went wrong. Similarly, realizing that markets do not operate exactly like general-equilibrium models does not imply that markets should be abandoned. Instead, it may be that our model was inadequate to understand the functioning of the market. In fact, there may be other elements, not necessarily products of the market, that contributed to what we labeled "market failure."
This is where the Austrian approach can help. Austrians argue that precisely those features of reality omitted by our models are what makes actual markets special. More specifically, markets are the means of coping with those "messy" features of reality that do not fit well into the mathematical language of economic models.
Efficient Markets vs. Markets as Indispensible Means of Social Cooperation The typical neoclassical story about efficient or perfectly competitive markets is that, if some assumptions hold, we can expect markets to be allocatively efficient. This allocative efficiency is interpreted as a set of output and price values that maximize total social welfare. This is often represented by welfare triangles.
Welfare triangles are geometric representations of the benefits from exchange. Figure 1 shows an example. The light blue triangle represents total social surplus. It is said that the competitive equilibrium price and quantity make this area as large as possible.
Figure 1
Competitive equilibrium and social welfare in the neoclassical model
The assumptions that need to hold for this result are often given in different forms, but the following list should provide a relatively complete summary:
Everyone has all the relevant information about everyone else in the society.
All producers in a given industry are small relative to the whole industry.
The consumer preferences can be described by a known and "well-behaved" utility function.
There are no transaction costs.
There are no externalities.
For an Austrian economist, this raises many red flags at the outset. But it is not only Austrians who raise criticism against this formulation. Most government interventions are based on the claim that some of the above assumptions don't hold, thus making the actual market outcome inefficient and in need of fixing.
However, Austrians raise a different criticism. They claim that this theory is an inadequate description of the market. As an analogy, if you build a theory on the premise that the sky is red, that theory is not going to be very useful for understanding the logical consequences of the fact that the sky is in fact blue.
Austrians throw out the window the first, complete-information assumption in the above list at the outset. This has implications for the other assumptions such as transaction costs and externalities, but this is an issue that contains enough material for a separate analysis.
Hayek based most of his work on deriving the logical consequences of the fact that most of us know very little about most other people. His mentor, Mises, starts with the fact that individual values are not directly observable to others and determines that only through exchange ratios (or prices) can these subjective values take an objectively observable form. Thus, only in a society where private property is exchanged between individuals can resource allocation be guided by human values or preferences.
Hayek uses this idea to illustrate how market prices serve as signals of time-and-place-specific circumstances known only to some individuals and only as bits of dispersed knowledge. For example, when prices are on the rise, consumers know that it is time to look for alternatives, and producers want to produce more of the relatively expensive good without actually having to know all the particular causes of the price increase. Thus, rising prices give both the information and incentives to different individuals to pursue courses of action that make the expensive good relatively more abundant and thus less expensive in the long run. We can see here that instead of grounding their defense of the market on the complete-information assumption, Austrians begin by recognizing the reality of incomplete information.
Views on Competition and Allocation of Production The second assumption in the Walrasian description of the efficient market is that all producers in a given industry are small relative to the whole industry. Alternatively, if some producers are disproportionally larger than others, there is a departure from the competitive equilibrium, and thus allocative inefficiency arises. In the extreme case, when there is only one producer in a market, there is a monopoly. Monopolies are said to be a problem because the price they charge is too high and the quantity they supply is too low.
Hayek, however, shows that in a world of near-infinite individual diversity, it is highly unlikely that one firm can exclude all other suppliers from the market just by offering the lowest price. In addition, as Rothbard pointed out, all firms compete for the consumers' money. In this sense, even a monopoly must still compete with the producers of all other goods. For example, if a healthcare provider imposes too high of a cost on the consumer (monetary, bureaucratic, or whatever), the consumer might simply abandon using any healthcare services for the sake of being able to afford a more preferred amount of other goods and services. I haven't visited a doctor in more than two years simply because it takes too much time and effort for my taste.
Finally, if individual values are indeed subjective and unobservable to an outside observer, claiming that the price that the monopoly charges is too high contradicts the subjective nature of value. Like any other acting individual, producers make choices based on their marginal utility (or value). Because individual values are unknown to others, making claims about correctness of someone's price has no objective foundation — it just reveals our own value judgment of their price.
Moreover, if one looks around, one can notice that monopoly-like suppliers are generally formed by a state-imposed legal act that limits the ability of other suppliers to access the market. We can look at the supply of road services, healthcare, copyrighted material, and to some degree the supply of agricultural products, and find specific legal acts that limit competition.
For an example of state-imposed restrictions on competition in agriculture, we can look at the primary supply of milk, poultry, and eggs in Canada. The supply of these commodities is limited at the national, provincial, and individual level by production quotas. Only registered permit holders can produce and sell milk, poultry, and eggs and only at the provincially administered prices and quantities. This system is backed by a plethora of acts and regulations. Interestingly, in one of the founding acts, the Farm Products Agencies Act, there is a clause that requires the agencies administering supply management to take into account the principle of comparative advantage in production when allocating production quotas across provinces.
Put plainly, the principle of comparative advantage states that total productivity increases if everyone specializes in what he or she has the greatest relative superiority in compared to others. But how do you knowwhat it is that you do better than others if you are good at many different things and you don't know how good others are in producing different goods? This is where the Austrian insights come in handy.
For example, we can use some of Mises's and Hayek's arguments to show that without markets (or, more precisely, without market prices) economists can't say much about how to allocate production in a way that takes into account the principle of comparative advantage. In short, this is because economists, like anyone else, don't have access to people's knowledge of their own production possibilities and values, which are also in a continuous state of change. As one of the above Austrian principles states, value is in the mind of an individual. It is then by definition subjective and directly unobservable to others.
But, if one looks only at the typically used neoclassical models, one gets the impression that the "correct" spatial allocation of production could be determined from objectively measurable quantities (i.e., regional input ratios, technology, etc.) regardless of whether there is a market process or not. For example, some of the major models classify goods by their objectively measurable labor or capital intensity and then look at the aggregate quantities of capital and labor in a country or a region. Countries and regions with a higher capital-to-labor ratio are then said to have a comparative advantage in capital-intensive goods, and the countries and regions with a higher labor-to-capital ratio are said to have a comparative advantage in labor-intensive goods.
However, in reality, these objectively measurable input intensities and input ratios exist only in the presence of a functioning market. For example, try calculating an aggregate ratio of all capital to all labor in a country in which exchange of private ownership is outlawed — thus, without using market prices. These market prices, according to Mises and Hayek, transform the subjective value in our mind into objective data available to others. If we are not explicit about this, we may misinterpret our models and lose the essence of the economic problem at hand.
This is why Austrians look at comparative advantage differently. First, they attribute it to an individual. Only individuals know their abilities, skills, plans, and potential opportunity costs. Individuals use this knowledge to determine whether to specialize in, say, producing computers or oranges. Second, since one doesn't have direct access to other people's knowledge, one needs a means of indirectly accessing that knowledge. This is where exchange of ownership and exchange ratios (or prices) — in short, the market — come into play.
The market is the tool that makes it possible for an individual to determine whether it is better to specialize in the production of apples, computers, or any of thousands of other products. I may have a great potential in many occupations, but depending on the market prices, I may choose one or the other. Market prices will indirectly inform me how others would value my services if I chose one profession compared to another. Thus, in the Austrian framework, the market is the tool for identifying individuals' comparative advantage in an advanced economy.
Given these insights, the context in which one would use economic models is quite different from the typical Walrasian approach. In this case, one would say that because markets exist, we may, for illustrative purposes, assume that individuals know the relevant economic characteristics of other individuals in the society. In the typical Walrasian approach, the complete information assumption is a precondition for the existence of efficient markets, while in the Austrian approach, the existence of markets is a precondition for the existence of prices that transform subjective and otherwise unobservable valuations of goods produced and owned by a multitude of individuals into objective and observable metrics.
For many neoclassical economists, the market is a tool (only one of the tools) for allocating production and consumption efficiently. Efficiency here is the state of the world where any change would just make things worse. In this theory, such an "optimal" solution can be reached using means other than the market because of lax assumptions about value and knowledge. More specifically, for a person to determine the optimal allocation of resources in an economy outside of the market process, that person needs to know people's values, skills, potentials, etc. Thus, in such a model, one needs to assume that these qualities exist as objectively measurable and knowable magnitudes.
Austrians, on the other hand, don't claim that there is anything like this "optimal" allocation of resources, either within or outside of the market. What they do claim is that, if people want to develop an advanced economy, the market is the way to do this. The path to developing such an economy is through constant guidance of resource allocation by people's values reflected in the market prices. In the market, someone will always be dissatisfied with something, but this is not a bad thing. This dissatisfaction is a motive for action and for the improvement of one's well-being. It is the driving force of the economy.
[product:0] Conclusion There are important advantages in being familiar with the Austrian theory. This theory helps one keep in mind fundamental principles such as the subjectivity of value and the incompleteness of information that form the basis for human action. This approach makes it easier to spot errors in one's economic thinking. One of the common errors is treating economic models as normative standards for reality rather than loose metaphors and illustrations of the logical conclusions resulting from prior theoretical analysis. This error creates a temptation to "fix" the reality to fit the model. Often times the fix only makes things worse, because it was not the reality that needed fixing. It was, in fact, the economist's model that did not capture the key features of reality.
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Copyright © 2012 by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.
All attempts at scientific explanation can at best succeed only in explaining the changes in something given. The given itself is inexplicable. It simply is. Why it is remains hidden from us. It is the irrational — that which reasoning cannot exhaust, that which concepts are unable to grasp without leaving something still unexplained.
For the science of human action, the valuations and goals of the final order at which men aim constitute the ultimate given, which it is unable to explain any further. Science can record and classify values, but it can no more "explain" them than it can prescribe the values that are to be acknowledged as correct or condemned as perverted. The intuitive apprehension of values by means of understanding is still not an "explanation." All that it attempts to do is to see and determine what the values in a given case are, and nothing more. Where the historian tries to go beyond this, he becomes an apologist or a judge, an agitator or a politician. He leaves the sphere of reflective, inquiring, theoretical science and himself enters the arena of human action.
Science belongs completely to the domain of rationality. There can no more be a science of the irrational than there can be irrational science. The irrational lies outside the domain of human reasoning and science. When confronted with the irrational, reasoning and science can only record and classify. They are unable to penetrate more "deeply," not even with the aid of the "understanding." Indeed, the criterion of the irrational is precisely that it cannot be fully comprehended by reasoning. That which we are able to master completely by reasoning is no longer irrational.
The purest example of the irrational as an object of scientific activity is to be found in what is called Kunstwissenschaft.Translator's note: The German term Kunstwissenschaft, which is used in the original, means a discipline that deals both with the history of art and with aesthetic evaluations of it. Kunstwissenschaft can never be more than the history of the arts and of artists, of art techniques, of the subjects and themes treated by art, and of the ideas governing it. There is no universally valid theory of the artistic, of aesthetic values, or of artistic individuality.
What writers on art say about it, whether in commendation or in condemnation, expresses only their own personal experience of the work of art. This may be called "understanding," but, as far as it goes beyond the ascertainment of the irrational facts of the case, it is definitely not science. One who analyzes a work of art breaks it up in the strict sense of the word. Its specific aesthetic quality, however, is effective only in the whole of the work, not in its parts. A work of art is an attempt to experience the universe as a whole. One cannot analyze or dissect it into parts and comment on it without destroying its intrinsic character.
Kunstwissenschaft, therefore, can never do more than skirt the fringes of art and works of art. It can never grasp art as such. This discipline may nevertheless appear indispensable to many because it provides access to the enjoyment of works of art. In the eyes of others it may be clothed with a special dignity reflected from the splendor of the objects of art themselves. Still others say that it cannot ever approach the specifically artistic. This too is true, although one is not therefore justified in looking down upon art historians and art history.
The position of science toward the other values of acting men is no different from that which it adopts toward aesthetic values. Here too science can do no more with respect to the values themselves than to record them and, at most, classify them as well. All that it can accomplish with the aid of "conception" relates to the means that are to lead to the realization of values, in short, to the rational behavior of men aiming at ends.
History and sociology are not fundamentally different in this respect. The only distinction between them is that sociology, as a theoretical science, strives for universally valid laws of rational behavior, whereas history, employing these laws, presents the temporal course of human action. The subject matter of history is the historically given in its individuality. It must treat this with the means provided by theory, but as long as it does not overstep its bounds and attempt to prescribe values, history cannot exhaust the individuality of the given even with the help of "understanding."
History may, if one insists, be called a science of the irrational, but one must not forget that it is able to gain access to the irrational only by means of rational science. At the point where these means fail, history can succeed in nothing beyond the ascertainment of the irrational facts of the case through empathic understanding.
Understanding does not explain the individual, the personal, or the values given in experience, because it does not grasp their meaning by way of conception. It merely beholds them. Hence, as far as understanding is involved, there can be no progress in the historical sciences in the sense in which there is progress in the natural sciences or in sociology.
There is progress in the historical sciences only as far as conception is involved — i.e., as far as improvement in the treatment of sources and more penetrating sociological cognition enable us to grasp the meaning of events better than was previously possible. Today, for instance, with the help of economic theory we are capable of comprehending the events of economic history in a way that was not available to the older historians. However, history must be repeatedly rewritten because the subjective element in the passing of time and the change in personalities again and again open up new vistas for the understanding.
This subjective element, which is always mixed in with understanding, is responsible for the fact that history can be written from a variety of points of view. There is a history of the Reformation from the Catholic standpoint and another from the Protestant standpoint. Only one who fails to recognize the fundamental differences that exist between conception and understanding, between sociology and history, will be prone to assume that these differences exist in the sphere of sociology as well and to contrast, for example, a German sociology to English sociology or a proletarian economics to bourgeois economics.
[Preface to Revised Edition of Man, Economy, and State with Power and Market, May 1993]
One of the unhappy casualties of World War I, it seems, was the old-fashioned treatise on economic "principles." Before World War I, the standard method, both of presenting and advancing economic thought, was to write a disquisition setting forth one's vision of the corpus of economic science. A work of this kind had many virtues wholly missing from the modern world. On the one hand, the intelligent layman, with little or no previous acquaintance with economics, could read it. On the other hand, the author did not limit himself, textbook-fashion, to choppy and oversimplified compilations of currently fashionable doctrine. For better or worse, he carved out of economic theory an architectonic — an edifice. Sometimes the edifice was an original and noble one, sometimes it was faulty; but at least there was an edifice, for beginners to see, for colleagues to adopt or criticize. Hyperrefinements of detail were generally omitted as impediments to viewing economic science as a whole, and they were consigned to the journals. The university student, too, learned his economics from the treatise on its "principles"; it was not assumed that special works were needed with chapter lengths fitting course requirements and devoid of original doctrine. These works, then, were read by students, intelligent laymen, and leading economists, all of whom profited from them.
Their spirit is best illustrated by a prefatory passage from one of the last of the species:
I have tried in this book to state the principles of economics in such form that they shall be comprehensible to an educated and intelligent person who has not before made any systematic study of the subject. Though designed in this sense for beginners, the book does not gloss over difficulties or avoid severe reasoning. No one can understand economic phenomena or prepare himself to deal with economic problems who is unwilling to follow trains of reasoning which call for sustained attention. I have done my best to be clear, and to state with care the grounds on which my conclusions rest, as well as the conclusions themselves, but have made no vain pretense of simplifying all things.Frank W. Taussig, Principles of Economics (New York: Macmillan, 1911), p. vii.
Since the brilliant burst that gave us the works of Wicksteed (1910), Taussig (1911), and Fetter (1915), this type of treatise has disappeared from economic thought, and economics has become appallingly fragmented, dissociated to such a degree that there hardly is an economics any more; instead, we find myriad bits and pieces of uncoordinated analysis. Economics has, first, been fragmented into "applied" fields — "urban land economics," "agricultural economics," "labor economics," "public finance economics," etc., each division largely heedless of the others. More grievous still has been the disintegration of what has been confined to the category of "economic theory." Utility theory, monopoly theory, international trade theory, etc., down to linear programming and games theory — each moves in its sharply isolated compartment, with its own hyperrefined literature. Recently, growing awareness of this fragmentation has led to vague "interdisciplinary" admixtures with all the other "social sciences." Confusion has been worse confounded, with resulting invasive forays of numerous other disciplines into economics, rather than the diffusion of economics elsewhere. At any rate, it is somewhat foolhardy to attempt to integrate economics with everything else before economics has itself been made whole. Only then will the proper place of economics among the other disciplines become manifest.
I think it fair to say that, with only a single exception (Ludwig von Mises's Human Action), not one general treatise on economic principles has appeared since World War I. Perhaps the closest approach was Frank H. Knight's Risk, Uncertainty, and Profit, and that was published far back in 1921. Since then, there has been no book of remotely as broad a scope.
The only place where we can find economics treated with any degree of breadth is in the elementary textbooks. These textbooks, however, are sorry substitutes for a genuine Principles. Since they must, by their nature, present only currently received doctrine, their work is uninteresting to the established economist. Furthermore, since they may only boil down the existing literature, they must of necessity present to the student a hodgepodge of fragmented chapters, each with little or no relation to the other.
Many economists see no loss in all this; in fact, they herald these developments as signs of the enormous progress the science has made on all fronts. Knowledge has grown so vast that no man can encompass it all. Yet economists should at least be responsible for knowing economics — the essentials of the body of their discipline. Certainly, then, these essentials could have been presented by this time. The plain fact is that economics is fragmented precisely because it is no longer regarded as an edifice; since it is considered a congeries of isolated splinters, it is treated as such.
Perhaps the key to this change is that formerly economics was regarded as a logical structure. Fundamentally, whatever the differences of degree, or even of proclaimed methodology, economics was considered a deductive science using verbal logic. Grounded on a few axioms, the edifice of economic thought was deduced step by step. Even when the analysis was primitive or the announced methodology far more inductive, this was the essence of economics during the 19th century. Hence, the treatise on economic "principles" — for if economics proceeds by deductive logic grounded on a few simple and evident axioms, then the corpus of economics can be presented as an interrelated whole to the intelligent layman with no loss of ultimate rigor. The layman is taken step by step from simple and evident truths to more complex and less evident ones.
The "Austrian" economists best perceived this method and used it most fully and cogently. They were the classic employers, in short, of the "praxeologic" method. In the present day, however, the prevailing epistemology has thrown over praxeology for methods at once too empirical and too "theoretical." Empiricism has disintegrated economics to such an extent that no one thinks to look for a complete edifice; and, paradoxically, it has falsified economics by making economists eager to introduce admittedly false and short-cut assumptions in order to make their theories more readily "testable." Alfred Marshall's distrust of "long chains of deduction," as well as the whole Cambridge impetus toward such short cuts, has contributed a great deal to this breakdown. On the other hand, verbal logic in economic theory has been replaced by mathematics, seemingly more precise and basking in the reflected glory of the physical sciences. The dominant econometric wing of mathematical economists also looks for empirical verifications and thereby compounds the errors of both methods. Even on the level of pure theoretical integration, mathematics is completely inappropriate for any sciences of human action. Mathematics has, in fact, contributed to the compartmentalization of economics — to specialized monographs featuring a hyperrefined maze of matrices, equations, and geometric diagrams. But the really important thing is not that nonmathematicians cannot understand them; the crucial point is that mathematics cannot contribute to economic knowledge. In fact, the recent conquest of mathematical economics by econometrics is a sign of recognition that pure mathematical theory in economics is sterile.
This book, then, is an attempt to fill part of the enormous gap of 40 years' time. Since the last treatise on economic "principles," economics has proceeded a long way in many areas, and its methodology has been immeasurably improved and strengthened by those continuing to work in the praxeological tradition. Furthermore, there are still great gaps in the praxeological corpus, since so few economists have worked at shaping it. Hence, the attempt in this book to develop the edifice of economic science in the manner of the old-fashioned works on its "principles" — slowly and logically to build on the basic axioms an integrated and coherent edifice of economic truth. Hyperrefinements have been shunned as much as possible. In short, Professor Taussig's quoted statement of intention has been mine also, with the addition that I have felt it necessary to include, at pertinent points, refutation of some of the main opposing doctrines. This was especially needed because economic fallacy prevails far more widely than in Taussig's time.
I have indicated briefly that there has been one general treatise since World War I. Professor Paul Samuelson has written rhapsodically of the joy of being under 30 at the time of publication of Keynes's General Theory. I can say the same for the publication of Ludwig von Mises's Human Action in 1949. For here at last was economics whole once more, once again an edifice. Not only that — here was a structure of economics with many of the components newly contributed by Professor Mises himself. There is no space here to present or expound Mises's great contributions to economic science. That will have to be done elsewhere. Suffice it to say that from now on, little constructive work can be done in economics unless it starts from Human Action.
Human Action is a general treatise, but not an old-style Principles. Instead, it assumes considerable previous economic knowledge and includes within its spacious confines numerous philosophic and historical insights. In one sense, the present work attempts to isolate the economic, fill in the interstices, and spell out the detailed implications, as I see them, of the Misesian structure. It must not be thought, however, that Professor Mises is in any way responsible for these pages. Indeed, he may well differ strongly with many sections of this volume. Yet it is my hope that this work may succeed in adding a few bricks to the noble structure of economic science that has reached its most modern and developed form in the pages of Human Action.
The present work deduces the entire corpus of economics from a few simple and apodictically true axioms: the Fundamental Axiom of action — that men employ means to achieve ends, and two subsidiary postulates: that there is a variety of human and natural resources, and that leisure is a consumers' good. Chapter 1 begins with the action axiom and deduces its immediate implications; and these conclusions are applied to "Crusoe economics" — that much maligned but highly useful analysis that sets individual man starkly against Nature and analyzes his resulting actions. Chapter 2 introduces other men and, consequently, social relations. Various types of interpersonal relations are analyzed, and the economics of direct exchange (barter) is set forth. Exchange cannot be adequately analyzed until property rights are fully defined — so chapter 2 analyzes property in a free society. Chapter 2, in fact, marks the beginning of the body of the book — an analysis of the economics of voluntary exchange. Chapter 2 discusses the free market of barter, and the subsequent chapters treat the economics of indirect — or monetary — exchange. Thus, analytically, the book deals fully with the economics of the free market, from its property relations to the economics of money.
Chapter 3 introduces money and traces the patterns of indirect exchange on the market. Chapter 4 treats the economics of consumption and the pricing of consumers' goods. Chapters 5– 9 analyze production on the free market. One of the features of this consumption and production theory is the resurrection of Professor Frank A. Fetter's brilliant and completely neglected theory of rent — i.e., the concept of rent as the hire price of a unit service. Capitalization then becomes the process of determining the present values of the expected future rents of a good. The Fetter-Mises pure time-preference theory of interest is synthesized with the Fetter rent theory, with the Austrian theory of the structure of production, and with separation of original from produced factors of production. One "radical" feature of our analysis of production is a complete break with the currently fashionable "short-run" theory of the firm, substituting for this a general theory of marginal value productivity and capitalization. It is a "general equilibrium" analysis in the dynamic Austrian sense, and not in the static, currently popular Walrasian sense.
Chapter 10 expounds a completely new theory of monopoly — that monopoly can be meaningfully defined only as a grant of privilege by the State, and that a monopoly price can be attained only from such a grant. In short, there can be no monopoly or monopoly price on the free market. The theory of monopolistic competition is also discussed. And chapter 11 sets forth the theory of money on the free market, along with an extensive discussion of the Keynesian theories.
Having completed the theory of the purely free market, I then turn, in the final chapter, to applying praxeological analysis to a systematic discussion of various forms and degrees of coercive intervention and their consequences. The effects of coercive intervention can be studied only after fully analyzing the construct of a purely free market. Chapter 12 presents a typology of intervention, discusses its direct and indirect consequences and the effects on utility, and sets forth a necessarily brief analysis of the various major types of intervention, including price control, monopoly grants, taxation, inflation, and government enterprise and expenditures. The chapter and the book conclude with a brief summary assessment of the free market, as contrasted to interventionist and other coercive systems.
For this revised edition, I have decided to keep the original text and footnotes intact, and to confine any changes to this revised preface. Professor Mises died in 1973, and the following year, as luck would have it, the Austrian School of economics that Mises had kept alive in an almost underground existence burst forward into a spectacular revival. It is no accident that this revival coincided with the virtual collapse of the previously dominant Keynesian paradigm. Keynesians had promised to steer the economy easily away from the recurring pitfalls of inflationary boom, and recession and unemployment; instead, they would insure permanent and stable prosperity, bringing us full employment without inflation. And yet, after three decades of Keynesian planning, we faced a new phenomenon that cannot even exist, much less be explained, in the Keynesian paradigm: inflation combined with recession and high unemployment. This unwelcome specter first appeared in the inflationary recession of 1973–74, and has been repeated since, the last time being the recession of 1990–?.
The Austrian revival of 1974 was also spurred by F.A. Hayek's receiving the Nobel Prize for economics that year, the first free-market and nonmathematical economist to be accorded that honor. The economics profession's obsession with the Nobel reawakened interest in Hayek and in the Austrian School. But this award to Hayek itself can be no coincidence, since it reflects disillusion by economists in Keynesian macro-models.
Since 1974, the number of Austrians, books and articles by Austrians, and interest in the school, has greatly multiplied. It is a reflection of the difference in the quality of academia in the two countries that, even though there are proportionately fewer Austrian School economists in Britain than in the United States, Austrian economics is accorded a great deal more respect in Britain. In British textbooks and surveys of thought, Austrian economics, while not often winning agreement, is treated objectively and fairly as a respectable wing of economic thought. In the United States, on the contrary, while there are a large number of sympathizers as well as adherents in the profession, Austrians are still marginalized, unheeded, and unread by the bulk of economists.
Intellectual curiosity has a habit of breaking through, however, especially among college and graduate students. As a result, the Austrian School has flourished over the last two decades, despite severe institutional obstacles.
In fact, the number of Austrians has grown so large, and the discussion so broad, that differences of opinion and branches of thought have arisen, in some cases developing into genuine clashes of thought. Yet they have all been conflated and jammed together by non-Austrians and even by some within the school, giving rise to a great deal of intellectual confusion, lack of clarity, and outright error. The good side of these developing disputes is that each side has clarified and sharpened its underlying premises and world-view. It has indeed become evident in recent years that there are three very different and clashing paradigms within Austrian economics: the original Misesian or praxeological paradigm, to which the present author adheres; the Hayekian paradigm, stressing "knowledge" and "discovery" rather than the praxeological "action" and "choice," and whose leading exponent now is Professor Israel Kirzner; and the nihilistic view of the late Ludwig Lachmann, an institutionalist antitheory approach taken from the English "subjectivist"-Keynesian G.L.S. Shackle. Fortunately, there is now a scholarly journal, The Review of Austrian Economics, where the reader can keep apprised of ongoing developments in Austrian economics, as well as other publications, conferences, and instructional courses of the Ludwig von Mises Institute. The Mises Institute, founded on the centenary of his birth, keeps alive the spirit of Mises as well as the paradigm that he has bequeathed to scholarship and to the world. For the latest on the three Austrian paradigms, the reader is referred to the Mises Institute working paper by the present author, "The Present State of Austrian Economics" (November, 1992).
My overriding intellectual debt, of course, is to Ludwig von Mises. But apart from that, I can never fully express my personal debt. His wisdom, kindness, enthusiasm, good humor, and unflagging encouragement of even the slightest signs of productivity among his students were a lifelong inspiration to those who knew him. He was one of the great teachers of economics, as well as one of the great economists, and I am grateful to have had the opportunity of studying for many years at his Seminar in Advanced Economic Theory at New York University.
I can also never fully express my gratitude to Llewellyn H. Rockwell, Jr., who, at a low point in Misesian economics, with no endowment, no large pledges of support, and armed only with an idea, founded and dedicated his life to the Ludwig von Mises Institute. Lew has done a remarkable job of building and expanding the Institute, and of devoting himself to the Misesian paradigm. In addition, Lew has been a close and valued friend and intellectual colleague for many years. It is obvious that, without his efforts, this new edition would never have seen the light of day.
Finally, I must at least try to convey how grateful I am to another long-time colleague, Burton S. Blumert, of the Mises Institute and head of the Center for Libertarian Studies, Burlingame, California. Self-effacing and indispensable, Burt is always there — with wit, wisdom, kindness, and friendship.
It is impossible to list all the friends and acquaintances who, over the many years, have taught and inspired me in the area of Austrian economics, or in the wider arena of political economy, and in the nature of coercion of freedom. I am grateful to them all. None of them, of course, are responsible for any errors herein.
Imagine for a moment that you are omniscient. Endowed with such knowledge, you would completely understand how the world "works." You would completely understand how light works, how molecules and atoms work, how genetics work, how tectonic plates work, and how the universe came into existence. There would be nothing about the social or natural worlds that you would not understand in its entirety.
Were you endowed with such omniscience, you would have no use whatsoever for "science." You would have no need to study the world in a patient and systematic way, because you would already possess all the knowledge about the world that "science" could ever hope to yield. Science would not only bore you to tears; it would appear to be an imperfect and dreadfully tedious means to arrive at the knowledge you already possess.
Unfortunately, however, no human being possesses omniscience. We are born into the world without knowledge about how light works, how tectonic plates work, how atoms work, and how the universe came into existence. We also lack perfect knowledge about how capitalism and socialism work, how democracy and monarchy work, and how price controls work.
Our uncertainty about how the social and natural worlds work restricts our ability to act. Our uncertainty about how tectonic plates work restricts our ability to predict and control earthquakes. Our uncertainty about how light works restricts our ability to harness it for our own purposes. And our uncertainty about how monarchy and democracy work restricts our ability to construct political and economic systems that are best suited to our nature. This list could be extended ad infinitum.
We are not without means to overcome our uncertainty about how the world works, however. We are not, like the brute animals, doomed to struggle for our existence in a world that we will never understand or be able to harness for our own purposes. We have reason and memory at our disposal, which, with the aid of our senses, allow us to examine the world and learn how its elements "work." These fantastic mental abilities afford us the means to investigate the world in the hope of overcoming at least a small part of our natural ignorance and uncertainty.
Our fantastic mental abilities do not, however, automatically yield to us infallible knowledge about how the world works. We can misinterpret what is going on, and we can reason unsoundly. Our senses can fail us, and our thinking can become clouded, biased, or myopic. In addition, the world we seek to understand is so fantastically large and complicated, and our time so very scarce, that each of us is severely limited in the amount of knowledge we can individually acquire about how the world works.
Hence, only by working with and learning from other men can we as individuals hope to learn more than a tiny fraction about how the world works. By working with and learning from other men, we can take advantage of an intellectual division of labor that allows individuals to investigate very specific aspects of the world and then share the fruits of their investigations with the rest of humanity. This specialization and exchange of ideas allows men to economize their scarce time, learn more about the world than they otherwise could as isolated individuals, and serves as a check on the fallible reasoning of each individual.
The concept of "science" in the Western world has been to connect a community of individuals who are committed to study the world in a specialized, systematic, and intersubjectively verifiable way. Ideally, this scientific community accumulates knowledge about how the world works as individuals learn from the specialized investigations of their colleagues and build on them, and as the scientific community critiques and refines their theories through time.
The process by which the scientific community investigates the world is not a magic or automatic path to enlightenment or omniscience, however. The theories that are fashionable in the scientific community at any specific moment may or may not accurately describe the actual working of the world. Communities of individual scholars, like the individual scholars themselves, can fall victim to intellectual error. They can misinterpret what is going on, and they can reason unsoundly. Their senses can fail them, and their thinking can become clouded, biased, or myopic.
The critical and inexorable problem that the community of scholars faces, therefore, is knowing whether the theories it currently embraces accurately and completely describe the workings of the world. This uncertainty about the accuracy of their scientific theories stems, once again, from the fact that no member of the scientific community is omniscient. No member of the scientific community is in a position to say with certainty that any theory does or does not accurately describe the workings of the world.
If even one member of the scientific community were omniscient, it would be possible to appeal to that member as an objective assessor of scientific theories. In that case, the omniscient assessor would not trouble himself with describing the world using the clumsy word "theory," however. He would say "the world works thusly," or "the world does not work thusly." If such a person existed, moreover, the practice of "science" would cease altogether, because certain knowledge about the world could be obtained from the omniscient person without the need to tediously and imperfectly study the world "scientifically."
Because the scientific community does not count omniscient members among its number, its members have developed a "scientific method" to try to deal with their uncertainty about their theories. The "scientific method," which consists of developing hypotheses and "testing" those hypotheses against empirical experience, does not provide the scientific community with certain knowledge, however. It merely serves a rather low hurdle that assists in weeding out what most scientists would consider implausible, unverifiable, and silly theories.
A theory's ability to clear this low hurdle by no means can be interpreted as "verifying" a theory, or "proving" its truth, however, because alternative theories could always be imagined that would also be consistent with the empirical "facts."[1] The scientific method does not provide the scientific community with a means to determine which theory, if any, out of the limitless set of alternative theories that could be dreamed up to explain the same empirical phenomena is "correct." Nor does the scientific method provide the scientific community with a means to know for certain that its members are not misinterpreting the empirical evidence. Only an omniscient being could know these things for certain.
Because empirical evidence does not "speak for itself," and because scientists are not omniscient (and thus cannot know if they are "correctly" interpreting empirical evidence), scientists can never know for certain if their theories correctly describe physical reality. This means that any theory that relies on the interpretation of empirical evidence can never be more than a subjective statement of belief about how a part of the world works, based on some empirical evidence.[2]
This definition is unavoidable, because no scientist is in an omniscient position to know for certain whether he has interpreted empirical evidence correctly, or whether his theory is the "correct" one out of the infinite set of alternative theories that could be imagined to explain a given phenomenon.
This is not to say that scientific theories that rely on the interpretation of empirical evidence are useless or meaningless, simply because they are subjective statements of belief. Nor does it imply that all empirically derived scientific theories are equally plausible, or that they all must be deemed "equal" in some other way, simply because they are all subjective statements of belief about how the world works. On the contrary, a theory that relies on empirical evidence is nothing more than an "expert opinion" about how a part of the world works, but it can nevertheless be useful — sometimes amazingly useful, in fact — even when it is known to be "incorrect" in some respects (e.g., Newtonian physics).[3] Moreover, individuals are free to evaluate the plausibility of scientific theories on their own, which means that they are free to accord some empirical scientific theories more plausibility than others.
The fact that scientific theories are subjective statements of belief does mean, however, that the scientist who claims that his empirically derived theory is a "fact" or "undeniably certain" does not understand the limitations of his method. He is deluding himself — and anyone else who believes his claims — if he thinks he is able to "prove" his empirically derived theory to be "irrefutably true." Only an omniscient being could possibly know for certain whether empirical evidence is being interpreted correctly, and know for certain that a specific theory out of the infinite set of alternative theories that could be imagined to explain a given phenomenon is "correct." But, again, an omniscient being would not bother with the clumsy and inefficient methods of science. He would merely say, "the world works thusly," or "the world does not work thusly." He certainly would not bother "testing" his ideas against empirical experience, because he would already know the outcome. Hence, the fact that the scientist bothers to "test" his theories and hypotheses reveals his lack of omniscience, and it also reveals, a fortiori, his inability to know for certain whether he is interpreting empirical evidence "correctly."
In order to move beyond making subjective statements of belief about how parts of the world work, the scientist would either need to become omniscient himself or consult someone who is omniscient, or else he would need to move beyond gathering and interpreting empirical evidence. Because the former options are, presumably, not open to him, the scientist's only viable option is to discover "facts" about the world, or parts of the world, that cannot possibly be thought to be false, and which are not open to misinterpretation. In other words, the scientist would have to transform himself from an empiricist into a "rationalist" who was concerned to discover fundamental truths about the world (i.e., a priori truths about the world) and elucidate them by means of a deductive and rationalistic method.[4] Only then would the scientist be in a position to say that he has found "facts" about parts of the world that are "indisputably true."
By dogmatically endorsing the "scientific method" as the only means to acquire knowledge about the world, the empirically minded scientist tacitly admits that it is possible to discover fundamental truths about the world without going out and "testing" them. For, the proposition "all hypotheses and theories must be 'tested' against empirical experience" purports to be objectively and universally true, yet the proposition itself has not and can never be "tested." Therefore the proposition is self-contradictory and thus false, a fact that establishes that it is indeed possible to discover irrefutable and demonstrable truths about the world without going out and testing them.
[product:0] Thus, absolute certainty in science cannot be acquired by means of the "scientific method" and the collection and interpretation of empirical evidence. For beings that lack omniscience, collection and interpretation of empirical evidence can only yield imperfect and subjective beliefs about how the world "works." Instead, absolute certainty in science can only be acquired by discovering propositions about the world that can be known to be true a priori — propositions that cannot possibly be thought to be false.
This observation, in a nutshell, forms the foundation and is the great strength of the Austrian School of economics, which stands virtually alone in the contemporary world as a bastion for thinkers who are unsatisfied with imperfect and subjective approaches to science.[5]
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Notes [1] Alexander L. George and Andrew Bennett, Case Studies and Theory Development in the Social Sciences (Cambridge, Mass.: MIT Press, 2004). p. 30.
[2] In some respects, this subjective definition for empirical scientific theories resembles the idea of a scientific "paradigm" advanced by likes of Thomas Kuhn and Paul Feyerabend. To my knowledge, however, relativists such as Kuhn and Feyerabend never went so far as to call an empirical scientific theory "subjective." Nor, importantly, did they claim it was possible to discover truths about the world that are not relativistic. As will be seen below, calling empirical scientific theories "subjective" by no means implies that it is impossible to acquire knowledge about the world that is objectively and irrefutably true. It only means that theories that rely on the interpretation of empirical evidence cannot be known to be objectively and irrefutably true.
[3] On the enduring usefulness of Newtonian physics, despite its clear deficiencies, see Thomas Kuhn, The Structure of Scientific Revolutions (Chicago: University of Chicago Press, 1962).
[4] For a brilliant elucidation of the rationalist method, see Hans-Hermann Hoppe, Economic Science and the Austrian Method (Auburn, Ala.: Mises Institute, 1995).
[5] On the a priori foundations of Austrian economics, see Ludwig von Mises, Epistemological Problems of Economics 3rd ed. (Auburn, Ala.: Ludwig von Mises Institute, 2003), Ibid., Human Action, (Auburn, Ala.: Ludwig von Mises Institute, 1999), Murray Rothbard, "In Defense of Extreme Apriorism," Southern Economic Journal, January 1957, 23(1), pp. 314-320., Ibid., Man, Economy, and State (Auburn, Ala.: Mises Institute, 2004), and Hans-Hermann Hoppe, op cit.
The development of modern neoclassical economics is the story of how a discipline lost its way. Before the mathematization of economics, economists tried to explain prices and macro patterns in the market place from individual human action. But modern "mathonomics" has evolved into a subfield of mathematics with no obvious ties to the real economy. Assuming "perfect" conditions and general equilibrium, the conclusions of economic analysis follow directly from the premises — as one would expect from solving mathematical equations — and are hence of little scientific interest. It follows that phenomena in the real economy that do not seem to fit the "perfect" models should be dismissed as imperfections; what remains to explain is the causes of action rather than its effect. The task of economics has therefore shifted from explaining the effect of human action to tracking the causes of it.
This radical shift suggests that we already know all there is to know about markets (at least to the limited extent predicted by mathematical models), while it provides a breeding ground for analysis of behavior instead of action. In other words, in order to track the ultimate causes of our mathematically precise economic models, economists shift focus toward psychology and the identifying building blocks of actors' perception of self. Economists have moved from being experts at explaining economic phenomena and the market process to being at best run-of-the-mill mathematicians and second-rate psychologists.
Considering this development, it is no wonder that economists are puzzled by phenomena like the "endowment effect." Indeed, I have myself experienced statements by established economist scholars about this psychological effect that is assumed to be a mystery. In layman terms, the endowment effect is
a hypothesis that people value a good or service more once their property right to it has been established. In other words, people place a higher value on objects they own than objects that they do not. In one experiment, people demanded a higher price for a coffee mug that had been given to them but put a lower price on one they did not yet own. (from Wikipedia)
From a mathematical-economic point view, the endowment effect demonstrates the inability of formal economics to explain what drives human action. Indeed, the endowment effect seems to shift an actor's indifference curves, and thus his subjective valuation of goods and services, depending not on qualities in the good itself or its price but on the contextual, circumstantial characteristics and psychological state of the instant and situation. The economic explanation to market valuation is therefore at odds with real valuation and the models need to be expanded to include psychological drivers of subjective valuation. And therefore economics must embrace behavioral studies and neuroscience.
From an Austrian point of view, however, there is no problem and never was one. The "endowment effect" is but an illusory problem that arises due to the confusion of means and ends in modern economics. The only reason economists today find bewilderment in such an "effect" is that they have adopted precise mathematics as the end of economic analyses rather than seeing it as one of its possible means. In fact, the endowment effect, while literally impossible in mathematical analysis and assumed away in indifference-curve analysis, is necessary in any type of exchange. Both Menger and Böhm-Bawerk were well aware of this, and neither they nor any later Austrians ever recanted — and for good reason.
[product:447] Let us borrow an illustration from Böhm-Bawerk's Positive Theory of Capital (pp. 143–47), in which a farmer "has just harvested five sacks of corn." These sacks are to keep him alive until the next harvest and therefore he makes plans for how to use them. Böhm-Bawerk writes,
One sack he absolutely requires for the sustenance of his life till the next harvest. A second he requires to supplement this bare living to the extent of keeping himself hale and vigorous. More corn than this, in the shape of bread and farinaceous food generally, he has no desire for. On the other hand, it would be very desirable to have some animal food, and he sets aside, therefore, a third sack to feed poultry. A fourth sack he destines for the making of coarse spirits. Suppose, now, that his various personal wants have been fully provided for by this apportionment of the four sacks, and that he cannot think of anything better to do with the fifth sack than feed a number of parrots, whose antics amuse him. (p. 150)
The farmer therefore dedicates each sack to a certain use intended to give him the most possible satisfaction. The sacks are substitutes, which means that it does not matter to this farmer which particular sack is used to distill brandy or feed the parrots. Indeed, to this farmer the sacks can be used interchangeably, and the loss of one sack of grain (no matter which one) will always mean (assuming the farmer's preferences do not change) the parrots will have to find food on their own or find another benevolent farmer with grain in excess of his personal needs. At any loss of grain, the farmer will readily reorganize the stock at hand so that he maximizes his utility.
Imagine if this farmer somehow loses two of his sacks so that he has only three sacks left. Obviously, he will use the three sacks for food but will have no grain to distill brandy or feed parrots. And if he were to increase his stock by one sack, he would distill brandy — the parrots would always (under the aforementioned preferences) have to wait until the farmer has a total of at least five sacks on hand.
Let us assume this farmer has some money under his mattress and the opportunity to purchase a fourth sack of grain. The economic problem is what the price of that fourth sack would be. From the farmer's perspective, it is obvious that he could give up some value to get his hands on the extra grain. How much? He would only purchase the sack of grain if it makes him better off, that is to say that he will not give up a higher value for the sack of grain than the value he would receive in using it. In fact, since he intends to use this fourth sack of grain to distill brandy, he would be willing (and, we have assumed, able) to pay anything less than the value he attributes to that brandy. Were he to pay more than this value, then he would be worse off; were he to pay an equal value, then going through with the exchange means nothing to him — so why would he do it? The only way this farmer would go through with the exchange is if he gives up less value than he receives. And the same goes for the seller — he or she will sell a sack of grain to the farmer only if the value of it is perceived as lower than the value of the payment for it.
This means both the buyer and seller gain from trade, which is an age-old economic truth. But it also means that the price, in terms of the actors' subjective valuation, is necessarily (a) lower than the value of the good purchased for the buyer, and (b) higher than the value of the good sold for the seller.
Let us assume the farmer (we'll call him A) has already purchased the fourth sack of grain and that he paid eight silver coins for it. Another farmer (let's call him B) visits and wishes to purchase a sack of grain. What price would A require in order to sell the sack to B? Neoclassical economics assumes indifference and therefore that the price of this fourth sack of grains is eight silver coins. But this is not true — we have already shown that A was willing to pay eight silver coins for the sack of grains because he valued the sack of grains at more than eight silver coins. He would not have chosen to give up those coins if he did not place a lesser value on them than the grain. Farmer B would have to pay farmer A a price that exceeds the value A sees in using the grain to distill brandy, perhaps ten silver coins (and, for the sake of simplicity, we can say that he values the brandy at nine silver coins).
The endowment effect is the price difference between eight and ten silver coins. To neoclassical economists, it is supposedly a mystery that farmer A, when having only three sacks of grain, is willing to pay the price of eight silver coins for an additional sack of grain, but when he has acquired it, he is not willing to sell it for less than ten silver coins!
[product:0] But there is no mystery to the endowment effect — and there is no effect. Indeed, farmer A does not value the fourth sack of grain differently depending on whether he wishes to acquire it or if he considers selling it — he values the sack of grain exactly the same. Throughout this example, the value of the fourth sack to the farmer is his use of it to distill brandy. The value is not the price he is willing to pay to acquire it, and it is not the price he is willing to accept to give it up. Exchange is not the result of an equality in valuation, as indifference-curve analysis assumes, but a result of inequality in the parties' valuation. The seller must value that which he gains through the exchange more than what he gives up, just as the buyer must value that which he gains more than that which he gives up. Only when this is the case is exchange possible and expected.
The bewilderment due to the endowment effect is only because neoclassical economics has sacrificed economic truth for the sake of the mathematical means in economic analysis. In a strictly mathematical analysis the conclusions follow directly from the assumptions. Those using such frameworks in economic analyses need to look somewhere outside the framework to find causes and explanations, because math is tautological and does not identify causes or provide explanations — only illustrations.
The obvious solution to this shortcoming in the framework is to replace it with something better and more realistic, not persist in seeking explanations elsewhere.
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[The Capitalist and the Entrepreneur (2010)]
While Schumpeter, Kirzner, Cantillon, Knight, and Mises are frequently cited in the contemporary entrepreneurship literature in economics and management, much of this literature takes, implicitly, an occupational or structural approach to entrepreneurship. Any relationship to the classic functional contributions is inspirational, not substantive.
The most important exception is the literature in management and organization theory on opportunity discovery or opportunity identification, or what Shane (2003) calls the "individual–opportunity nexus." Opportunity identification involves not only technical skills like financial analysis and market research, but also less tangible forms of creativity, team building, problem solving, and leadership (Long and McMullan, 1984; Hills, Lumpkin, and Singh, 1997; Hindle, 2004). While value can, of course, be created not only by starting new activities but also by improving the operation of existing activities, research in opportunity identification tends to emphasize new activities. These could include creating a new firm or starting a new business arrangement, introducing a new product or service, or developing a new method of production. As summarized by Shane (2003, pp. 4–5),
Entrepreneurship is an activity that involves the discovery, evaluation, and exploitation of opportunities to introduce new goods and services, ways of organizing, markets, process, and raw materials through organizing efforts that previously had not existed (Venkataraman, 1997; Shane and Venkataraman, 2000). Given this definition, the academic field of entrepreneurship incorporates, in its domain, explanations for why, when, and how entrepreneurial opportunities exist; the sources of those opportunities and the forms that they take; the processes of opportunity discovery and evaluation; the acquisition of resources for the exploitation of these opportunities; the act of opportunity exploitation; why, when, and how some individuals and not others discover, evaluate, gather resources for, and exploit opportunities; the strategies used to pursue opportunities; and the organizing efforts to exploit them. (Shane and Venkataraman, 2000)
This conception is admirably broad, incorporating not only opportunity discovery, but also the processes by which opportunities are pursued and exploited. What unifies these varied aspects of the entrepreneurial function is the concept of the opportunity. The discovery and (potential) exploitation of opportunities is proposed as the unit of analysis for entrepreneurship research. But what exactly are opportunities? How are they best characterized? How much explicit characterization is necessary for applied research in entrepreneurial organization and strategy?
Opportunities: Objective or Subjective?Shane and Venkataraman (2000, p. 220) define entrepreneurial opportunities as "those situations in which new goods, services, raw materials, and organizing methods can be introduced and sold at greater than their cost of production." These opportunities are treated as objective phenomena, though their existence is not known by all agents. Shane and Venkataraman also distinguish entrepreneurial opportunities from profit opportunities more generally. While the latter reflect opportunities to create value by enhancing the efficiency of producing existing goods, services, and processes, the former includes value creation through "the very perception of the means-ends framework" itself (Kirzner, 1973, p. 33). Shane and Venkataraman seem to have in mind the distinction between activities that can be modeled as solutions to well-specified optimization problems — what Kirzner (1973) calls "Robbinsian maximizing" — and those for which no existing model, or decision rule, is available.
However, Shane and Venkataraman appear to misunderstand Kirzner (and the Austrians more generally) on this point. In a world of Knightian uncertainty, all profit opportunities involve decisions for which no well-specified maximization problem is available. Kirzner does not mean that some economic decisions really are the result of Robbinsian maximizing, while others reflect discovery. Instead, Kirzner is simply contrasting two methodological constructions for the analysis of human action.
More generally, the opportunity-identification literature seeks to build a positive research program by operationalizing the concept of alertness. How is alertness manifested in action? How do we recognize it empirically? Can we distinguish discovery from systematic search? As summarized by Gaglio and Katz (2001, p. 96),
Almost all of the initial empirical investigations of alertness have focused on the means by which an individual might literally notice without search. For example, Kaish and Gilad (1991) interpret this as having an aptitude to position oneself in the flow of information so that the probability of encountering opportunities without a deliberate search for a specific opportunity is maximized. Therefore, in their operational measures of alertness, they asked founders to recall: (a) the amount of time and effort exerted in generating an information flow; (b) the selection of information sources for generating an information flow; and (c) the cues inherent in information that signal the presence of an opportunity. From this data the authors deduced: (d) the quantity of information in the flow and (e) the breadth and diversity of information in the flow.
Their results conform to expectations in some ways but also reveal some unexpected patterns. Compared to the sample of corporate executives, the sample of new venture founders do appear to spend more time generating an information flow and do seem more likely to use unconventional sources of information. Interestingly, the founders do seem more attentive to risk cues rather than to market potential cues. However, the data also reveal that only inexperienced or unsuccessful founders engage in such intense information collection efforts. Successful founders actually behave more like the sample of corporate executives. Cooper et al. (1995) found a similar pattern of results in their survey of 1100 firms although Busenitz (1996), in an altered replication of Kaish and Gilad's survey, did not. Indeed Busenitz found few significant differences between corporate managers and new venture founders. In addition, validity checks of the survey measures yielded low reliability scores, which led the author to conclude that future research in alertness required improved theoretical and operational precision.
This positive research program misses, however, the point of Kirzner's metaphor of entrepreneurial alertness: namely, that it is only a metaphor. Kirzner's aim is not to characterize entrepreneurship per se, but to explain the tendency for markets to clear. In the Kirznerian system, opportunities are (exogenous) arbitrage opportunities and nothing more. Entrepreneurship itself serves a purely instrumental function; it is the means by which Kirzner explains market clearing. Of course, arbitrage opportunities cannot exist in a perfectly competitive general-equilibrium model, so Kirzner's framework assumes the presence of competitive imperfections, to use the language of strategic factor markets (Barney, 1986; Alvarez and Barney, 2004).
Beyond specifying general-disequilibrium conditions, however, Kirzner offers no theory of how opportunities come to be identified, who identifies them, and so on; identification itself is a black box. The claim is simply that outside the Arrow–Debreu world, in which all knowledge is effectively parameterized, opportunities for disequilibrium profit exist and tend to be discovered and exploited. In short, what Kirzner calls "entrepreneurial discovery" is simply that which causes markets to equilibrate.The foregoing description applies primarily to what Kirzner calls the "pure entrepreneur" (see footnote 2 above). As he explains, flesh and blood entrepreneurs do not correspond exactly to this ideal type (they can simultaneously be laborers, capitalists, consumers, etc.) — and they do more than simply discover costless profit opportunities. However, in Kirzner's framework, the attributes of real-world entrepreneurs defy systematic categorization.
Contemporary entrepreneurship scholars, considering whether opportunities are objective or subjective (McMullen and Shepherd, 2006; Companys and McMullen, 2007), note that Kirzner tends to treat them as objective. Again, this is true, but misses the point. Kirzner is not making an ontological claim about the nature of profit opportunities per se — not claiming, in other words, that opportunities are, in some fundamental sense, objective — but merely using the concept of objective, exogenously given, but not yet discovered opportunities as a device for explaining the tendency of markets to clear. Incidentally, the occupational choice literature cited above treats opportunities, implicitly or explicitly, as objective. Agents are assumed to compare the expected benefits of employment and self-employment, meaning that the set of possible entrepreneurial outcomes must be fixed, and the probability weights assigned to individual outcomes known in advance.
The Knightian perspective also treats entrepreneurship as an instrumental construct, used here to decompose business income into two constituent elements — interest and profit. Interest is a reward for forgoing present consumption, is determined by the relative time preferences of borrowers and lenders, and would exist even in a world of certainty. Profit, by contrast, is a reward for anticipating the uncertain future more accurately than others (e.g., purchasing factors of production at market prices below the eventual selling price of the product), and exists only in a world of true uncertainty. In such a world, given that production takes time, entrepreneurs will earn either profits or losses based on the differences between factor prices paid and product prices received.
For Knight, in other words, opportunities do not exist, just waiting to be discovered (and hence, by definition, exploited). Rather, entrepreneurs invest resources based on their expectations of future consumer demands and market conditions, investments that may or may not yield positive returns. Here the focus is not on opportunities, but on investment and uncertainty. Expectations about the future are inherently subjective and, under conditions of uncertainty rather than risk, constitute judgments that are not themselves modelable.
Put differently, subjectivism implies that opportunities do not exist in an objective sense. Hence, a research program based on formalizing and studying empirically the cognitive or psychological processes leading individuals to discover opportunities captures only a limited aspect of the entrepreneurial process. Opportunities for entrepreneurial gain are, thus, inherently subjective — they do not exist until profits are realized. Entrepreneurship research may be able to realize higher marginal returns by focusing on entrepreneurial action, rather than its presumed antecedents.Here I follow Gul and Pesendorfer's (2005, p. 1) more general critique of neuroeconom"cs, namely that cognitive psychology and economics "address different questions, utilize different abstractions, and address different types of empirical evidence," meaning that the two disciplines are in essentially different, though potentially complementary, domains. In other words, understanding the cognitive processes underlying entrepreneurial behavior may be interesting and important, but not necessary for the economic analysis of the behavior itself.
Alvarez and Barney (2007) argue that entrepreneurial objectives, characteristics, and decision making differ systematically, depending on whether opportunities are modeled as discovered or created. In the "discovery approach," for example, entrepreneurial actions are responses to exogenous shocks, while in the "creation approach," such actions are endogenous. Discovery entrepreneurs focus on predicting systematic risks, formulating complete and stable strategies, and procuring capital from external sources. Creation entrepreneurs, by contrast, appreciate iterative, inductive, incremental decision making, are comfortable with emergent and flexible strategies, and tend to rely on internal finance.Miller (2007) distinguishes further between opportunity recognition, opportunity discovery, and opportunity creation.
The approach proposed here is close to Alvarez and Barney's creation approach, but differs in that it places greater emphasis on the ex post processes of resource assembly and personnel management rather than the ex ante processes of cognition, expectations formation, and business planning. Moreover, Alvarez and Barney write as if "discovery settings" and "creation settings" are actual business environments within which entrepreneurs operate. Some entrepreneurs really do discover exogenously created profit opportunities, while others have to work creatively to establish them.
As I read Knight and Kirzner, by contrast, both the discovery and creation perspectives are purely metaphorical concepts (useful for the economist or management theorist), not frameworks for entrepreneurial decision making itself. This suggests that opportunities are best characterized neither as discovered nor created, but imagined. The creation metaphor implies that profit opportunities, once the entrepreneur has conceived or established them, come into being objectively, like a work of art. Creation implies that something is created. There is no uncertainty about its existence or characteristics (though, of course, its market value may not be known until later). By contrast, the concept of opportunity imagination emphasizes that gains (and losses) do not come into being objectively until entrepreneurial action is complete (i.e., until final goods and services have been produced and sold).The concept of "opportunity imagination" calls to mind Boulding's (1956, p. 15) notion of "image," defined as "the sum of what we think we know and what makes us behave the way we do." Human action, in Boulding's framework, is a response to the actor's (subjective) image of reality. This does not mean that images are completely detached from reality, but that reality is altered, or interpreted, by the actor's subjective beliefs. Penrose's (1959) concept, of the firm's subjective opportunity set also reflects entrepreneurial imagination in this sense (Kor, Mahoney, and Michael, 2007).
Moreover, explaining entrepreneurial loss is awkward using both discovery and creation language. In Kirzner's formulation, for example, the worst that can happen to an entrepreneur is the failure to discover an existing profit opportunity. Entrepreneurs either earn profits or break even, but it is unclear how they suffer losses. Kirzner (1997) claims that entrepreneurs can earn losses when they misread market conditions. "Entrepreneurial boldness and imagination can lead to pure entrepreneurial losses as well as to pure profit. Mistaken actions by entrepreneurs mean that they have misread the market, possibly pushing price and output constellations in directions not equilibrative" (Kirzner, 1997, p. 72).
But even this formulation makes it clear that it is mistaken actions — not mistaken discoveries — that lead to loss. Misreading market conditions leads to losses only if the entrepreneur has invested resources in a project based on this misreading. It is the failure to anticipate future market conditions correctly that causes the loss. It seems obscure to describe this as erroneous discovery, rather than unsuccessful uncertainty bearing.In his defense, Kirzner's (1997) remarks appear in the context of defending the equilibrating tendency of the market, against the Walrasian picture of instantaneous market adjustment. Still, the defense could perhaps be made equally well without reference to the discovery metaphor.
Likewise, realized entrepreneurial losses do not fit naturally within a creation framework. Alvarez and Barney (2007) emphasize that "creation entrepreneurs" do take into account potential losses, the "acceptable losses" described by Sarasvathy (2001). "[A]n entrepreneur engages in entrepreneurial actions when the total losses that can be created by such activities are not too large" (Alvarez and Barney, 2007, p. 19). However, when those losses are realized, it seems more straightforward to think in terms of mistaken beliefs about the future — expected prices and sales revenues that did not, in fact, materialize — than the "disappearance" of an opportunity that was previously created. Entrepreneurs do not, in other words, create the future, they imagine it, and their imagination can be wrong as often as it is right.To go from judgment to an explanation for market efficiency requires assumptions about the tendency of entrepreneurial judgments to be correct. Mises's (1951) explanation is based on a kind of natural selection, namely that market competition rewards those entrepreneurs whose judgments tend to be better than the judgments of their fellow entrepreneurs. Of course, one needn't go as far as Friedman (1953) in assuming that the result is "optimal" behavior, in the neoclassical economist's sense of optimality, to defend the effectiveness of this selection process.
Opportunities as a Black BoxConfusion over the nature of opportunities is increasingly recognized. As noted by McMullen, Plummer, and Acs (2007, p. 273),
a good portion of the research to date has focused on the discovery, exploitation, and consequences thereof without much attention to the nature and source of opportunity itself. Although some researchers argue that the subjective or socially constructed nature of opportunity makes it impossible to separate opportunity from the individual, others contend that opportunity is as an objective construct visible to or created by the knowledgeable or attuned entrepreneur. Either way, a set of weakly held assumptions about the nature and sources of opportunity appear to dominate much of the discussion in the literature.
Do we need a precise definition of opportunities to move forward? Can one do entrepreneurship research without specifying what, exactly, entrepreneurial opportunities are? Can we treat opportunities as a black box, much as we treat other concepts in management, such as culture, leadership, routines, capabilities, and the like (Abell, Felin, and Foss, 2008)?
One approach is to focus not on what opportunities are, but what opportunities do. Opportunities, in this sense, are treated as a latent construct that is manifested in entrepreneurial action — investment, creating new organizations, bringing products to market, and so on. A direct analogy can be drawn to the economist's notion of preferences. Economic theory (with the exception of behavioral economics, discussed later) takes agents' preferences as a given and derives implications for choice. The economist does not care what preferences "are," ontologically, but simply postulates their existence and draws inferences about their characteristics as needed to explain particular kinds of economic behavior. Empirically, this approach can be operationalized by treating entrepreneurship as a latent variable in a structural-equations framework (Xue and Klein, 2010).
By treating opportunities as a latent construct, this approach sidesteps the problem of defining opportunities as objective or subjective, real or imagined, and so on. The formation of entrepreneurial beliefs is treated as a potentially interesting psychological problem, but not part of the economic analysis of entrepreneurship. It also avoids thorny questions about whether alertness or judgment is simply luck (Demsetz, 1983), a kind of intuition (Dane and Pratt, 2007), or something else entirely.
The Unit of AnalysisAs explained earlier, the opportunity-creation approach proposed by Alvarez and Barney (2007) differs in important ways from the opportunity-discovery approach. The creation approach treats opportunities as the result of entrepreneurial action. Opportunities do not exist objectively, ex ante, but are created, ex nihilo, as entrepreneurs act based on their subjective beliefs. "Creation opportunities are social constructions that do not exist independent of the entrepreneur's perceptions" (Alvarez and Barney, 2007, p. 15). In this sense, the creation approach sounds like the imagination approach described here. Still, like the discovery approach, the creation approach makes the opportunity the unit of analysis. How entrepreneurs create opportunities, and how they subsequently seek to exploit those opportunities, is the focus of the research program.
At one level, the distinction between opportunity creation and opportunity imagination seems semantic. Both hold that entrepreneurs act based on their beliefs about future gains and losses, rather than reacting to objective, exogenously given opportunities for profit. There are some ontological and epistemological differences, however. The creation approach is grounded in a social constructivist view of action (Alvarez and Barney, 2007). It holds that the market itself is a social construction, and that realized gains and losses are, in part, subjective. The imagination approach described here is, in this sense, less subjectivist than the creation approach. It is tied closely to Mises's (1912; 1920) concept of monetary calculation, in which realized gains and losses are objective and quantifiable, and used to filter (or select) the quality of entrepreneurial expectations and beliefs. It is compatible with a range of ontological positions, from evolutionary realism to critical realism (Lawson, 1997; Mäki, 1996) to Misesian praxeology (Mises, 1949).
An alternative way to frame a subjectivist approach to entrepreneurship, emphasizing uncertainty and the passage of time, is to drop the concept of "opportunity" altogether. If opportunities are inherently subjective and we treat them as a black box, then the unit of analysis should not be opportunities, but rather some action — in Knightian terms, the assembly of resources in the present in anticipation of (uncertain) receipts in the future. Again, the analogy with preferences in microeconomic theory is clear: the unit of analysis in consumer theory is not preferences, but consumption, while in neoclassical production theory, the unit of analysis is not the production function, but some decision variable.
One could also view opportunities and actions as distinct — but complementary — aspects of the entrepreneurial process. To use Alvarez and Barney's (2007) terminology, the discovery perspective treats actions as responses to opportunities, while the creation perspective treats opportunities as the result of action. By contrast, the perspective outlined here treats opportunities as a superfluous concept, once action is taken into account. Opportunities exist only as manifested in action, and are neither its cause nor consequence of action. Hence, we can dispense with the very notion of opportunities itself and focus on the actions that entrepreneurs take and the results of those actions.
One way to capture the Knightian concept of entrepreneurial action is Casson and Wadeson's (2007) notion of "projects." A project is a stock of resources committed to particular activities for a specified period of time. Project benefits are uncertain, and are realized only after projects are completed. Casson and Wadeson (2007) model the set of potential projects as a given, defining opportunities as potential projects that have not yet been chosen. As in the discovery-process perspective, the set of opportunities is fixed. However, as Casson and Wadeson point out, the assumption of fixed "project possibility sets" is a modeling convenience, made necessary by their particular theory of project selection.
More generally, the use of projects as the unit of analysis is consistent with either the discovery or creation perspective. Focusing on projects, rather than opportunities, implies an emphasis on the actions that generate profits and losses. It suggests that entrepreneurship research should focus on the execution of business plans. In this sense, entrepreneurship is closely linked to finance — not simply "entrepreneurial finance" that studies venture funding and firm formation, but the more general problem of project finance under (true) uncertainty. Not only venture capital, but also public equity and debt, are entrepreneurial instruments in this perspective.
Capital budgeting is also a form of entrepreneurial decision making. Of course contemporary finance theory focuses primarily on equilibrium models of resource allocation under conditions of risk, not Knightian uncertainty, so entrepreneurship theory cannot be simply a reframing of modern finance theory. Instead, a financiers-as-entrepreneurs approach treats investors not as passive suppliers of capital to decision-making firms, but as the locus of economic decision making itself, as economic agents who experiment with resource combinations (chapter 3 above), develop and exploit network ties (Meyer, 2000), manage and govern subordinates (Kaplan and Strömberg, 2003), and the like.
This article is excerpted from The Capitalist and the Entrepreneur‚ chapter 5, "Opportunity Discovery and Entrepreneurial Action" (2010).
Seated in a third-year law course discussing sales and the Uniform Commercial Code, the topic of subjective valuation was miraculously brought up by another student. Slow your pulse and don't hyperventilate; the room did not fill with white light as an angel touched down. His point, though well-intentioned, was slightly off.
The hypothetical went like this: A company has all the requisite licensing and is operating lawfully but is selling merchandise out of a van on the street. It leads its customers to believe they are getting deals because the merchandise they are buying is stolen. In reality, the company's goods are not stolen, and its prices are grossly inflated against the backdrop of the actual market.
As we debate the legality of this hypothetical transaction, a student notes that the purchaser subjectively valued his "stolen" goods at the bloated price when he purchased them, so even though he recognizes his error as soon as he enters Walmart, it is too late and he is stuck with his goods.
No, no, no. I am rolling up my newspaper to smack you on the nose right now. This argument will simply never fly in the mainstream and it will never convince a leftist, socialist, or statist of the realities of capitalism and Austrian economics.
Austro-libertarianism, in practice, is not an endless battlefield of caveat emptor, where the bodies of the uninformed masses are stacked ten high, walletless and decapitated.
A libertarian society is first and foremost against aggression. Lying, deceiving, and defrauding someone into purchasing your goods — or, more accurately, the idea of the goods you have portrayed — is akin to using outright force to take his or her property.
In the above hypothetical, the purchaser purchased the goods under the auspice of illegality and perhaps found joy in the spectacle. His or her subjective valuation of the entire scenario is what he or she paid for. This is conceded. More importantly though, the seller, is lying about his or her products, and this is never tolerated in a libertarian society — not by its citizens and not by its laws.
Whether discussing our Austro-libertarian views in the classroom, boardroom, or the break room, it is imperative that we maintain a realistic and large-scale perspective of society. The above hypothetical scenario is
unbelievably unlikely to actually exist;not going to last more than one or two days with the modern spread of information, if it were to actually exist; andincentivizes lying to customers.To get bogged down into this kind of frivolous debate is a pitfall that we must avoid.
Mises was the master of keeping the whole picture in focus. He had the uncanny ability to develop comprehensive, grand-scale ideas and interweave isolated examples that flowed so logically, nearly all arguments to the contrary are deflated. If we are going to dance the left-liberal dance, and engage in seemingly trivial argument of unlikely realities, we must be clear on the actual Austrian concepts, of which subjective valuation is just one of the many. No Austrian or libertarian concept promotes or endorses lying to customers to create a fallacious idea of what a good or service is.
This should not be taken to discredit the value of salesmanship in an Austro-libertarian society. Informing consumers of what they are missing out on when they do not have a product or service is an honorable undertaking. Salesmen perform an important function within the scope of subjective valuation but cannot and do not use outright lies to achieve their goals. Under the American common law and the Uniform Commercial Code, for example, the words and actions of salesmen often create binding, though unintentional, warranties. Consumers are protected through a development of private law systems much the same as they would be in an Austrian-type society.
Additionally, consider referencing the Uniform Commercial Code as an argument for the practicality of a private law system, or at least an antifederalist republic of the United States. The UCC is a privately composed amalgamation of legal sources drafted to promote commerce. The code has been adopted by all 50 states and 4 major territories in whole or at least in part. Each state can and does retain its own aspects of the common law that conflict with the UCC and its adoption was not forced by the federal government.
Why have all states adopted such private law? It works. It does what it was designed to do. It promotes efficiency, streamlines transactions, and provides stability that encourages capital investment in what might otherwise be considered too risky a venture.
If an antifederalist step toward decentralization of our government were taken, and states' rights were to be increased — a step in the direction of liberty, I propose — these types of comprehensive systems would be far more frequently employed. For example, once the citizens of Alabama recognize that Florida's approach of anti-interventionist tactics in economic affairs result in a boon in Florida residents' standards of living, other states and communities will follow suit. The citizens will demand it.
This is a simple way we can shape a discussion to focus on what Austro-libertarianism really does teach. Although the concept of subjective valuation, when taken in the abstract, explains why a person bought what he or she bought, even if he or she got taken for a bath, on a broad scale, Austro-libertarianism does not promote fraud, reward lying, or forgive deceit. The opposite is true. Honesty is rewarded, and efficiency and the constant improvement in people's standards of living are the lifeblood of the producer and distributors.
The grave robber joins the bootlegger, the gunrunner, the drug dealer, and the ivory poacher as another phony criminal created by laws that shouldn't exist, writes Adam Young.
This audio Mises Daily is narrated by Colin Hussey.
In a previous article I explained some of the major problems with a cost theory of value. In the current essay I will lay out the basics of the modern subjectivist approach to price theory and show how it is a clear improvement over the cost theory.
The Austrian Approach Starts with Individual PreferencesAlthough the "marginalist revolution" of the 1870s involved three independent discoveries of the concept by Léon Walras, William Stanley Jevons, and founder of the Austrian School Carl Menger, I am going to focus on price theory as it developed in the hands of the Austrians. Furthermore, I will present a modern statement of the theory, as taught in Murray Rothbard's Man, Economy, and State.
The older Austrians, like Böhm-Bawerk, who actually worked out the details of the theory, would have had different nuances and (from our perspective) may have even gone down cul-de-sacs that a modern exposition avoids. The present essay is just intended to give the basics of the modern subjectivist approach, not a history of its development.
The starting point of Austrian price theory views individuals as holding rankings of successive units of goods (and services). Austrian theory does not need to assume that individuals assign cardinal units of happiness or "utility" to various goods, but merely that they can be ranked from most to least preferred.
If we work through the numerical example of pages 107–10 of Man, Economy, and State, we can see how a modern Austrian explains market-price formation. Consider two men, Smith and Johnson. Smith currently possesses a large number of barrels of fish, while Johnson owns a horse. The following diagrams show how the two men subjectively rank various amounts of fish and the horse:
Subjective Rankings Johnson's Subjective Rankings
In the diagrams above, a parentheses indicates that the person doesn't own the item in question, but can imagine owning it and compare it to the other items that he actually owns. Thus we see that Smith (on the left) values 103 barrels of fish more than 102 barrels or 101 barrels. The fourth-best thing, as far as Smith is concerned, would be to have a horse (which he currently lacks). Then the next-best outcome would be to have only 100 barrels of fish, and so on.
Johnson, on the right, currently doesn't have any fish. But he considers that having 84 barrels would be the best, then having only 83, then 82 and then 81. The fifth-best outcome (of the scenarios he is considering) would be to have just a horse, which he currently possesses. Then the next-best thing would be to not have his horse, and instead to have 80 barrels of fish, etc.
Once we know how to read Rothbard's charts, we immediately see that there is a "gain from trade" to be exploited here. Because economic value is subjective, it is possible for the men to exchange some of their property and both walk away with the "more valuable" item. This would not be true for objective, intrinsic properties of goods. For example, it would be impossible for both men to walk away with the heavier object after a trade. But value is in the eye of the beholder, and hence voluntary trades are win-win activities in which both parties benefit by giving up something of lesser value in exchange for something of greater value.
Determining the (Equilibrium) PriceFrom simple inspection of the preference rankings of Smith and Johnson, Rothbard says that we can't precisely pin down the exchange rate or "price" of a horse in terms of fish. Instead we can only specify a range of possible prices. What we can say is that Smith would be willing to trade at most 100 barrels of fish for a horse, while Johnson would require at least 81 barrels of fish in order to give up his horse. Therefore, if the men trade, economic analysis tells us the price of a horse will fall somewhere in the range of 81 to 100 barrels of fish. (Other considerations, such as the relative bargaining savvy of the two men, would be needed to predict the actual price.)
The zone of indeterminacy can be narrowed, however, if we introduce more people into the market, and if we make a modest assumption about the bargaining process. To demonstrate, Rothbard next introduces a third man, Brown, who (like Smith) starts out with a bunch of fish but no horse. Here are the preference rankings of the three men:
As the diagram indicates, Brown would only be willing to offer at most 90 barrels of fish for Johnson's horse, in contrast to Smith, who is willing to offer up to 100 barrels.
With the addition of Brown, in actual practice it's possible that Brown and Johnson would trade. After all, both men would subjectively benefit if Johnson gave Brown his horse in exchange for, say, 89 barrels of fish.
But Rothbard argues that this would not constitute an equilibrium outcome, because Smith would have objected. He could have said to Johnson, "Whoa, what are you doing? Why give your horse to Brown for a mere 89 barrels, when I will gladly give you 90?"
If we define an equilibrium price as one that none of the market participants would have an incentive to disrupt in such a manner, then the introduction of Brown has narrowed the range of possible equilibrium prices. In equilibrium, it will still be the case that Johnson trades his horse to Smith for some fish. But in order to keep Brown from upsetting the transaction with a counteroffer, the range of possible prices of a horse is now 91 to 100 barrels of fish. (Recall that the original range was the wider 81 to 100 barrels.)
As more participants are added to both the horse and fish side of the market, the zone of possible equilibrium prices continues to shrink. Eventually, it may collapse to a single point. Later in his exposition, Rothbard shows how the economist could take every person's preference rankings and construct the more familiar supply and demand curves, which intersect at this unique equilibrium price.
The Subjectivist Approach Is a Complete Theory of Price FormationNotice that Rothbard's example was able to explain the price of a horse (in fish) without any reference to other prices in the economy. This was one of the major drawbacks of the cost theory of value. By saying (for example) that the price of a car "had to" be $10,000 because of the costs of the steel, rubber, glass, and labor that went into its construction, the cost theory of value was merely explaining one price (of a car) in relation to other prices (of steel, rubber, glass, etc.). The cost theory didn't actually explain market prices in terms of more fundamental building blocks. But Rothbard achieves precisely this with his example of the fish-and-horse market.
Also notice that Rothbard's approach can work for any type of good or service. It doesn't matter whether the horses were bred for sale or whether they were discovered the day before "for free." The subjectivist approach can therefore explain the price of Picassos as well as the price of peanut butter. In contrast, the cost theory of value at best could explain the (long-run) price of reproducible goods.
This point is particularly important in modern times when it comes to the pricing of digital goods, as Jeff Tucker recently pointed out to me. Items such as an ebook have a certain fixed cost, but virtually zero marginal cost. In other words, once paying the author for the content (and paying the overhead for the distribution network), whether the publisher sells 10 ebooks or 10 million of them, the costs of production are basically the same. In this type of setting, the modern subjectivist approach to pricing is necessary to make sense of the market, even though at first blush an ebook is a reproducible good and would seem to fall under the jurisdiction of the cost theory.
Subjectivist (Marginalist) Theory Incorporates the Truth of the Cost TheoryThe modern subjectivist theory incorporates the truth of the cost theory. In other words, the limited situations in which the cost theory worked can also be handled by the subjectivist theory. In order to do this, the economist simply needs to take into account the fact of marginal utility, meaning that people make their trades using concrete units of goods rather than entire classes. (For more on marginal utility, see this article.)
For example, the cost theory of value would say that if the price of a good fell below the cost of producing it, then producers would switch to alternate lines, and the resulting shortfall in supply would raise the price. The subjectivist approach can tell the same story, because individuals will devote the first horse to more important ends than the third horse. Thus, the marginal utility of the first horse is higher than that of the third horse, and as the quantity of horses dwindles, their market price will tend to increase, using Rothbard's approach as outlined above. (This was not obvious in the actual example above, which only used one horse to keep things simple.)
ConclusionThe subjectivist, marginalist approach to price theory is superior to the older cost theory. The modern approach can truly explain market prices in terms of more fundamental building blocks. The subjectivist theory can explain anything the cost theory can, as well as a whole host of other scenarios.
One of the most important developments in the history of economic thought was the so-called Marginal Revolution of the early 1870s, in which the older cost (and more specifically, labor) theory of value was overturned by subjective value theory. This was an unambiguous advance in the science of economics, analogous to the superiority of Einsteinian relativity over Newtonian mechanics. The revolution is of special importance for Austrian economists, since Carl Menger — founder of the Austrian School — is credited as one of the three pioneers of the new approach.In the present article, I'll explain a generic cost theory approach and point out some of its major shortcomings. In a future article, I'll show how the modern, subjectivist approach has more explanatory power and avoids all of these pitfalls.
A Generic Cost Theory of ValueIn a short online essay, I don't want to get bogged down with quotations from specific economists from the past. Instead, I will try to present a generic version of the cost theory of value in order to summarize the viewpoint. The classical economists — including such giants as Adam Smith, David Ricardo, and Frederic Bastiat — had nuanced treatments of the subject in their writings, but all generally adhered to some form of the cost theory (and more specifically, a labor theory of value, which Karl Marx adopted from the other classical economists). Those who want a more academic treatment, dealing with arguments from proponents of the cost theory, should consult this article.
The Purpose of Economic Value TheoryThe purpose of economic value theory — whether a cost, labor, or subjective approach — is to explain the prices of various goods and services in a market economy, i.e., to explain their "market value." For example, why is it that gold bars and automobiles are so valuable, while tinfoil and tube socks are not?
Explaining the formation and magnitudes of various market prices is not the sole task of economic theory, but it is a crucial component of it. The cost theory of value is a legitimate approach, and it did shed some light on the subject. But in light of the flaws we will discuss, the cost theory was ultimately displaced by a more satisfactory explanation.
The Cost Theory of ValueAs its name suggests, the cost theory of value explains the final price of a good (or service) by how much it costs to produce it. Suppose a particular car has a retail price of $10,000. The cost theory would explain this market value by pointing out that the producer had to spend (say) $5,000 on the engine, $2,500 on the metal and plastic for the frame, $1,000 on the glass for the windshield and windows, $500 for the tires, and $500 for the labor and depreciation of the machinery needed to assemble the vehicle.
The direct cost of production of $9,500, coupled with a retail price of $10,000, allows for a healthy return on the invested capital. The cost theory of value would argue that if the final price were lower than $10,000 — say, $9,300 — then producers would have no incentive to stay in automobile production. Some of them would leave the industry and invest their financial capital elsewhere. The exodus would reduce the supply of automobiles, pushing up their price until it once again made sense for producers to make automobiles.On the other hand, if the price of an automobile were significantly higher than $10,000 — say, $13,000 — then the "rate of profit" in this industry would be much higher than in other enterprises of comparable risk. Investors would flock into automobile production, increasing the supply and pushing down prices.
In summary, the cost theory of value provided a coherent explanation for a genuine empirical regularity in a market economy. It really is the case that retail prices bear a strong correlation to the costs of production for various goods and services. The cost theory of value gave a plausible mechanism to explain this phenomenon. The development of the cost theory of value was a definite advance in economic science.
To relate the cost theory to modern times, notice that it is a very natural approach, and shows a sophisticated understanding of markets. For example, tourists to New York City might initially be shocked at how much a deli sandwich costs in the Big Apple. But a thoughtful member of the group might observe, quite correctly, that the owner of the deli pays astronomical rent every month because of his location across the street from Broadway shows. Once he points out that the sandwiches "have to cost that much" in order for the deli to stay in business, the other tourists in his group might be less outraged at the owner.
Problems with the Cost Theory of ValueAlthough it was better than nothing, the cost theory of value nonetheless suffered from several important flaws. Fundamentally, the cost theory is deficient because it doesn't actually explain the determinants of market prices. Rather, the cost theory merely explains relationships among market prices.
"Costs" are prices too. To "explain" the price of a $10,000 car by reference to the prices of the engine, tires, glass, and so on, doesn't really explain market prices per se. At best, it pushes back the explanation one step: Why does the engine have a price of $5,000, etc.?The labor theory of value avoids this particular snare by explaining the ultimate price of a good by the total amount of labor going into its production, including the labor required in the past to produce the components of the final good. However, the labor theory of value carries other problems beyond those of a generic cost theory, as I explain in "The Labor Theory of Value: A Critique of Carson's Studies in Mutualist Political Economy," Journal of Libertarian Studies, vol. 20 (Winter 2006), pp. 17–33.Even on its own terms, the cost theory of value (at least as I have summarized it above) acknowledges that the present day "spot" price of a good is determined by something other than the costs of its production. The theory explicitly deals with the cases where the actual market price is either higher or lower than the long-run "anchor" price set by the cost theory, and tries to explain the forces that would move those "aberrational" prices back toward the long-run "natural" price.
The classical economists weren't dummies. They understood that a sudden urge among the public to buy more of a certain good would lead to an immediate increase in its price. But the cost theory could only comment on this situation by saying that the market would tend toward a restoration of the same rate of profit in the industry through an increase in production to match the increased demand.
In other words, the cost theory of value could explain the long-run target toward which the day-to-day spot prices would tend. The cost theory could not explain what actually formed those spot prices on any given day.
Because the cost theory couldn't explain how actual market prices were formed "from scratch," it was useless when it came to nonreproducible goods. Obviously the price of the Mona Lisa, or of an original Shakespeare manuscript, would have nothing to do with the cost of producing these masterpieces.
Cost Theory Has Things BackwardHere we see the methodological problem of the cost theory: By explaining final retail prices through the cost of making the goods, the cost theory implies that economic value is an objective property of physical items that flows from resources into the goods that they produce. In contrast, the subjective value theory of Menger and others starts with the valuation of consumer goods and works its way back through the prices of labor and other inputs accordingly.
When a consumer is deciding on a purchase, the cost of producing the item is usually irrelevant. For example, going along with our hypothetical example above, if a new company decided to use twice as many resources to make an equivalent car, it couldn't charge $20,000 simply because "that's how much it cost."
For a different example, if a farmer discovers a meteorite chock full of gold on his property, he will charge whatever the market will bear for it. He won't sell it for less than other gold producers on account of his virtually zero cost of production.ConclusionAlthough the cost theory of value provided a coherent explanation of the long-run relationship between prices and costs for reproducible goods, it was not an adequate theory of market price determination. The marginal, subjectivist approach pioneered by Carl Menger and others is far superior, as I will show in a future essay.
"That's quite a markup," remarked my father as he paid for my six-year-old son's treat after a soccer game. "Three dollars for a cup of ice."
It's true; the price tag did seem steep at first. But as we analyzed the situation more carefully — my father is also a fan of free markets — we realized that there was no reason to be outraged at the vendor's price.
The ContextBefore speculating on the ins and outs of the frozen-drink market, let me give the background. My son plays soccer for a town league. Every Saturday, the teams all play each other at one central location, with at least 20 little fields set up for the various age brackets. During the course of the day, I'd guess that at least a thousand people (counting spectators) cycle through the fields.
During Easter weekend my parents were visiting, and we all went to my son's game. My son pointed out with enthusiasm a truck that was parked in a very accessible area, because it housed ice drinks. (I think technically they were not the ICEE brand, but it was the same idea.)
After my son's team absolutely blew out their opponents, I suggested to my son that if he asked nicely, Grandpa would probably buy him a treat at the truck. And now I have brought all readers up to speed from where our story first began. …
How Could Somebody Charge $3 for a Cup of Ice?As a card-carrying armchair economist, I did not conduct any actual research for this article. Nevertheless, it may interest some readers to learn how to think like an economist on such everyday puzzles.
Factors on the Demand SideThe first important point is that my father voluntarily paid the $3 for the refreshment, albeit with some significant social pressure leaning on him after the promise made to my son. But if, for example, he had gotten to the truck and the sign said each frozen drink cost $30, my father clearly would have walked away. We could've told my son that it was too much money, and that we'd stop at a convenience store instead.
We already have more insight into the "high" price of the drinks — their extremely convenient location. An ice-cold-drink-at-the-store is not the same good as an ice-cold-drink-next-to-the-soccer-field. There is nothing irrational or "uneconomical" about consumers being willing to pay more for the immediate quenching of their thirst.
Although I obviously didn't think it through at the time, I realized in retrospect that when I suggested to my son that my dad would buy him the treat, I knew that the price had to be "reasonable," because the truck had obviously been at the games before (since my son recognized it), and because I could see a crowd of people in front of it.
These considerations shed some light on the "demand side" of the equation. Especially because it was a hot day, it's no mystery that so many people were willing to exchange $3 for a "cup of ice."
Factors on the Supply SideNow let's look at the supply side. In general, if we're trying to understand why a price might be high, it's not enough in economics to explain that people really value something. We need to go further, and explain why the quantity supplied stays low enough so that what's called the "marginal utility" of the small number of units remains high.
Let me clarify with a different example. If someone were selling bottles of water at $100 a piece, we could explain that by saying that the consumers valued each bottle more than the other goods and services that could have been obtained with the $100. However, because that price is so unusually high, we would want to explore the situation more in order to figure out why more bottles weren't being channeled to these particular consumers, who were obviously on the verge of dying of thirst.
By the same token, we can speculate on the "supply side" of our frozen drink supplier, to see if the apparently high price of $3 really isn't so surprising after all.
One obvious observation is that it was a hot day, and so refrigerating the ice in a relatively small container (i.e. that could fit in a truck) might be expensive, especially because it has to sit in the hot sun for at least several hours. The vendor also had to buy the sugar flavoring (available in several colors) that the kids would squirt into their "cup of ice." Who knows how much those cost to restock, but the vendor would also have to worry about some kids dribbling large amounts onto the ground before their parents intervened.
Another obvious expense in the operation was the truck itself. This wasn't some guy's F-150 with a cooler thrown in the back; the whole truck had been configured to sell frozen treats. (For example, one side of the truck was painted full of descriptions of the available items.) Now, perhaps the owner used the vehicle for his personal transportation needs, but it's possible that the truck was dedicated entirely to his business. In that case, the $3 per sale would need to cover not just the ice, cup, and flavoring, but also a tiny portion of the truck payment and upkeep, including gas.
Another major cost was the vendor's time. I love watching my son play, but I know I'm ready to get the heck out of Dodge when the game ends. In order to make it worthwhile to stand at that field for several hours, the vendor would have to charge a high enough "markup" to pay himself a decent hourly wage.
Yet another consideration is the risk involved. If there are thunderstorms (or even if the field is too muddy from previous rains), all the games would be cancelled on a particular Saturday. (I think they make them up — if at all — with double-headers in subsequent weeks, rather than extending the season.) So when deciding on his pricing strategy, the frozen-drink vendor would need to consider that he might miss out on a large fraction of potential sales due to weather. If the weather is particularly cold, then it might not make sense to drive the truck to the field even if the games are on.
Finally, we have to consider that the coveted location is itself valuable. The truck's owner obviously had to get permission from the league to be able to park right in the middle of all the fields, so that the majority of parents and kids would pass near it on their way home. This is what gives the truck vendor such an advantage over his competitors in nearby convenience stores and restaurants, and the soccer league might charge him a fee for this privilege (unless he's friends with the people running it).
Depending on the fee that might be charged for use of the location, the entire problem might get pushed back a step. Rather than asking, "How can this vendor get away with skimming so much off the parents?" we instead would want to know, "How can the soccer league get away with earning so much from providing concessions during the games?"
The answer to this second question would follow similar lines. We would first realize that nobody was forced to join the league, and that if the organizers really were making a killing, then competing soccer leagues (charging lower registration fees and/or providing concessions at lower prices) would spring up.
ConclusionThe point of this article wasn't to say whether $3 for an iced drink was "too high" or "just right," according to some particular theory of justice. Rather, as dispassionate economists, we can analyze why consumers were willing to pay so much for each unit of a good, and why producers didn't rush in to sell more units at a lower price. Such an exercise is useful in understanding how the world works, and it also promotes social harmony when we see things from another's perspective. And believe me, social harmony is valuable indeed after a bunch of parents have watched their 6-year-olds play soccer.
Menger went on to accomplish a radical break with tradition: a thoroughly individualistic view of humanity and of the world, writes Eugen-Maria Schulak and Herbert Unterköfler.
This audio Mises Daily is narrated by Paul Strikwerda.
Social justice actually refers to an intention to use force to acquire one's desires. Not to earn desirable goods by rational thought and action, production and voluntary exchange, but to go in there and forcibly take goods from those who can supply them, writes Ben O'Neill.
This audio Mises Daily is narrated by Colin Hussey.
The characters are rugged individuals — ingenious in their ability to fend for themselves, under all manner of adverse conditions — and asking for help from nobody, writes Frank Chodorov (1887–1966).
This audio Mises Daily is narrated by Steven Ng.
One of the most subtle aspects of modern economic theory is the relation between subjective value and objective money prices. This is an area where the Austrians have an advantage over other schools, because they care more about their forebears than most other economists, and because Austrians were instrumental in the development of subjective-value theory.
On a blog devoted to open-source standards, the discussion recently turned to economics. Specifically, the programming expert thought he had discovered a fatal flaw with the gold standard. It will be instructive to parse his post and correct his misunderstanding of modern price theory and the case for gold as money.
Subjective versus Exchange ValueOur writer, Andy Updegrove, begins his post by noting an oddity when it comes to market value:
Standards cover an awful lot of ground — how big things are; how much they weigh; how fast they go; how much power they consume; how pure they are; how they must be shaped so that they fit together….
In short, standards relate to measurable things. Indeed, the earliest formal standards created in societies everywhere were usually those related to weights and measures. …
There is, however, one exception to this rule. Curiously enough, it involves a standard that is as old as weights and measures themselves. And despite its ancient lineage, nations still can't agree for very long on what measuring stick should be used, or how it should work. This is rather remarkable, given that the standard in question is perhaps the only one that nearly everyone makes use of almost [e]very day of their lives.
That standard, of course, is money — dollars, Euros, renminbi — each one a measure of value.
Already we've hit an ambiguity. When Updegrove says "value," does he mean the subjective value that an individual attributes to a particular unit of a good, or does he mean the objective market-exchange value that the price system assigns to it? Once we take account of this distinction, the alleged paradox falls away.
If we are referring to subjective value, then there is no "unit" of measurement at all. Suppose we take an old photograph of Jill's grandmother, and ask Jill, "Do you value this object?" Jill might say, "Yes, very much so." Then we hold up her calculator, and ask if Jill values it as well. Jill might say, "Yes, but not as much."
Finally, we ask Jill, "By what percentage does your valuation of the photograph exceed your valuation of the calculator?" Jill would be unable to answer such a nonsensical question. She can rank the two objects according to her subjective tastes; she can report that she values the photograph more than the calculator. But this doesn't imply that there are cardinal units of psychic satisfaction, with the photograph bestowing more units than the calculator.
On the other hand, suppose Jill is really strapped for cash, and so she is auctioning off her possessions on eBay. We might ask, "What do you think the photograph and calculator are worth? What's their value?" Jill might answer, "Well, the photograph comes from the Great Depression, so some history buff might give me $15 for it. And this HP scientific calculator sells new for $50, so I'm hoping I can get $30 for it used." If we then asked, "How much more valuable is the calculator than the photograph?" Jill could answer, "Well I'm just guessing, but probably about twice as much."
Even though our hypothetical conversations with Jill used similar terminology, notice that what we really meant was quite different in the two cases. Originally, when Jill said she valued the photo more than the calculator, she meant her own subjective valuation. If we threatened to destroy one of the objects, Jill would have preferred that we spare the photo. (Of course, things get complicated if Jill decides to sell the items; in that case the calculator would become more valuable to her, even subjectively, and she would prefer that we destroy the photo.)
With subjective preferences, there is no "measurement" going on. Modern economics can explain consumer behavior without assuming any underlying units of "utility." We only need to assume that people know how to rank units of goods in order from most to least preferred.
But when we switched from individual, subjective valuation to the market's objective valuation, things were different. Jill was no longer reporting on her personal taste, but rather on her estimate of what prices she could fetch if she sold the two items. The prices are denominated in money, which can be expressed in cardinal units. In that sense, money prices measure market exchange value.
For example, suppose one new calculator has the same market-exchange value as 1/3 of a Blackberry, and as 200 gumballs. This implies that one Blackberry has the same market-exchange value as 600 gumballs. But instead of walking around with all of these pairwise comparisons, it is much simpler to use a common denominator, i.e., a common unit of exchange value. Specifically, for every good we simply report its exchange value against dollar bills. Thus, the new calculator exchanges for 50 dollar bills, one gumball exchanges for 1/4 of one dollar bill (25 cents), and the Blackberry trades for 150 dollar bills.
Both Parties Benefit from a Voluntary TradeUpdegrove is vaguely aware of these issues. Indeed, the reason so many people feel qualified to comment on economics — whereas they wouldn't dream of pontificating on the technique of a double bypass — is that we all live economics in our daily lives. Here's Updegrove elaborating on (what seems to him) the problem of market measurement:
The problem starts with the fact that while any two people may agree on what it means to say that a given object weighs a pound, the value of the object in Pounds [£] is necessarily in the eye of the beholder. There are temporal issues to address as well. While the weight of the object in question will still be one pound tomorrow if left undisturbed, its value in the marketplace will likely have changed, even if only slightly.
Part of the problem here is that Updegrove doesn't understand how subjective preferences give rise to objective prices. This is a complex topic; I refer the interested readers to chapters 6 and 7 of my new textbook for high schoolers.
Let's start with the basics. When two people engage in a voluntary trade, they both benefit. In other words, they both walk away with the "more valuable" object. As Updegrove realizes, this would be impossible with an objective property, such as weight; it's impossible for both parties to walk away from a trade with the heavier object.
But once we realize that value is in the eye of the beholder, then we can understand that people value objects differently and hence can each swap a less-preferred item for a more-preferred one.
What's really interesting is that this holds not only in barter — where Johnny trades his bologna sandwich for Sally's peanut-butter sandwich, and both kids think they got the better end of the bargain — but also in monetary exchanges.
For example, if I give a butcher $30 for a ham, it is because I value the ham more than the $30 in cash that I hand over. But, on his end, the butcher values my $30 more than that particular ham.
In this trade, it's not the case that I thought, "This ham is worth $30." No, I thought the ham was worth more than $30, if "worth" refers to the subjective value I place on it. If I thought the ham were worth $30, then why would I bother swapping my $30 for it?
Switching examples, if I buy 100 shares of stock at $10 apiece, we can conclude three things:
(1) I valued the 100 shares of stock more than my $1,000.
(2) The seller valued the $1,000 more than his 100 shares.
(3) The market value of the 100 shares equals $1,000. Someone else who owns, say, 50 shares of the same stock would think that it constituted $500 of wealth in his portfolio. All that statement means is that the last traded price was $10 per share.
Once again, we see the importance of distinguishing between subjective valuation and objective market prices.
Market Valuation and the Gold StandardUpdegrove finally relates his musings to the topic of the gold standard:
Determining what the dollar is "standing on" matters. …
So it is that people have struggled from the dawn of time with how to measure what is, in fact, an abstraction. That effort has too often involved forcing the round peg of traditional standards rules into the square hole of monetary policy. When that happens, people time and again have turned to a single gleaming, elemental reference point to give some sort of reality to the value of their dollars and pounds, roubles and francs.
I refer, of course, to gold — the "Mama Bear" of monetary reference points. …
[G]old has always provided an appealing option as a reference point for establishing value. … In the modern era, bank notes have largely replaced coins, but in many cases (as in the United States) those bank notes could be exchanged for actual gold coins, and later for silver. Only in the mid twentieth century were "silver certificates" removed from circulation in the U.S. After World War II, the gold standard was internationally formalized with the dollar as the first link in the valuation chain: under the Bretton Woods treaty, the value of the dollar was fixed at 1/35th of a Troy ounce of pure gold, and other nations indirectly established the value of their currency relative to gold via conversion rates into dollars. …
Perhaps it would help gold bugs abandon the dream of resurrecting the past to find the future by pointing out one simple fact: if we're going to peg everything to gold, what is it that we're going to peg gold to? Yes, such a system might to some degree rationalize economic relations between countries, but the world as a whole would remain unsupported. Sadly, there simply aren't any more turtles underneath to support whatever value it is we agree to give to gold.
I'm actually sympathetic to Updegrove. It's true that some of the more passionate defenders of gold will refer to it as "real money," possessing "intrinsic value," with which the dollar must be "backed up."
Yet, as our discussion has made clear, strictly speaking, there is nothing immutable in what money measures. It directly measures market-exchange value, but that in turn is determined by subjective (and fleeting) valuations of individuals.
Wealth or exchange value is an objective concept, but it is not stable. This is why it is so difficult for analysts who are used to conventional measures to grasp what happens in an economy. It is analogous to a sound technician, whose job involves ranking songs according to their loudness using a decibel scale, talking to a DJ who ranks those same songs according to how often they are requested by listeners.
When enthusiasts say that gold is "real money," and that it provides a "solid foundation" for the economy — in contrast to fiat paper — what they mean is that commodity money emerged spontaneously out of the free market as traders placed a premium on goods of higher liquidity. In contrast, it took coercion for governments around the world to wean their subjects off of gold and silver and to foist paper notes upon them.
The great virtue of commodity money — and the great vice of government paper money — is that the former cannot be easily produced. Its stability is dependent on physical constraints rather than the mere discipline of central bankers.
ConclusionThe actual process through which subjective valuations lead to objective market prices is complicated. The average person doesn't need to understand it. However, everyone should be aware of the basic principles of modern value theory, as sketched in this article. Precisely because value is subjective, voluntary trades are win-win situations. At the same time, market prices are objective measures of wealth, and they allow firms to calculate whether they are using resources efficiently or not.
[Excerpted from An Austrian Perspective on the History of Economic Thought, vol. 1, Economic Thought Before Adam Smith (1995). An MP3 audio file of this article, read by Jeff Riggenbach, is available for download.]
Although the physiocrats had useful insights into political economy and the importance of the free market, their distinctive contributions to technical economics were not only wrong, but in some cases proved to be a disaster for the future of the economic discipline.
Thus for centuries the mainstream of economic thought, generally embedded in Scholastic treatises, held that the value, and therefore the prices, of goods were determined on the market by utility and scarcity, that is, by consumer valuations of a given supply of a product. Scholastic and post-Scholastic economics had basically solved the age-old "value paradox" of diamonds and bread, or diamonds and water: how is it that bread, so useful to man, is worth very little on the market, whereas diamonds, a mere frippery, are so expensive?
The solution was that if quantities of supply are taken into account, the seeming contradiction between "use value" and "exchange value" disappears. For the supply of bread is so abundant that any given loaf will have a negligible value — in use or in exchange — whereas diamonds are so scarce that they will command a high value on the market.
"Value," then, does not pertain in the abstract to a class of goods; it is imparted by consumers to specific, real units, and such value depends inversely on the supply of a good. The only thing left to complete the explanation was the "marginal" insight imparted by the Austrians and other neoclassicals in the 1870s.
The Scholastics saw that the utility of any good diminishes as its stock increases; the only thing lacking was the marginal analysis that real-world purchases and evaluations focus on the next unit (the "marginal" unit) of the good. Diminishing utility is diminishing marginal utility. But while the capstone of utility and subjective-value theory was yet missing, enough was already in place to provide a cogent explanation of value and price.
Despite his troubling injection of "intrinsic value" as a quantity of land and labor in production, Cantillon had continued in this late-Scholastic, proto-Austrian tradition and had indeed made many contributions to it, particularly in the study of money and entrepreneurship. It was the physiocrats who broke with centuries of sound economic reasoning and contributed to what would become, in the hands of Smith and Ricardo, a reactionary and obscurantist destruction of the correct analysis of value.
Dr. Quesnay begins his value analysis by disregarding centuries of value theory and tragically sundering the concepts of "use value" and "exchange value."
Use value reflects the individual needs and desires of consumers, but, according to Quesnay, these use values of different goods have little or no relation to each other or, therefore, to prices. Exchange value, or relative prices, on the other hand, have no relation to man's needs or to agreements among bargainers and contractors.
Instead, Quesnay, the would-be "scientist," rejected subjective value and insisted that the values of goods are "objective" and mystically embedded in various goods irrespective of consumers" subjective valuations. This objective embodiment, according to Quesnay, is the cost of production, which in some way determines the "fundamental price" of every good.
As was even true for Cantillon, this "objective" cost of production appears to be somehow determined externally, from outside the system.
This article is excerpted from An Austrian Perspective on the History of Economic Thought, vol. 1, Economic Thought Before Adam Smith (1995). An MP3 audio file of this article, read by Jeff Riggenbach, is available for download.
[An MP3 audio file of this article, read by Steven Ng, is available for download.]
Few debates in the social sciences are ostensibly more boring and pointless than those involving the definitions of words. If one group of people chooses to define a word one way, while another group of people chooses to define that same word in a completely different way, why would anyone possibly care?
It turns out, however, that the definitions of words can often have profound implications for social science. Examples abound where the definitions of single words have made important and lasting impacts on all subsequent thought in the disciplines where they were adopted. The words "inflation," "capitalism," "institution," "socialism," "right," "liberty," and even the word "science" itself have been defined in countless and sometimes conflicting ways; and each definition has profoundly influenced the thinkers who adopted it.
In this article, I focus on the definition of one word in particular: probability. I attempt to demonstrate that the definition we choose to adopt for this similarly innocuous-looking word has important methodological and epistemological implications for social science.
In order to accomplish this task, I first offer a discussion of the two most general definitions of probability that are available for us to adopt: the so-called objective and subjective definitions. I then turn to an examination of some of the methodological and epistemological implications for social science that inevitably flow from the adoption of one or the other of these definitions. I conclude with a brief defense of the subjective definition for probability, which, I argue, is the definition we are forced to adopt given the nature of the real world.
The Two General Definitions of Probability At the most general and abstract level, there are two definitions for probability that are open for social scientists (and natural scientists, for that matter) to adopt. On the one hand, we could choose to define probability as a measure of an objective, real, physical property of the world. According to this objective definition, we would conceive of probability as being something "out there" in the world to be measured, recorded and analyzed in the same manner as we do with, for example, the hardness of different metals. Just as aluminum and cobalt have real physical differences that we can observe and measure, so too do things and events have different and real physical probabilities that we can observe and measure.
On the other hand, we could choose to define probability, not as an objective physical property in the world, but rather as a measure of man's subjective beliefs about what will happen in the world. According to this subjective definition, there exists no such thing as physical probabilities "out there" in the world, because things in the world are all governed by the principle of "causality" — which is to say that nothing that happens in the world is random or accidental.[1]
In the natural world, an event occurs because some force or forces caused it to happen. Leaves do not simply fall off of trees for no reason, and neither does any other event in the world occur for no reason whatsoever. Similarly, in the realm of human action, an action occurs because the actor values acting more than not acting. There is no such thing as an action that would occur in the world for no reason whatsoever. There is thus a causal explanation for everything that occurs in the world, according to the subjective definition, and probability is a way for man to measure and try to overcome his ignorance of those causal explanations.
The social scientist must decide which of these two general definitions of probability he will adopt. If he is honestly seeking to understand the world in which he lives, he must adopt the definition for probability that accurately describes to the phenomena he is seeking to define and study.
He is free, of course, to adopt a definition for probability that bears no relation to the real world, just as he is free to adopt a definition for "hardness" that would have no relation to the real world. He does so, however, at the peril of abandoning the realm of science and entering the realm of fantasy. The man engaged in true science seeks to describe and understand the real world, not make-believe concepts and castles in the sky.
Implications of the Objective Definition of Probability There are several important methodological and epistemological implications that necessarily flow from the adoption of an objective definition for probability by social scientists. First on the epistemological side is the implication that there exists only one "correct" probability for any given event or phenomenon in the world; this probability is to be more or less perfectly measured by scientists. Just as there is only one "correct" and "objective" hardness of the element cobalt, so too would there exist only one "correct" and "objective" probability of rain tomorrow in Denver. One would scarcely have an objective definition for probability, after all, if there were several different and competing probabilities out there for any given event.
The goal of the scientist investigating problems of this sort would thus to be to search out methods capable of revealing, however imperfectly, the one correct and objective probability for any given event at any specific moment in time.[2] An important corollary to this is that scientists are likely to conceive of there being only one legitimate method for the accurate measurement of objective probabilities. Just as there are standardized and universally recognized methods for the measurement of lengths and weights, so too is there only one "correct" and "scientific" way of measuring probability.[3]
Another important implication of an objective definition for probability is that probability will necessarily be conceived as a property that can only be known a posteriori, through measurement. Just as we cannot know the length or the hardness of some object before measuring it, so too would we have no inkling about the probability of some event occurring until we actually went out and measured it. The obvious methodological implication of this is that scientists are bound to focus exclusively on past data to generate probabilities, regardless of the specific methods they might choose to employ. At root, then, the defender of an objective definition for probability is an empiricist.
Moreover, by treating probability as a property that can only be known a posteriori, consistent social and natural scientists are bound to treat events for which there exist no past data as completely outside the purview of probability. Again, just as we are in no position to say what the length of a steel rod is until we actually go out and measure it, so too are we incapable of saying what the probability of some future event is unless we have some a posteriori measurements of similar phenomena to use as a guide. Hence, if we adopt an objective definition for probability, there can be no statements of probability for completely singular and unprecedented events.[4]
A broader and more important epistemological and methodological consequence of treating probability as an objective property of things in the world is that probability is likely to be conceived as a concern of the natural sciences alone. If things have objective, physical probabilities "in" them, in the same way that things have objective and inherent weights and lengths, then the measurement of this physical property is in principle no different than measuring any other objective physical property in the world. It is simply a property to be identified and measured by dispassionate natural scientists in the same way that natural scientists measure the weights of hippopotamuses, the intensity of hurricanes, or the average height of dwarfs. This is not to say that the social scientist cannot make use of objective probability measurements in his empirical research, but it does mean that in gathering data of this sort the social scientist is not acting as a social scientist per se.
A proper analogy here is of the social scientist that takes blood-pressure measurements in the course of his research. In measuring blood pressure, the social scientist is not acting as a social scientist per se; rather, he is simply adopting the methods for measuring blood pressure that have been developed in the natural sciences and then utilizing the data he subsequently generates for his social research. No one would ever confuse the specific methods of measuring blood pressure with a specially designed machine as a concern of the social sciences, and, if probability is conceived as an objective physical property "in" things in the world, then neither is anyone likely to view the measurement of objective probabilities as a concern of the social sciences.
Implications of the Subjective Definition of Probability The implications for social science that flow from the adoption of a subjective definition for probability are radically different from those that flow from the adoption of an objective definition. In the first place, a subjective definition for probability does not imply that scientists must conceive of there being only one "correct" or "objective" probability "out there" for any given event.
On the contrary, because the subjective definition of probability means that probability is a measure of man's subjective beliefs about the likelihood of the occurrence of some event, this means that the number of probabilities for the same event that could conceivably exist in the world at any given moment is only limited by the number of people on the planet. Each of these different probabilities would represent a measure of some man's subjective beliefs about the likelihood of the event's occurrence, based upon evidence he deems to be relevant to the event's outcome.
"Probability in the natural world is thus merely a measure of man's uncertainty about the causal factors at work in the natural world."
This is not to say that all of these competing probabilities must be treated as equally valuable predictors of the event's outcome, however. Some men have developed and will develop methods that prove to be very reliable predictors of certain events, and their methods and the probabilities they generate will no doubt be accorded respect that other men's probabilities will not. But a subjective definition of probability opens up the field of probability to a wide array of different methods and approaches for generating probabilities — something that is precluded by the adoption of an objective definition.
The foregoing observation has a fortuitous implication for social science in that it focuses the attention of the scientist on accurately predicting future events, rather than obsessively searching for and perfecting the one "correct" method to be employed on every occasion. With no definitional barriers in his way dictating that he only ever employ one method for generating probabilities, the social scientist is free to use any methods he can either borrow or devise to predict outcomes. He is likely to seek out and use methods that have a proven track record of accurate predictions in similar situations, but even if he opts to employ a new and untested method, this method will be subject to real-world testing as it either succeeds or fails to accurately predict outcomes. Either way, the social scientist cannot cloak his predictions with preternatural authoritativeness, simply because he has utilized a particular method.
The subjective definition for probability also undercuts the idea that only a posteriori data can ever legitimately be used to generate probabilities. According to the subjective definition, probabilities are merely measures of man's beliefs about the likelihood that something will or will not occur in the world, so there is no reason why scientists cannot legitimately make use of a priori information, expert opinions, indirect information, or anything else that they might deem relevant to predicting the event's outcome.
Again, with a subjective definition for probability the only important measure of a method's usefulness is the accuracy with which it predicts future outcomes that man was previously uncertain about. The subjective definition does not tie the social scientist's hands with a dogmatic prescription that only a posteriori data be used to measure his uncertainty. If anything, the subjective definition admonishes the social scientist to go out and find any information out there that he can use in order to better predict what he and others are uncertain about.
Another critically important implication of the subjective definition for probability is that it opens the door to generating probabilities for singular events and phenomena.[5] The objective definition, as was seen above, was predicated on the use of a posteriori data from similar cases, which precluded the generation of probabilities for singular cases with no past precedent.
Because the subjective definition does not require the use of a posteriori data, however, it does not similarly preclude and condemn the generation of probabilities for singular cases. All phenomena in the world are thus fair game for probabilistic measurement, because man is ignorant or uncertain to greater or lesser degrees about virtually everything he encounters in the world. The subjective definition invites man to go out and measure his uncertainty everywhere he finds it.
The implication of this is that the subjective definition for probability, unlike the objective definition, does not exile probability to the natural sciences. Because the subjective definition opens the door to generating probabilities for singular events and phenomena, this obviously includes generating probabilities for singular human actions for which there are no precedents and no past data.
The subjective definition thus welcomes the use of probability in all fields of science, not just the natural sciences. This is fortuitous, because man is often just as uncertain about whether his neighbor will take his trash out tomorrow as he is about the weather this afternoon, and the subjective definition for probability invites him to measure his uncertainty in the former case just as much as he does in the latter.
Which Definition Is Correct? An analysis of the implications of possible definitions of probability does not, in itself, help us to determine which one is correct. The implications of the definitions are only useful insofar as they highlight that the question of which definition we adopt is not inconsequential or trivial. The question that remains, then, is, which one is "correct"?
The answer, I would suggest, is that the subjective definition is the correct definition for the world in which we live, because we live in a world where events and actions never occur without any reason whatsoever.[6] The events and phenomena that occur in the natural world around us always occur for a causal reason. Things fall to the ground for a reason. Things catch fire for a reason. Things grow for a reason. All natural events that occur in the world occur for a causal reason, and natural science itself is predicated on the idea that man can discover and understand the causal factors that govern the world.
Because this is so, natural things do not possess a mystical property of "probability" inside them; rather, they behave according to the causal laws of the natural world. Probability in the natural world is thus merely a measure of man's uncertainty about the causal factors at work in the natural world.
If man knew every causal factor affecting any given event in the natural world, he would know the outcome beforehand. He would never need or use probability.
Similarly, in the realm of human action, actions always occur for a causal reason. Man drives to the grocery store for a reason. Man drinks alcohol for a reason. Man paints his house for a reason. Every human action occurs because the actor subjectively prefers acting to not acting, and the study of human action (praxeology) is itself predicated on the idea that man can discover and understand the logic that governs the realm of human action.
Because this is so, we know that human beings do not possess a mystical property of "probability" inside them; rather, they always act on their subjective beliefs and values. Probability in the human world is thus merely a measure of man's uncertainty about the subjective beliefs and values that influence the actions of other men.
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If man knew every subjective factor affecting any given action, he would know the outcome beforehand. He would never need or use probability.
If, contrary to fact, actions and events occurred in the world for no reason whatsoever, there might be justification for saying that things had probabilities "inside" them that man could measure. But the world is not so constituted. Everything that occurs in the world occurs for a reason, and if man knew all the factors affecting any action or outcome, he would know the outcome in advance and for certain.
Man is not omniscient, however, which is why he uses probability to help him predict outcomes — by measuring his uncertainty about the outcome. The uncertainty resides in himself, however, not "out there" in the world; so probability is a subjective measure of human uncertainty, not a measure of something in the world.
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Notes
[1] On the principle of causality, see, for example, Ludwig von Mises, Theory and History (Auburn, Ala.: Ludwig von Mises Institute, 1985), p. 74, Ibid., Human Action 4th ed. (Irvington-on-Hudson, NY: Foundation for Economic Education, 1996), p. 22; and Hans-Hermann Hoppe, Economic Science and the Austrian Method (Auburn, Ala.: Mises Institute, 1995), pp. 77–78.
[2] An obvious analogy to the point being made here can be seen in the realm of inferential statistics, where the researcher attempts to estimate the "true" value of a given constant (e.g., μ) from a sample of the population. Even though the researcher is never in a position to know the actual value of μ, he nevertheless attempts to estimate this value as best he can, given the data available to him. Similarly, if probability is conceived as a "real" physical property of things, then the goal of the researcher is to estimate or discover this value as best he can, given the data available to him.
[3] For the most dogmatic statement of this idea, see Richard von Mises, Probability, Statistics and Truth (New York: Chapman and Hall, 1988).
[4] For a statement of this idea, see Ludwig von Mises, Human Action, p. 113.
[5] For more on this particular point, see Mark R. Crovelli, "On The Possibility of Assigning Probabilities to Singular Events, or: Probability is Subjective Too!" Libertarian Papers 1, 26 (2009).
[6] For a more thorough defense of the subjective definition of probability, see Crovelli, "On the Possibility."
Human beings do not possess a mystical property of "probability" inside them; rather, they always act on their subjective beliefs and values. Probability in the human world is thus merely a measure of man's uncertainty about the subjective beliefs and values that influence the actions of other men, writes Mark R. Crovelli.
This audio Mises Daily is narrated by Steven Ng.
The case of Terri Schiavo is almost as controversial as it is tragic. In 1990 Mrs. Schiavo, who reached her 40th year in 2005, fell victim to brain damage. She has been in a vegetative state ever since, kept alive not under her own power, but aided by a welter of feeding tubes and other paraphernalia of modern medicine.
The controversy? Her husband Michael is adamant that the doctors pull the plug on Terri, and her parents are just as determined to keep her alive.
Volume 22, Number 1 (2011)
There are moments in history when the people are on the move, consistent with the logic of history, and no force on earth can stop them. You can see it in the images of Russians in 1990 pulling down cast-iron statues of Lenin. You can see it in the images of the Romanian people charging Ceausescu's palace in 1989.
And I just saw it last night at Bed, Bath, and Beyond as the people raided the towers of K-cups holding coffee and tea to go into the Keurig coffee maker that is the blazing-hot item for the holidays (second only to our new pocket paperback of Human Action).
To understand why the Keurig coffee maker is firing up the forces of history in a progressive direction, we need to reflect on the dynamics of the relentless technological trend from the collective to the individual. In ancient times, bathing, for example, was a community activity: one pool of water that all people would visit. With technological progress came the family tub, in which people would dunk themselves one after another. In modern times, we each fill our own bath or take an individual shower.
So it is with phones, which, when first invented, were found one per community in the general store. Then there were party lines that several households would share. Then the phone came to the single-family home. Finally, the process of individuation culminated in the pocket cell phone, with one phone number per person. And so it is all over the world, and throughout human history, provided there is the freedom to innovate, produce, and distribute.
It's true with books too. There was the Library of Alexandria for the whole world. Then there were public libraries for whole cities. Then we progressed to private libraries in homes. Now we long for the ultimate individuation: libraries on our cell phones and books we can carry on our person. This relentless push to fulfill the demands of individualism is the driving force of human history.
And so it is with coffee. For too long we've lived with a community form of delivery. Whatever collectivist pot was made for the whole group is what we drank. Never mind that it is burned from the heating pad. Never mind that it is too strong or too weak, too dark or too light, or that it is just plain gross. Never mind that the preparation and cleanup requires that we stare at unappetizingly soaked coffee grounds that clog our sinks and stink up our trash. It was what we had, and we made do.
Then came Starbucks and other specialized shops. Here we could order what we wanted and every drink was prepared fresh and according to our specifications. We are all, after all, individuals, each of us with different tastes, desires, and demands. When given the chance to express our wishes, we take it, and therein lies a great entrepreneurial opportunity for those who are daring and creative enough, and willing to take on the responsibility for giving history a push forward.
In retrospect, the whole Keurig mania seems perfectly obvious, even inevitable. We want Starbucks in our homes. We want endless variety. We want it to be fast. We do not want to wake up to the shattering sound of coffee beans in a horrible grinding machine. In fact, though we had never thought of it before, we do not want to look at coffee grounds, before or after they become soaked.
When you first observe the K-cup that Keurig uses, your thought might be: this is ridiculously inefficient. Why would anyone take a tiny amount of coffee and package it in plastic with a complicated internal filtering system and waste foil to cover the top just to produce a single cup of coffee? But you know what? History is not about some outsider's view of what is or is not efficient according to some preset calculus. History is about the ideas and preferences of real human beings.
K-cups also owe their success to a software-style model of development. Keurig developed the hardware and sold it (and its K-cup patent) to Green Mountain Coffee Roasters. The company might have then to decided to cash in on its monopoly privileges but GMCR seemed to understand that there are more profits to be made through liberality than restriction. It licensed many different companies to produce the K-cup firmware, so that now there is a gigantic market for these things, and even a market for contraptions to display them.
When the patent expires in 2012, the price of the K-cup will probably fall but the blow to GMCR will be minimal (as this blogger argues) because so many are already competing for market share. Note too that the mainstreaming of the K-cup came only after this liberalization; only as recently as 2007, when you only found these coffee makers in upscale law firms, was the company still hammering knock-off cup makers with lawsuits.
When the patent expires next year, all bets are off. I fully predict that the next generation will never see another coffee ground, never have to deal with grungy wet filters, any more than people who eat bacon today have to watch pigs being rounded up and slaughtered. The division of labor will kick in so that consumers have only one job to do: drink great coffee according to their own individual preferences.
It's expensive, you say, even three or five times as much as buying grounds and beans in bulk. So it is. Cell phones are expensive. Baths are expensive. Toilet paper is expensive, and so is shampoo, deodorant, beef, and clothing from the department store. Some things that make life wonderful are worth paying for. That's the whole point of the material world, isn't it? To make life wonderful?
Here's the best part. Consider how this celebratory episode in capitalist decadence has been marketed. We are led to believe that this technology is European (fashionable people somehow love burned-out, low-growth economies) when in fact the company that owns it is American. And notice that all of the marketing vaguely hints at a PC sensibility. The word "green" appears everywhere. Paul Newman (don't we just love everything this guy makes?) sponsors his own K-cups. People on the packages are doing things like standing around trees on green hills. Surely this ridiculous excess is all very ecofriendly. Surely it is! The genius of capitalism is never more on display than in the last few years when we've seen how the private sector can even sell anticapitalism and make the big bucks.
Human Action Pocket EditionPrepare the landfills for mountains of used K-cups because that it is what is headed our way. And when they are full, we can cover them with dirt and start again, and do this again and again until the invention of the Keurig coffee maker recedes into memory as just another landmark in the long struggle to leave the state of nature and climb to ever-higher stages of the great chain of being. At each stage, we can easily observe the path from the collective to the individual and also revel in the lovely irony that it is precisely our uniqueness that unites us all in the common cause of defending the freedom to buy and sell, which is the driving force of history.
As for the wonders of the pocket edition of Human Action, don't get me started.
A man who is obliged to justify his handling of a matter in the eyes of other people often resorts to a pretext. As the motive of his deviation from the most suitable way of procedure he ascribes another reason than that which actually prompted him, writes Ludwig von Mises (1881–1973).
This audio Mises Daily, excerpted from the audiobook version, is narrated by John Pruden.
It is a hopeless task to interpret a symphony, a painting, or a novel. The interpreter at best tries to tell us something about his reaction to the work. He cannot tell us with certainty what the creator's meaning was or what other people may see in it, writes Ludwig von Mises (1881–1973).
This audio Mises Daily, excerpted from the audiobook version, is narrated by John Pruden.
The collectivist doctrines look upon the individual merely as a refractory rebel. This sinful wretch has the impudence to give preference to his petty selfish interests as against the sublime interests of the great god society, writes Ludwig von Mises (1881–1973).
This audio Mises Daily, excerpted from the audiobook version, is narrated by John Pruden.
What differentiates the realm of the natural sciences from that of the sciences of human action is the categorial system resorted to in each in interpreting phenomena and constructing theories. The natural sciences do not know anything about final causes; inquiry and theorizing are entirely guided by the category of causality. The field of the sciences of human action is the orbit of purpose and of conscious aiming at ends; it is teleological.
Both categories were resorted to by primitive man and are resorted to today by everybody in daily thinking and acting. The most simple skills and techniques imply knowledge gathered by rudimentary research into causality. Where people did not know how to seek the relation of cause and effect, they looked for a teleological interpretation. They invented deities and devils to whose purposeful action certain phenomena were ascribed. A god emitted lightning and thunder. Another god, angry about some acts of men, killed the offenders by shooting arrows. A witch's evil eye made women barren and cows dry.
Such beliefs generated definite methods of action. Conduct pleasing to the deity, offering of sacrifices and prayer were considered suitable means to appease the deity's anger and to avert its revenge; magic rites were employed to neutralize witchcraft. Slowly people came to learn that meteorological events, disease, and the spread of plagues are natural phenomena and that lightning rods and antiseptic agents provide effective protection while magic rites are useless. It was only in the modern era that the natural sciences in all their fields substituted causal research for finalism.
The marvelous achievements of the experimental natural sciences prompted the emergence of a materialistic metaphysical doctrine, positivism. Positivism flatly denies that any field of inquiry is open for teleological research. The experimental methods of the natural sciences are the only appropriate methods for any kind of investigation. They alone are scientific, while the traditional methods of the sciences of human action are metaphysical, that is, in the terminology of positivism, superstitious and spurious. Positivism teaches that the task of science is exclusively the description and interpretation of sensory experience. It rejects the introspection of psychology as well as all historical disciplines. It is especially fanatical in its condemnation of economics.
Auguste Comte, by no means the founder of positivism but merely the inventor of its name, suggested as a substitute for the traditional methods of dealing with human action a new branch of science, sociology. Sociology should be social physics, shaped according to the epistemological pattern of Newtonian mechanics.
The plan was so shallow and impractical that no serious attempt was ever made to realize it. The first generation of Comte's followers turned instead toward what they believed to be biological and organic interpretation of social phenomena. They indulged freely in metaphorical language and quite seriously discussed such problems as what in the social "body" should be classed as "intercellular substance." When the absurdity of this biologism and organicism became obvious, the sociologists completely abandoned the ambitious pretensions of Comte. There was no longer any question of discovering a posteriori laws of social change. Various historical, ethnographical, and psychological studies were put out under the label sociology. Many of these publications were dilettantish and confused; some are acceptable contributions to various fields of historical research.
Without any value, on the other hand, were the writings of those who termed sociology their arbitrary metaphysical effusions about the recondite meaning and end of the historical process which had been previously styled philosophy of history. Thus, Émile Durkheim and his school revived under the appellation group mind the old specter of romanticism and the German school of historical jurisprudence, the Volksgeist.
In spite of this manifest failure of the positivist program, a neopositivist movement has arisen. It stubbornly repeats all the fallacies of Comte. The same motive inspires these writers that inspired Comte. They are driven by an idiosyncratic abhorrence of the market economy and its political corollary: representative government, freedom of thought, speech, and the press. They long for totalitarianism, dictatorship, and the ruthless oppression of all dissenters, taking, of course, for granted that they themselves or their intimate friends will be vested with the supreme office and the power to silence all opponents.
Comte without shame advocated suppression of all doctrines he disliked. The most obtrusive champion of the neopositivist program concerning the sciences of human action was Otto Neurath, who, in 1919, was one of the outstanding leaders of the short-lived Soviet regime of Munich and later cooperated briefly in Moscow with the bureaucracy of the Bolsheviks.Otto Neurath, "Foundations of the Social Sciences," International Encyclopedia of Unified Science, Vol. 2, No. 1. Knowing they cannot advance any tenable argument against the economists' critique of their plans, these passionate communists try to discredit economics wholesale on epistemological grounds.
The two main varieties of the neopositivistic assault on economics are panphysicalism and behaviorism. Both claim to substitute a purely causal treatment of human action for the — as they declare unscientific — teleological treatment.
Panphysicalism teaches that the procedures of physics are the only scientific method of all branches of science. It denies that any essential differences exist between the natural sciences and the sciences of human action. This denial lies behind the panphysicalists' slogan "unified science." Sense experience, which conveys to man his information about physical events, provides him also with all information about the behavior of his fellow men.
"The applied science of social physics, social engineering, can deal with man in the same way technology deals with copper and hydrogen." Study of the way his fellows react to various stimuli does not differ essentially from study of the way other objects react. The language of physics is the universal language of all branches of knowledge, without exception. What cannot be rendered in the language of physics is metaphysical nonsense. It is arrogant pretension in man to believe that his role in the universe is different from that of other objects. In the eyes of the scientist all things are equal. All talk about consciousness, volition, and aiming at ends is empty. Man is just one of the elements in the universe. The applied science of social physics, social engineering, can deal with man in the same way technology deals with copper and hydrogen.
The panphysicalist might admit at least one essential difference between man and the objects of physics. The stones and the atoms reflect neither upon their own nature, properties, and behavior nor upon those of man. They do not engineer either themselves or man. Man is at least different from them insofar as he is a physicist and an engineer. It is difficult to conceive how one could deal with the activities of an engineer without realizing that he chooses between various possible lines of conduct and is intent upon attaining definite ends. Why does he build a bridge rather than a ferry? Why does he build one bridge with a capacity of ten tons and another with a capacity of twenty tons? Why is he intent upon constructing bridges that do not collapse? Or is it only an accident that most bridges do not collapse?
If one eliminates from the treatment of human action the notion of conscious aiming at definite ends, one must replace it by the — really metaphysical — idea that some superhuman agency leads men, independently of their will, toward a predestined goal: that what put the bridge-builder into motion was the preordained plan of Geist or the material productive forces which mortal men are forced to execute.
To say that man reacts to stimuli and adjusts himself to the conditions of his environment does not provide a satisfactory answer. To the stimulus offered by the English Channel some people have reacted by staying at home; others have crossed it in rowboats, sailing ships, steamers, or, in modern times simply by swimming. Some fly over it in planes; others design schemes for tunneling under it. It is vain to ascribe the differences in reaction to differences in attendant circumstances such as the state of technological knowledge and the supply of labor and capital goods. These other conditions too are of human origin and can only be explained by resorting to teleological methods.
The approach of behaviorism is in some respects different from that of panphysicalism, but it resembles the latter in its hopeless attempt to deal with human action without reference to consciousness and aiming at ends. It bases its reasoning on the slogan "adjustment." Like any other being, man adjusts himself to the conditions of his environment. But behaviorism fails to explain why different people adjust themselves to the same conditions in different ways. Why do some people flee violent aggression while others resist it? Why did the peoples of Western Europe adjust themselves to the scarcity of all things on which human well-being depends in a way entirely different from that of the Orientals?
Behaviorism proposes to study human behavior according to the methods developed by animal and infant psychology. It seeks to investigate reflexes and instincts, automatisms and unconscious reactions. But it has told us nothing about the reflexes that have built cathedrals, railroads, and fortresses, the instincts that have produced philosophies, poems, and legal systems, the automatisms that have resulted in the growth and decline of empires, the unconscious reactions that are splitting atoms. Behaviorism wants to observe human behavior from without and to deal with it merely as reaction to a definite situation. It punctiliously avoids any reference to meaning and purpose. However, a situation cannot be described without analyzing the meaning which the man concerned finds in it. If one avoids dealing with this meaning, one neglects the essential factor that decisively determines the mode of reaction. This reaction is not automatic but depends entirely upon the interpretation and value judgments of the individual, who aims to bring about, if feasible, a situation which he prefers to the state of affairs that would prevail if he were not to interfere. Consider a behaviorist describing the situation which an offer to sell brings about without reference to the meaning each party attaches to it!
"A situation cannot be described without analyzing the meaning which the man concerned finds in it." In fact, behaviorism would outlaw the study of human action and substitute physiology for it. The behaviorists never succeeded in making clear the difference between physiology and behaviorism. Watson declared that physiology is "particularly interested in the functioning of parts of the animal… Behaviorism, on the other hand, while it is intensely interested in all of the functioning of these parts, is intrinsically interested in what the whole animal will do."John B. Watson, Behaviorism (New York, W. W. Norton, 1930), p. 11. However, such physiological phenomena as the resistance of the body to infection or the growth and aging of an individual can certainly not be called behavior of parts. On the other hand, if one wants to call such a gesture as the movement of an arm (either to strike or to caress) behavior of the whole human animal, the idea can only be that such a gesture cannot be imputed to any separate part of the being.
But what else can this something to which it must be imputed be if not the meaning and the intention of the actor or that unnamed thing from which meaning and intention originate? Behaviorism asserts that it wants to predict human behavior. But it is impossible to predict the reaction of a man accosted by another with the words "you rat" without referring to the meaning that the man spoken to attaches to the epithet.
Both varieties of positivism decline to recognize the fact that men aim purposefully at definite ends. As they see it, all events must be interpreted in the relationship of stimulus and response, and there is no room left for a search for final causes. Against this rigid dogmatism it is necessary to stress the point that the rejection of finalism in dealing with events outside the sphere of human action is enjoined upon science only by the insufficiency of human reason. The natural sciences must refrain from dealing with final causes because they are unable to discover any final causes, not because they can prove that no final causes are operative. The cognizance of the interconnectedness of all phenomena and of the regularity in their concatenation and sequence, and the fact that causality research works and has enlarged human knowledge, do not peremptorily preclude the assumption that final causes are operative in the universe.
The reason for the natural sciences' neglect of final causes and their exclusive preoccupation with causality research is that this method works. The contrivances designed according to the scientific theories run the way the theories predicted and thus provide a pragmatic verification for their correctness. On the other hand the magic devices did not come up to expectations and do not bear witness to the magic world view.
It is obvious that it is also impossible to demonstrate satisfactorily by ratiocination that the alter ego is a being that aims purposively at ends. But the same pragmatic proof that can be advanced in favor of the exclusive use of causal research in the field of nature can be advanced in favor of the exclusive use of teleological methods in the field of human action. It works, while the idea of dealing with men as if they were stones or mice does not work. It works not only in the search for knowledge and theories but no less in daily practice.
The positivist arrives at his point of view surreptitiously. He denies to his fellow men the faculty of choosing ends and the means to attain these ends, but at the same time he claims for himself the ability to choose consciously between various methods of scientific procedure. He shifts his ground as soon as it comes to problems of engineering, whether technological or "social." He designs plans and policies which cannot be interpreted as merely being automatic reactions to stimuli. He wants to deprive all his fellows of the right to act in order to reserve this privilege for himself alone. He is a virtual dictator.
As the behaviorist tells us, man can be thought of as "an assembled organic machine ready to run."Watson, p. 269. He disregards the fact that while machines run the way the engineer and the operator make them run, men run spontaneously here and there. "At birth human infants, regardless of their heredity, are as equal as Fords."Horace M. Kallen, "Behaviorism," Encyclopaedia of the Social Sciences, 2, 498. Starting from this manifest falsehood, the behaviorist proposes to operate the "human Ford" the way the operator drives his car. He acts as if he owned humanity and were called upon to control and to shape it according to his own designs. For he himself is above the law, the godsent ruler of mankind.Karl Mannheim developed a comprehensive plan to produce the "best possible" human types by "deliberately" reorganizing the various groups of social factors. "We," that is Karl Mannheim and his friends, will determine what "the highest good of society and the peace of mind of the individual" require. Then "we" will revamp mankind. For our vocation is "the planned guidance of people's lives." Mannheim, Man and Society in an Age of Reconstruction (London, Routledge & Kegan Paul, 1940), p. 222. The most remarkable thing about such ideas is that in the thirties and forties they were styled democratic, liberal, and progressive. Joseph Goebbels was more modest than Mannheim in that he wanted only to revamp the German people and not the whole of mankind. But in his approach to the problem he did not differ essentially from Mannheim. In a letter of April 12, 1933, to Wilhelm Furtwangler he referred to the "we" to whom "the responsible task has been entrusted, to fashion out of the raw stuff of the masses the firm and well-shaped structure of the nation (denen die verantwortungsvolle Aufgabe anvertraut ist, aus dem rohen Stoff der Masse das feste und gestalthafte Gebilde des Volkes zu formen)." Berta Geissmar, Musik im Schatten der Politik (Zürich, Atlantis Verlag, 1945), pp. 97–9. Unfortunately neither Mannheim nor Goebbels told us who had entrusted them with the task of reconstructing and re-creating men.
As long as positivism does not explain philosophies and theories, and the plans and policies derived from them, in terms of its stimulus-response scheme, it defeats itself.
This article is excerpted from chapter 11 of Theory and History. An audio version of this article, excerpted from the forthcoming audiobook version, read by John Pruden.
The most obtrusive champion of the neopositivist program concerning the sciences of human action was Otto Neurath, who, in 1919, was one of the outstanding leaders of the short-lived Soviet regime of Munich and later cooperated briefly in Moscow with the bureaucracy of the Bolsheviks, writes Ludwig von Mises (1881–1973).
This audio Mises Daily, excerpted from the audiobook version, is narrated by John Pruden.
[Excerpted from chapter 10 of Theory and History.]
As historicism sees it, the essential error of economics consists in its assumption that man is invariably egoistic and aims exclusively at material well-being.
According to Gunnar Myrdal, economics asserts that human actions are "solely motivated by economic interests" and considers as economic interests "the desire for higher incomes and lower prices and, in addition, perhaps stability of earnings and employment, reasonable time for leisure and an environment conducive to its satisfactory use, good working conditions, etc." This, he says, is an error. One does not completely account for human motivations by simply registering economic interests. What really determines human conduct is not interests alone but attitudes. "Attitude means the emotive disposition of an individual or a group to respond in certain ways to actual or potential situations." There are "fortunately many people whose attitudes are not identical with their interests."Gunnar Myrdal, The Political Element in the Development of Economic Theory, trans, by P. Streeten (Cambridge, Harvard University Press, 1954), pp. 199–200.
Now, the assertion that economics ever maintained that men are solely motivated by the striving after higher incomes and lower prices is false. Because of their failure to disentangle the apparent paradox of the use-value concept, the classical economists and their epigones were prevented from providing a satisfactory interpretation of the conduct of the consumers. They virtually dealt only with the conduct of the businessmen who serve the consumers and for whom the valuations of their customers are the ultimate standard.
When they referred to the principle of buying on the cheapest market and selling on the dearest market, they were trying to interpret the actions of the businessman in his capacity as a purveyor of the buyers, not in his capacity as a consumer and spender of his own income. They did not enter into an analysis of the motives prompting the individual consumers to buy and to consume. So they did not investigate whether individuals try only to fill their bellies or whether they also spend for other purposes, e.g., to perform what they consider to be their ethical and religious duties. When they distinguished between purely economic motives and other motives, the classical economists referred only to the acquisitive side of human behavior. They never thought of denying that men are also driven by other motives.
The approach of classical economics appears highly unsatisfactory from the point of view of modern subjective economics. Modern economics rejects as entirely fallacious also the argument advanced for the epistemological justification of the Classical methods by their last followers, especially John Stuart Mill. According to this lame apology, pure economics deals only with the "economic" aspect of the operations of mankind, only with the phenomena of the production of wealth "as far as those phenomena are not modified by the pursuit of any other object." But, says Mill, in order to deal adequately with reality "the didactic writer on the subject will naturally combine in his exposition, with the truth of pure science, as many of the practical modifications as will, in his estimation, be most conducive to the usefulness of his work."John Stuart Mill, Essays on Some Unsettled Questions of Political Economy (3d ed. London, 1877), pp. 140–1. This certainly explodes Mr. Myrdal's assertion, so far as classical economics is concerned.
Modern economics traces all human actions back to the value judgments of individuals. It never was so foolish, as Myrdal charges, as to believe that all that people are after is higher incomes and lower prices. Against this unjustified criticism which has been repeated a hundred times, Böhm-Bawerk already in his first contribution to the theory of value, and then later again and again, explicitly emphasized that the term "well-being" (Wohlfahrtszwecke) as he uses it in the exposition of the theory of value does not refer only to concerns commonly called egoistic but comprehends everything that appears to an individual as desirable and worthy of being aimed at (erstrebenswert).Böhm-Bawerk, "Grundzüge der Theorie des wirtschaftlichen Güterwerts," Jahrbücher fiir Nationalökonomie und Statistik, N.F., 13 (1886), 479, n. 1; Kapital und Kapitalzins (3d ed. Innsbruck, 1909), 2, 316–17, n. 1.
In acting, man prefers some things to other things and chooses between various modes of conduct. The result of the mental process that makes a man prefer one thing to another thing is called a judgment of value. In speaking of value and valuations economics refers to such judgments of value, whatever their content may be. It is irrelevant for economics, up to now the best developed part of praxeology, whether an individual aims like a member of a labor union at higher wages or like a saint at the best performance of religious duties. The "institutional" fact that most people are eager to get more tangible goods is a datum of economic history, not a theorem of economics.
All brands of historicism — the German and the British historical schools of the social sciences, American institutionalism, the adepts of Sismondi, Le Play, and Veblen, and many kindred "unorthodox" sects — emphatically reject economics. But their writings are full of inferences drawn from general propositions about the effects of various modes of acting. It is, of course, impossible to deal with any "institutional" or historical problem without referring to such general propositions. Every historical report, no matter whether its theme is the conditions and events of a remote past or those of yesterday, is inevitably based on a definite kind of economic theory. The historicists do not eliminate economic reasoning from their treatises. While rejecting an economic doctrine they do not like, they resort in dealing with events to fallacious doctrines long since refuted by the economists.
The theorems of economics, say the historicists, are void because they are the product of a priori reasoning. Only historical experience can lead to realistic economics. They fail to see that historical experience is always the experience of complex phenomena, of the joint effects brought about by the operation of a multiplicity of elements. Such historical experience does not give the observer facts in the sense in which the natural sciences apply this term to the results obtained in laboratory experiments. (People who call their offices, studies, and libraries "laboratories" for research in economics, statistics, or the social sciences are hopelessly muddle-headed.) Historical facts need to be interpreted on the ground of previously available theorems. They do not comment upon themselves.
The antagonism between economics and historicism does not concern the historical facts. It concerns the interpretation of the facts. In investigating and narrating facts a scholar may provide a valuable contribution to history, but he does not contribute to the increase and perfection of economic knowledge.
Let us once more refer to the often-repeated proposition that what the economists call economic laws are merely principles governing conditions under capitalism and of no avail for a differently organized society, especially not for the coming socialist management of affairs. As these critics see it, it is only the capitalists with their acquisitiveness who bother about costs and about profit. Once production for use has been substituted for production for profit, the categories of cost and profit will become meaningless. The primary error of economics consists in considering these and other categories as eternal principles determining action under any kind of institutional conditions.
However, cost is an element in any kind of human action, whatever the particular features of the individual case may be. Cost is the value of those things the actor renounces in order to attain what he wants to attain; it is the value he attaches to the most urgently desired satisfaction among those satisfactions which he cannot have because he preferred another to it. It is the price paid for a thing. If a young man says: "This examination cost me a week end with friends in the country," he means: "If I had not chosen to prepare for my examination, I would have spent this week end with friends in the country." Things it costs no sacrifice to attain are not economic goods but free goods and as such no objects of any action. Economics does not deal with them. Man does not have to choose between them and other satisfactions.
Profit is the difference between the higher value of the good obtained and the lower value of the good sacrificed for its obtainment. If the action, due to bungling, error, an unanticipated change in conditions, or to other circumstances, results in obtaining something to which the actor attaches a lower value than to the price paid, the action generates a loss. Since action invariably aims to substitute a state of affairs which the actor considers as more satisfactory for a state which he considers less satisfactory, action always aims at profit and never at loss.
This is valid not only for the actions of individuals in a market economy but no less for the actions of the economic director of a socialist society.
[Journal of Libertarian Studies, 1977.]
Libertarianism — the political philosophy based on the concept of individual rights — seems to be an inherently clear, unambiguous position. Its fundamental principle, the principle that man's rights to his life, liberty, and property are noncompromisable foundations for human coexistence in society, seems to offer a sufficient basis for answering, or solving, all so-called social problems — as libertarian literature amply demonstrates.See Ayn Rand, Capitalism: the Unknown Ideal (New York: Signet Books, 1967); Murray N. Rothbard, Man, Economy and State with Power and Market (The Scholar's Edition) (Aubrun: Ludwig von Mises Institute, 2009); Murray N. Rothbard, For a New Liberty (Auburn: Ludwig von Mises Institute, 2006); and Morris and Linda Tannehill, The Market for Liberty (Tanehill, 1970).
There is, however, one threat to this seeming clarity: the debate between limited-government libertarians, headed by Rand,See Rand, Capitalism, pp. 329–338. and anarchocapitalists, mainly influenced by Rothbard.See Rothbard, For a New Liberty, pp. 47–78.
At first sight, the debate seems easily localizable. It seems to affect no fundamental principles but to involve merely a specific application of these principles. If one reads some of the literature written concerning this debate,I could not find any explicit statement by Rothbard on this subject. But his whole economic analysis is based on taking individual preference scales as givens, on which praxeological analysis is based. While Rothbard is evidently not an ethical subjectivist or irrationalist, he never discusses, as I can ascertain, any moral principles apart from those of individual rights. These, as discussed in Rothbard, For a New Liberty, pp. 23–46, are discussed independently of any discussion of individual values. the major impression each side give is that the other side is inconsistent, that he fails to understand what the commonly agreed upon principle of individual rights implies, and that once his inconsistency is indicated to him, he (or them) will change his (or their) mind. Surprisingly enough, this change of mind did not take place in the last decade, though some "conversions" did take place. Each side has its own arguments, and its own rebuttals of the other side's argument, and the debate seems to persist, not to die out.
PurposeThe purpose of the present article is to show that what seems to be a fundamental agreement concerning basic principles, uniting libertarians of both traditions, is, to a large extent, an illusion. The illusion is created both by the use of the same terminology (i.e., of individual rights), and by the fact that there exists a large core of agreement between the two camps — agreement concerning the principle of individualism. But this agreement is much less thoroughgoing than it seems.
More specifically, I will try to show that the "political" debate — what form should a free society take politically — anarchocapitalism or limited government, follows from much deeper, though undetected, disagreements. The most fundamental one is metaphysical: What kind of freedom does human nature allow — and to what extent is man unfree, or determined, in his actions?
This fundamental disagreement is reflected in a variety of derivative disagreements: Are values objective, as Rand claims, or are they inherently subjective, as Rothbard implies? Does the principle of individual rights follow from the principles of objective ethics, as Rand preaches,See Ayn Rand, The Virtue of Selfishness (New York: Signet Books, 1964). or does it follow from a second-order understanding of the objective moral principles that make possible individual, subjective, first-order value systems, as Rothbard presupposes?This is my understanding of the argument in Rothbard, For a New Liberty, pp. 23–46.
Does the principle of individual rights, in any way, require for its implementation any preceding contract, and does it rely on any moral principle of the sanctity of promises and contracts, as is implied by Rand's philosophy?See Rand, Virtue of Selfishness, pp. 110–111, 116–117, as well as Paul Beaird, "On Proper Government," Option (January–June 1976). Or does it rely on the metaphysical concept of a free will, making the concept of "sacred contracts" superfluous? I will try to show that these questions divide the two camps, and that their legal recommendations, in specific cases, also differ.
Since I am not a subjectivist, I do believe that there is right and wrong in this debate. But I will not present any systematic argument to support any position in this article. I will do that in a separate article. In the present article, I only wish to point out that a proper understanding and resolution of the debate that at present divides the libertarian movement cannot stop at political examples and arguments. I must go right back to metaphysical premises and examine them.
An ExampleTo clarify my point, and make my later, more abstract arguments easier to follow, let us consider an example. I make a contract with you to exchange my dog for your hen. I gave you my dog. You now say, "Sorry, I refuse to give you my hen. I love it too much."
Clearly, you are morally in the wrong, and a just system of laws would imply just that, when applied to this case. But why are you in the wrong, what are your liabilities, and what is the way to right the wrong? Here Rand and Rothbard would differ. Since neither of them has ever considered in writing this specific example, I allow myself to represent their positions as I understand them.
To begin with, Rand would say that you are wrong because you have defaulted on a promise contained in a contract. You owe me a hen, because you have promised to give me one once you possessed my dog. Your debt has been incurred by your promise. This is a matter for a civil court, dealing with restoration of justice damaged by contract violation.Rand, Virtue of Selfishness, pp. 110–111.
Rothbard, however, would say that you are in the wrong for a different reason. You don't owe me a hen. The hen is yours, and remained yours. As for the contract, your default amounts to a cancellation of it. The contract ceases to be valid once one of us refuses to abide by it.
"The Randist analysis of the nature of crime implies the necessity for a minimal government."But if so, what makes you morally wrong? Simply the fact that you now control a dog that belongs to me makes you a criminal. Once you have, by refusing to fulfill your part of the contract, cancelled the contract, you have thereby cancelled your right to control the dog. If you continue to hold the dog, you are in the same category as a robber, or a thief. You control and use property that belongs to another without his permission, by force. Thus, the correct procedure to right the wrong is for me to sue you at a criminal court.
Observe the difference: For a Randist, a promise creates an obligation. You are free to make a promise. Once you have made it, you are not free, morally speaking, to default on it. A later decision cannot cancel the prior decision. Once you have promised to give your hen, when certain conditions have been satisfied, the satisfaction of these conditions transfers automatically the hen to me, from the point of view of the right to own it. If you refuse to deliver the hen, you are trying to detain the transfer of property that is already not yours. But the dog does belong to you.
For a Rothbardian, though, a promise does not create an obligation. A promise is a declaration of an intended action, or a declaration of a present decision to do something in the future. It has no moral significance beyond that. The same fundamental freedom of choice that makes it possible for you to promise makes it possible for you, later, to cancel the promise. You cannot be sued for canceling promises.
But on the other hand, for a Rothbardian, your property right cannot be transferred without your consent. Thus, if you give somebody a dog on the condition that you will get a hen from him, and he fails to deliver his part in the contract, the condition for transfer of ownership is not fulfilled, so the ownership has not been transferred (though the physical transfer of the good in question did imply a transfer in actual control of the property).
Thus, the injustice incurred by a contract violation is not that a promise has been broken. It is that a breach has been created between ownership and control and that that breach is maintained by force (because you refused to return the dog to me).
Observe that this creates practical differences between a Randist and a Rothbardian, concerning their recommendations to handle this case and other similar cases:
These are considerable differences between the two positions. But let us consider another example, this time of a noncontractual nature.
Another ExampleSuppose I wake up in the middle of the night and find you there, rushing out of my window, with my watch at your hand. Obviously, you are a thief. Obviously, I should take you to some form of court or other. Obviously, you have initiated force against my right to my property. All these points are agreed upon by libertarians, as well as most nonlibertarians.
There is, still, however, a divisive question: on the basis of what authority (i.e., moral authority) do I take you to court? Do I have the right to make you compensate me without a court action? Does your action affect your rights? Here again, the Randist and the Rothbardian would markedly differ. The Randist (as Paul Beaird has most convincingly argued) would claim that by violating my property rights, you have lost your property right to the same extent.Beaird, "Proper Government," p. 16. Moreover, your action justifies me in taking you to court, because by consenting to live in a human society, you have consented, in principle, to the fundamental principle underlying the possibility of human coexistence in society: the principle of individual rights. In a way, you have, by your action, breached a contract.
My appeal to court is necessary to restore justice, because your action has been a default on an implicit contract. I cannot, however, redress justice by my own action, because any contract has, as Beaird has indicated, a delivery clause and a recourse clause. Once you failed to deliver (by violating my right to property), the contract is still in force. In this case, the "implicit" contract between us allows me only to take you to the police, because you have consented, by being in this specific society, to be thus treated in the case of breach of "social contract."
Observe that this is not a social-contract theory. It does not assume that if we are all in a society that has some government or other, we are all to be considered to have implicitly consented to the rule of this government and to the authority of its laws. The social-contract theory, as Hobbes has shown by example, allows for all sorts of dictatorship and is incompatible with individual rights.
Nevertheless, there is an element of "social contract" here, in the following sense: individual rights are objective values, to be identified by human consciousness as necessary conditions for human existence in society. If one identifies these values, he thereby has to secure some means of safeguarding these values by subscribing, voluntarily, to a government that implements these principles — namely, a minimal government.Rand, Virtue of Selfishness, p. 110. This act of subscription (which, Beaird stresses, must be explicit and voluntary) binds contractually all subscribers — both to the principle of individual rights and to the authority of the government to which they have subscribed to administer justice in accordance with these rights.
Thus, any criminal violation of rights is a breach of such a contract, and it must be handled by the government, not by the victim. In other words, the Randist analysis of the nature of crime implies the necessity for a minimal government, which governs with the consent of the governed.
To put the issue more crudely, each crime is a case of contract violation. Individual rights are enforceable, as legal principle, only on the basis of contractual commitment to them. Thus, while individual rights have objective validity as values, they have no legal force without the consent of all concerned. In other words, if you did not subscribe to any government, your rights have not been "translated" to enforcible terms, and you have no right to use force (your own force) to defend them.
Rothbard, however, tells a different story, a story in which no concept of "social contract" plays absolutely any role, and in which individual rights have nothing to do with anybody's contractual subscription either to the abstract principle or (additionally) to a government enforcing it. Individual rights are natural, deriving from man's nature as a free being. A man has the right to his life, property, and liberty independently of whether or not he lives in a social context, subscribes to a government, or has made any direct or indirect contractual commitments with others.
Contractual commitment, as we have seen above, has no independent moral significance in Rothbard's framework. A breach of contract is only bad because it creates a breach of property ownership and its control — and only when it produces this effect!Rothbard, For a New Liberty, p. 2, and especially pp. 28–30, where Rothbard explicitly disconnects rights from any government action.
Civil Law and Criminal LawIn order to clarify the difference between the two points of view, an extra bit of terminology is needed. This pertains, fundamentally, to the difference between civil law and criminal law.
Civil law usually pertains to offenses arising from contractual relations. A default in delivery on a commercial contract is usually dealt with by a civil court of law. Criminal law usually pertains to offenses against individual rights (such as theft, murder, robbery, rape, etc.) that do not involve any violation of preexisting contractual relations. What makes these offenses "bad" is their being violations of individual rights.
"Contractual commitment, as we have seen above, has no independent moral significance in Rothbard's framework. A breach of contract is only bad because it creates a breach of property ownership and its control — and only when it produces this effect!"In terms of this distinction, Rand's position implies an implicit reduction of criminal law to civil law — in the sense that any violation of individual rights is conceptualized by reference to a preexisting social contract (between the subscribers to government and their government) that makes the violation punishable, or actionable. Rothbard's position implies an explicit reduction of civil law to criminal law: a contract violation is bad only because, and to the extent that, it involves dissociation of ownership and control.
This is a large difference, and it relates directly to the opposing views concerning minimal government. For Rand, the contract that makes individual rights defensible is a contract with a government. Hence, for her, libertarianism is impossible without a government: it presupposes a government, albeit a minimal government.
For Rothbard, individual rights are independent of any contract, they are natural, and the fundamental defense of them is by the individual himself. The marketing of defense services through defense agencies is not in any way a necessary ingredient in the implementation of rights. Rather, it is a special case of the principle of specialization of services on the market, and has nothing to do with the moral validity of individual rights, nor with their implementability.
Values and Metaphysical FreedomWhat is the root of the disagreement between Rand's and Rothbard's positions? To answer that, it is important to understand on what basis each of them establishes the moral validity of individual rights. Rand's concept of rights derives from her particular theory of values. This, in turn, depends on her theory of man's metaphysical freedom. Similarly, Rothbard's position is ultimately defensible through recourse to his fundamental assumptions concerning values and human freedom.
According to Rand's theory of human freedom, man's only fundamental freedom, the sole domain in which he is capable of being a "first cause," the only realm where he can exercise absolutely unpredetermined choice, is his own consciousness. Man's basic choice is between identifying the facts of reality through an act of consciousness, or evading the knowledge of these facts.
This freedom does not extend to man's decisions and actions: Your decisions and actions are the necessary product of your values and premises, Rand claims. Your values and premises are the products of acts of identification. You identify, as a value, whatever sustains your life.Rand, Virtue of Selfishness, chap. 1. You identify, as premise, any fact of which you are aware.
Thus, your values are the products of two factors: your needs, or requirements for survival, which are factual givens, over which you exercise no choice, and your readiness to identify and acknowledge these needs, over which you have voluntary control. But if you evade the knowledge of your needs, they still exist, and so are, objectively speaking, values, though they are unidentified values.
Rothbard's theory of man, however, assumes another dimension of freedom in man: the freedom to make decisions, to originate action. For Rothbard, values and their hierarchy are not the product of perception alone, though, clearly, his writing implies that awareness of the facts is highly relevant to your choice of values. (That is why you will prefer three ounces of gold to two ounces of gold.)See Rothbard, Man, Economy and State, pp. 260–268. But the ultimate source of values is your choices and there are no subject-independent (or "objective") factors that determine what your values should be.
Indeed, Rothbard does not assume, as Rand does, that your own life is necessarily your highest value. He leaves the question of what is your highest value outside of philosophical (and economical) discussion, to you. This, observe, is not subjectivism in the sense that values are arbitrary. It is subjectivism in the sense that the subject, not the external facts, is assumed to be the source, or generator of values.
"Rothbard is more extreme than Rand politically because he is more extreme than her metaphysically."Consequently, it is impossible, in Rothbard's framework, to speak about any common values that are thereby established as objective moral principles. Rather, the principle of individual rights, in so far as any explicit formulation is to be given to Rothbard's implicit presentation, is established on the second level of value analysis.This is my interpretation of arguments such as those in Rothbard, For a New Liberty, pp. 26–28. It is not a value in the economic sense; the question of the price of individual rights cannot arise, because the concept of price presupposes the concept of ownership, which presupposes the concept of right to property.Indeed, the concept of defense agencies introduces the issue of the price of defense of rights. But this issue is irrelevant, because an individual has rights even if he chooses to defend them himself, and not to relegate his defense to a specializing defense agency. It is, rather, established by reflection on the implications of man's metaphysical nature: as a fundamentally free agent.
For Rothbard, if I understand him correctly, individual rights are self-evident implications of the metaphysical nature of man for social coexistence. The argument is mainly by elimination. Clearly, somebody must decide what you will do: Why should it be, and how could it be, anybody else but you? Again, somebody must decide what to do with the property you have produced: How could it be anybody else but you?
The whole argument presupposes that action (including use of property) requires decision, and that there are no automatic solutions to the problem: What action shall be taken, and by whom? Thus, the question is who is to make the decision. In other words, man's fundamental metaphysical freedom to make decisions is a necessary component of the argument.
Hence, the argument does not require that other persons would either recognize my rights or pledge themselves to respect them. No social contract of any nature (and no preceding, large-scale comprehension of the philosophical principles involved) is presupposed in the defense of individual rights. Having the right to life, liberty, and property, you automatically have the right to defend these rights, and you only derivatively transfer the exercise of the right to a defense agency of your choosing.
Moreover, in view of the fact that all violations of your rights (including what Rand would have labeled "contract violation") are criminal, in all cases the purpose of defense is to reclaim stolen property (of goods or services or their equivalent). Hence, the consent of the offender is not required, because his rights are not violated in any way through the reclamation.[18]
Thus, the fact that Rothbard's libertarianism is more "extreme" than Rand's, because she consents to a minimal government and he requires abolition of all government, is not accidental. Neither does it arise because one of them (or any of their followers) has committed a trivial mistake in the understanding of agreed upon moral principles. Randists and Rothbardians are not libertarians in the same sense — though they talk a misleadingly similar language. They mean different implications in the concept of rights — because they have different metaphysical assumptions to back their endorsement of the morality of the principle of individual rights in the first place.
Rothbard is more extreme than Rand politically because he is more extreme than her metaphysically. Rand allows only freedom of consciousness. Rothbard also allows freedom of decision. The choice between the two positions cannot be consistently made on political grounds. It has to deal with the basic metaphysical disagreement, and to deal with certain corollaries of it as well, such as: Are there objective values? Are values determined solely by my decisions, or by my awareness of given facts?
Similarly, while for Rand a promise (and any other decision) is a necessary product of the totality of one's premises and values, and once it is made, it is a fact, which one can either identify or evade, so that the immorality of breaking promises reduces to the primary sin of evasion, for Rothbard a promise is a reflection of a free decision, and a decision is valid only till another decision supersedes it.
This article is excerpted from "Political Freedom and Its Roots in Metaphysics," Journal of Libertarian Studies, 1977, vol. 1, no. 3, pp. 205–213.
[9] Rothbard, Man, Economy and State, pp. 152–153.[10] Indeed, one of the inherent difficulties of the concept of self-sale to slavery is the inability of the slave to continue to possess any personal property. If slavery means total obedience to one's master, how can a slave refuse an order to transfer his property to his master?
[18] Rothbard, Man, Economy and State, p. 771.
A Randist would demand, acting as a judge, that the contract be fulfilled, or that the defaulter will recompense the injured party in accordance with the value of the property he promised to transfer and failed. In other words, if a hen costs now $30, and it should have been transferred ten days ago, and the value lost by the fact of nontransfer is $10, a Randist judge would order payment of $40 compensation.
But a Rothbardian judge would demand the criminal to return a dog, not a hen — or, equivalently, to pay for the value of the dog in the market now (so as to enable the victim to buy a new dog) — and also to pay, according to market rates, for the services provided by the stolen dog throughout the period in which there was a breach between ownership and control. If the contract was written, say, 12 days ago, and at that time hens and dogs had the same market price, but now, when the trial takes place, they have different prices, the two judges would reach different verdicts.
A Randist judge would demand compensation whenever a promise was unilaterally made and broken (i.e., a promise of a gift, or of charity service). A Rothbardian judge would not consider these legal matters — though he may privately advise the victim to advertise the fact of default as much as he can, so as to make the defaulter realize that breaking promises is bad for your business reputation.[9]
A Randist judge would have to defend, in court, a contract in which a man sells himself to be a slave: once a man made a contractual commitment to be a slave, and to forego any further freedom of choice, he has to abide by his promise. A Rothbardian would consider the contract cancelled the minute the slave refuses to be a slave any more (thereby implying that the contract was never valid). At the same time, if the slave got some money, which he has been capable to continue to control independently, for becoming a slave,[10] then he no more legally holds the money: the money belongs to the deceived, purported slavemaster. Thus, the institutions of justice should remedy the breach of control and ownership incurred.
We have room for but one language in this country, and that is the English language, for we intend to see that the crucible turns our people out as Americans, of American nationality, and not as dwellers in a polyglot boarding house.
— Theodore Roosevelt[1]
There are 6,909 languages alive in the world today. Seventy-four are indigenous to California alone — languages like Hupa, Kawaiisu, and Shoshone — while Papua New Guinea has over 800, with a median of just 1,200 speakers per language.
As astonishing as these figures seem, they obscure a stark reality: potentially half of these languages are set to vanish in the next century. Don't believe me? Consider that in North America, out of 296 known languages at the time of European contact, only 33 are being actively passed down to the next generation. The rest will become extinct upon the death of their last speakers (if they haven't already), probably sometime this century.[2]
Many people have no problem with this. After all, doesn't linguistic unity promote economic efficiency and cultural amity? Maybe so, but I won't address that issue here. Linguists like David Harrison (When Languages Die), Nicholas Evans (Dying Words), and Daniel Nettle and Suzanne Romaine (Vanishing Voices) have already argued the case for linguistic diversity, and I find some (not all) of their arguments to be lacking, prone to a conflation of language and cultural knowledge (see especially Harrison).[3]
But while there are good reasons for preserving languages, I'm interested in something else entirely: how language policy is a perfect example of the socialist-calculation problem. Governments necessarily adopt nonoptimal language policies. They are incentivized to violate the rights of minority language speakers and support fewer languages rather than more. In grounding the issue of language death in praxeology, it's easy to see how, to a large extent, language decline results directly from the trespasses and perverse incentives of the state, leaving the state of language diversity far worse off than it would have been otherwise.
In the same way that there are market forces and there are socialist-planning schemes for determining the value and existence of commodities in a market — and thus for eliminating commodities of little worth — there are market-driven and state-driven causes of language decline. In any economy, entrepreneurs invest and speculate based on what they expect future prices or values to be. Similarly, people learn languages in expectation of their future value, e.g., learning French for a trip to Paris; learning Chinese for the inevitable collapse of the dollar; or learning your native or local language(s) so as to communicate your basic wants in society. In this way language is a type of social capital, subject to all the same market forces (and government distortions) as any other good.
Natural Language DeathNow let's apply these market concepts to language decline. Like any good in the market, languages disappear as demand for their use declines. There are two ways this happens: the natural growth of speech communities, and crowding out by the state.
The historical growth of languages parallels the growth of human societies. At the dawn of the Agrarian Revolution, ca. 10,000 BC, speech communities were extremely small, between 500 and 1,000 people. Assuming the classic population estimate of 10 million,[4] there may have been as many as 10,000–20,000 languages in existence. With the rise of settled societies that could support larger communities, the size of speech communities grew accordingly, and the number of languages declined.[5]
This is a clear case of free-market language decline, and globalization is another. Today there are strong incentives for learning English. It provides access to lucrative markets, whether you own a tourist shop in Kenya or a multinational corporation in China. It is requisite for higher education, certain types of jobs, emigration to English-speaking countries, and it has great psychic value as a language of prestige, wealth, and media. As the number of people and media sources we interact with on a daily basis continues to increase, the number of languages in the world will steadily decrease. Just as the introduction of new production technologies allows producers to make more with less, globalization allows speakers to fulfill more of their socioeconomic needs with fewer languages. In fact, most people in America and England fulfill all those socioeconomic needs with precisely one language — English.
"Adopting a national language is essentially the nationalization of the language industry."These are not bad reasons for language shift, just as a farmer is not wrong for abandoning toil in the field in favor of a paying factory job. After all, "The right to language choice includes the right to choose against a language."[6] The difference is that the adoption of a second language doesn't require the loss of the first: "Healthy bilingualism is a state in which two languages are seen as complementary, not in competition."[7] Language is a nonscarce resource.[8]
In fact, the majority of the world is actively multilingual, speaking four or five languages, due to the fact that different languages are required for the fulfillment of different ends. In Kenya, for example, one must know a local mother tongue to fulfill social needs, a regional lingua franca (Swahili) for commercial needs, and English for media-based and educational needs. In Arnhem Land, Australia, by contrast, one must marry outside one's clan, and each clan speaks a different language.[9] So the social uses for language vary from culture to culture. Languages are a commodity, which people both value and create demand for. Like free markets, language communities are self-organizing, emergent systems, meaning we cannot predict how languages (the social capital) will be used on the market. And like any spontaneous order, language communities can be quickly disrupted by the intrusions of the state.
Globalization does not explain why, for example, there were approximately 1,500 languages spoken in South America at the time of European contact, while today there are only 350. The cause is more obviously Spanish colonialism — it's difficult for a language to survive when all its speakers are dead or enslaved.
But while many linguists happily blame colonialism for language extinction and end the story there, few appreciate an obvious fact: languages are dying today just as fast as they ever have in history. For many languages, the only remaining speakers are elderly and have but a handful of years left. Globalization does not adequately account for this fact. Nor do the colonizing, massacring tendencies of the 17th and 18th centuries explain why languages are still dying today. Our culprit, as it tends to be, is the nation-state.
Language Policy and the Socialist-Calculation ProblemEach nation must at some point address the question, "What is the optimal number of languages for the state?" The answer that states tend to give is simply "one." For a long time, states could actively pursue this goal as a part of their campaign to kill or remove any indigenous population that became a nuisance. The United States was particularly adept at this, waging a series of wars against Native Americans from the 17th through the 19th centuries, and enacting the Indian Removal Act in 1830 under Andrew Jackson.
Starting with the late 1800s and WWII, however, the killing of innocent indigenous populations by the state fell somewhat into disfavor. So once again, states faced the question of how to get to their preferred number of spoken languages. This time, schools for indigenous populations were designed in the Americas, Russia, and Africa, often with the explicit intent of assimilating the masses:
The Indian boarding schools were modeled on the pioneering efforts of General Richard Henry Pratt at his Carlisle Indian School, founded in Pennsylvania in 1878. Pratt believed the role of education was to wean the Indian from his native traditions and replace them with the "civilizing" influences of white American culture. He strongly favored the total assimilation of the American Indian into the dominant culture, and he felt that the best and most efficient way to do this was to take Indian children away from their families and culture and immerse them in the language and culture of middle-class American society.[10]
One wonders what a general was doing creating school curricula in the first place.
The impact of such policies is rarely immediate. People see children being taken from their homes and educated. What is unseen, following the tradition of Hazlitt and Bastiat, is that the destruction of a language and its enveloping culture gradually erodes the social institutions established to handle social strife and incentivize proper behavior among the general populace. Thus it is no surprise that rates of alcoholism and alcohol-related deaths on Native lands are higher than anywhere else in the country.
Also unseen is the fact that language decline does not happen overnight. It typically takes three generations: the first generation is punished for using the language in school, internalizes the idea that the language is worthless, and will not teach it to their children; although the second generation knows some of the language, they are "semilinguals," able to understand but not speak the language themselves; by the third generation, the language is effectively gone. So it is that today we are suffering the delayed effects of what was unseen in the late 19th and early 20th centuries.
"States do not cope well with diversity or decentralization."In response to this, disenfranchised minorities have recently begun to assert their linguistic rights, and the optimal-language question has become one of the hot topics of the past two decades. As Native American communities moved toward greater self-determination during the civil rights movement of the '60s and '70s, there arose a growing awareness of linguistic rights issues on both the national and international scale. In 1990 the US Congress passed the Native American Languages Act (NALA), meant to "preserve, protect, and promote the rights and freedom of Native Americans to use, practice and develop Native American languages." The Universal Declaration of Linguistic Rights, signed by UNESCO, followed in 1996. Of course, governments usually interpret these as positive rights.
Accordingly, today many states are considering adopting 2 or even 3 national languages. Some truly enlightened states have adopted even more — as many as 11 languages in South Africa (out of about 20), and 22 in India (out of 415).
We begin to see the socialist-calculation problem at work. How does the state determine the optimal number of languages to support? The answer, of course, is that it cannot. The "ideal" number of languages and the "optimal" level of linguistic diversity can only be found, if at all, through the coordination of human action in the market (i.e., the social sphere of interaction). The state, by contrast, follows a number of perverse incentives, which tend toward supporting fewer, rather than more languages.
We ought to ask two questions regarding language policy, one Misesian, one Hayekian. The Misesian question is, even if nations were incentivized to support greater linguistic diversity rather than less, how do they know this is efficient? On what criteria do they base the optimal-language decision? In contrast, Hayek would ask why nation-states are incentivized to treat fewer languages rather than more.
Of course, we have already answered the Misesian question of why it is impossible for states to set an "ideal" language policy. As we have seen, language choice is the result of a multitude of factors, including anthropological, sociological, and economic ones. Each individual takes all these factors into consideration (consciously or subconsciously) when choosing which language to learn or pass on to their kids. Moreover, the individual has a variety of feedback mechanisms for evaluating these choices, such as social pressures or economic advantages gained by knowing a certain language. The state, however, lacks both the inputs and the feedback mechanisms required to set a language policy that is adequate for each individual. These individuals, because of the various socioeconomic factors which come into play when making decisions regarding language, will place different values on each language; that is, individuals value language subjectively. The state has no way of accessing these valuations.
"Individuals value language subjectively. The state has no way of accessing these valuations."This is apparent in the way that states set language policies in real life. The state has immense difficulty adopting language policies that adequately address the sociolinguistic needs of its people. Feltman and Sherley-Appel note that "Language policies are often designed to accomplish tangible goals in the political and educational spheres; to encourage assimilation or discourage immigration; to integrate citizens of disparate backgrounds, or to restrict definitions of citizenship and confer advantage on citizens meeting certain demographic requirements."[11] The authors go on to illustrate ways in which such legislation is often counterproductive to those very ends. It is an excellent illustration of the "random and piecemeal" nature of language policy in the United States "composed of multiple trends with contradictory aims."[12] It becomes rapidly evident that national language policies are rarely based on linguistic or economic factors, but rather political ones.
The Hayekian question is, why do nation-states opt for fewer languages rather than more? Here we can say that the focus on a single language is the state's attempt to bring together the information and resources needed to run an economy. The task is made much easier when the state has only one or two factors it must consider. States do not cope well with diversity or decentralization. Here I take a page from Navajo history:
The Americans, accustomed to thinking of all Indian tribes as savage bands ruled over by a hereditary chief — a political organization not unlike that of most contemporary European states in a more simple form — would fail to recognize the fact that a treaty with a Navajo "chief," to be effective, had to be agreed upon by the entire nation much as the same treaty had to be ratified by the United States Senate. This lack of understanding of the Navajo tribal structure would eventually lead the Americans to think of the Dineh [Navajo] as the most treacherous, treaty-breaking tribe with whom the westward-expanding Americans had yet come into contact. As a result the Navajos, who looked upon the Americans as allies at first, soon found themselves faced with the most formidable foe they had ever encountered and one who would, within less than two decades [from 1840], conquer and all but destroy them.[13]
The Navajo were not one centralized tribe, but a collection of ethnically and culturally similar bands. States, however, must have a centralized point of authority to interact with, or else they cannot coordinate (thus the success of the persistent anarchist nature of Pennsylvania in warding off statist power grabs in the 1680s and '90s).[14] As such, states are highly incentivized to promote homogeneity when it comes to culture, and standardization when it comes to language.
Furthermore, the state is not highly incentivized to recognize minority languages. Running a multilingual government is a logistical nightmare (just ask India), and multilingualism is a direct affront to the ideas of national identity and standard education. Misconceived patriotism has given rise to many attempts at English-only legislation over the years, and the professed intent of the education system has always been assimilatory rather than appreciative.[15] This is, of course, the type of policy most harmful to minority languages. The exaltation of English in schools does not, as has been professed, open the gateway to well-paying jobs, but rather actively contributes to the impoverishment of those who don't speak it. As shown in Growing Up Bilingual, interrupting the learning and socialization process of one's first language and replacing it with another (at the time when an immigrant or Native American child enters school) results in a child who is neither fully socialized nor competent in either language. If instead the child is allowed to focus on their primary language for a while longer, many researchers believe that they will be far more successful in the long run. Thus even when the state actively tries to promote multiple languages, it is done in a way that hinders their continued use.
Having answered both the Misesian and Hayekian questions, it's easy to see how the socialist-calculation problem ties into language. Adopting a national language is essentially the nationalization of the language industry. Like any good in the market, the state is unable to offer the same coordinating harmony that would otherwise be present in the free market, thus resulting in an overall distortion of the market and a greater scarcity of that good.
ConclusionLinguists on the whole have been slow to catch on to the broader incentives created and adhered to by central governments, and how these have contributed to the decline in language diversity. They use capitalism and vague notions of "Western society" as ready targets while underscoring environmental connections to language. As one author states,
Policies narrowly focused on economic development defined in Western terms have narrowed people's options and are then used to justify more economic development, usually in the form of mining natural resources such as gas and oil that the rest of Canada urgently needs, as the solutions to problems that were caused by the imposition of a Western economy in the first place. … More often than not, a human and ecological wasteland is left in the wake of Western economic and resource development schemes.[16]
Passages like this make clear the lack of understanding concerning market forces, property rights, and the government's role in obstructing both. Linguist Salikoko Mufwene offers a brilliant analysis of the problem:
Can most of the indigenous languages be maintained without changing the current socio-economic world order among both the victims and those who control it? The answer to this latter question is obviously negative. The embarrassment is that language rights advocates have given little thought to the revolution that is entailed by their discourse. They have provided no answer to the implicit question of what alternative socio-economic world order must be recommended to the victims to meet their new material and spiritual aspirations, which depend in part on languages of the workforce.[17]
In other words, language activists correctly identify the symptoms but not the causes. Yet the causes are simple to understand. There are natural, market forces that lead to language shift, and there are coercive, state-driven ones. Austrolibertarians already know what that alternative socioeconomic world looks like. Were it not for the state's incessant need to homogenize and its inability to cope with diversity, the languages of the world would not be in the dire situation they are today.
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Notes[1] Roosevelt, Theodore, Works (Memorial ed., 1926), vol. XXIV, p. 554 (New York: Charles Scribner's Sons).
[2] The preceding statistics are hotly contested. Linguists have leveled heavy criticism at the Ethnologue in particular for being either out of date or imprecise concerning distinctions between language and dialect. However, few linguists deny that we are experiencing a loss in linguistic diversity. The praxeological reasons why languages are disappearing obviate the need for any particular set of statistics, as we will see.
[3] Mufwene offers a fuller critique along these same lines. His paper carefully disentangles the many arguments in favor of linguistic diversity, and is well worth a read.
[4] Lee, R. B. and I. DeVore (eds). 1968. Man the Hunter. Chicago: Aldine.
[5] The situation is actually more complicated than this. Some linguists posit that there were as few as 3,000 languages at the dawn of the Neolithic. The adoption of farming resulted in a population boom in which the number of languages actually increased due to the drastic increase in the number of communities. However, because the size of speech communities was also growing during the Agrarian Revolution, the ratio of languages to people would have been decreasing, even as the number of languages increased.
[6] Hinton, Leanne. 2002. Commentary: Internal and External Advocacy. Journal of Linguistic Anthropology. Vol. 12, No. 2, pp. 150–156.
[7] Crystal, David. 2000. Language Death. Cambridge: Cambridge University Press, p. 81.
[8] In fact, many people draw parallels between language and intellectual property for this reason. It should come as no surprise that several Native American groups have actively tried to copyright their language so as to prevent outsiders from learning it.
[9] Evans, Nicholas. Dying Words: Endangered Languages and What They Have To Tell Us. Malden, MA: Wiley-Blackwell, p. 8.
[10] House, Deborah. 2002. Language Shift Among the Navajos: Identity Politics and Cultural Continuity. Tucson, AZ: University of Arizona Press.
[11] Feltman, Rachel and Clara Sherley-Appel. "Lawmakers and Language Policy for Immigrants." Language of Law: Pulling Together Different Strands. Seconda Università degli Studi di Napoli. Santa Maria Capua Vetere, Italy. 18 June.
[12] Hinton, Leanne. 2004. The Death and Rebirth of Native American Languages. Endangered Languages and Linguistic Rights: On the Margins of Nations. Proceedings of the Eighth FEL Conference. Barcelona: Foundation for Endangered Languages, p. 20.
[13] Locke, Raymond Friday. The Book of the Navajo. Los Angeles: Mankind Publishing, p. 200.
[14] Rothbard, Murray N. "'The Holy Experiment': The Founding of Pennsylvania, 1681–1990," Ch. 55 in Conceived in Liberty, Vol. I: A New Land, A New People: The American Colonies in The Seventeenth Century. Auburn, Alabama: Mises Institute.
[15] Marlow, Patrick E. "Bilingual Education, Legislative Intent, and Language Maintenance in Alaska." Endangered Languages and Linguistics Rights: On the Margins of Nations. Proceedings of the Eighth FEL Conference. Barcelona: Foundation for Endangered Languages, pp. 25–30.
[16] Romaine, Suzanne. 2008. "Linguistic Diversity, Sustainability, and Future of the Past" in Sustaining Linguistic Diversity: Endangered and Minority Languages and Language Varieties. Washington, DC: Georgetown University Press, p. 18.
[17] Mufwene, Salikoko S. 2005. "Globalization and the myth of killer languages." In Perspectives on Endangerment, ed. by Graham Huggan & Stephan Klasen, pp. 19-48. Hildesheim/New Yrok: Georg Olms Verlag.
[This is an excerpt from an essay that was originally published in the Annals of the American Academy of Political and Social Science, volume 1 (1891).]
The question of the relation of cost to value is properly only a concrete form of a much more general question — the question of the regular relations between the values of such goods as in causal interdependence contribute to one and the same utility for our well-being.
The utility furnished by a quantity of materials from which a coat can be produced is apparently identical with the utility that the completed coat will furnish. It is thus obvious that goods or groups of goods that derive their importance to our welfare through the medium of one and the same utility must also stand in some fixed, regular relation to one another in respect to their value.
The question of this regular relation was first put into clear and comprehensive form by the Austrian economists; it had previously been treated only in a very unsatisfactory manner under the heading of cost of production. There is, however, a corollary to this general and important proposition that is not less important and interesting, but that has hitherto never received the modest degree of attention in economic theory that has been bestowed upon the problem of cost.
Very commonly, several goods combine simultaneously to the production of one common utility; for example, paper, pen, and ink serve together for writing; needle and thread for sewing; farming utensils, seed, land, and labor for the production of grain. Menger has called goods that stand in such relation to one another complementary goods. Here rises the question, as natural as it is difficult: How much of the common utility is in such cases to be attributed to each of the cooperative complementary factors? And what law determines the proportionate value and price of each?
The fate of this problem hitherto has been very remarkable. The older theory did not rank it as a general problem at all but was nevertheless compelled to decide a series of concrete cases that depended implicitly upon that problem. The question of the distribution of property especially gave occasion for such decisions. Since several factors of production — soil, capital, hired labor, and labor of the employer himself — cooperate in the production of a common product, the question as to what share of value shall be assigned to each of the factors, in compensation for its assistance, is obviously a special case of the general problem.
Now, how were these concrete cases decided? Each one was decided by itself without regard to the others, and hence, eventually, they formed a complete circle. The process was as follows: if rent was to be explained, it was decided that to the soil belonged the remainder of the product after the payment of cost of production, under that term was included the compensation of all the other factors — capital, labor, and profit of manager.
Here the function of all the other factors was regarded as fixed or known, and the soil was put off with a remainder varying according to the quantity of the product. If then it was necessary in another chapter to determine the profits of the entrepreneur, it was decided again that to him should be given the overplus left after all the other factors were compensated. In this case the share of the soil, the rent, was reckoned along with labor, capital, etc., as fixed, and the entrepreneur's profit was treated as the variable, rising and falling with the quantity of the product.
In just the same manner the share of capital was treated in a third chapter. The capitalist, says Ricardo, receives what is left from the product after the payment of wages. And as if to satirize all these classical dogmas, last of all, Mr. F.A. Walker has completed the circle by stating that the laborer receives what is left over from all the other factors.
It is easy to see that these statements lead in a circle, and to see, also, why they so lead. The reasoners have simply neglected to state the problem in a general form. They had several unknown quantities to determine, and instead of taking the bull by the horns and straightway inquiring after the general principle, according to which a common economic result should be divided into its component factors, they tried to avoid the fundamental question — that of the general principle. They divided up the investigation, and in this partial investigation allowed themselves each time to treat as unknown that one of the unknown quantities that formed the special object of the investigation — but to treat the others, for the time being, as if known. They thus shut their eyes to the fact that a few pages earlier — or later — they had reversed the operation and had treated the supposed known quantity as unknown, and the unknown as known.
"Instead of taking the bull by the horns and straightway inquiring after the general principle, according to which a common economic result should be divided into its component factors, they tried to avoid the fundamental question — that of the general principle." After the classical school came the historical. As often happens, they took the attitude of skeptical superiority and declared altogether insoluble the problem that they were unable to solve. They thought it to be in general impossible to say, for example, what percent of the value of a statue is due to the sculptor and what percent to the marble.
Now if the problem be but rightly put — that is, if we wish to separate the economic and not the physical shares, the problem becomes soluble. It is actually solved in practice in all rational enterprises by every agriculturalist or manufacturer. Theory has nothing to do but to rightly and carefully hold up the mirror to practice in order, in turn, to find the theoretical solution.
To this end, the theory of final utility helps in the simplest way. It is the old song again. Only observe correctly what the final utility of each complementary factor is, or what utility the presence or absence of the complementary factor would add or subtract, and the calm pursuit of such inquiry will of itself bring to light the solution of the supposed insoluble problem.
The Austrians made the first earnest attempt in this direction. Menger and the author of this paper have treated the question under the heading Theorie der komplementaren Guter; Wieser has treated the same subject under the title Theorie der Zurechnung (theory of contribution). The latter, especially, has in an admirable manner shown how the problem should be put, and that it can be solved. Menger has, in the happiest manner, as it seems to me, pointed out the method of solution.Menger, Grundsätze der Volkswirtschaftslehre, pp. 138 et seq. [See also the English translation, The Principles of Economics]; Böhm-Bawerk, "Grundzüge der Theorie des wirtschaftlichen Güterwerthes," part 1, pp. 56 et seq., Positive Theorie des Kapitales (1889), pp. 178 et seq. [See also the English translation of Böhm-Bawerk's The Positive Theory of Capital. ]; Wieser, Der naturliche Werth, pp. 67 et seq.
I have called the law of complementary goods the counterpart of the law of cost. As the former disentangles the relations of value that result from temporal and causal juxtaposition, from the simultaneous cooperation of several factors toward one common utility, so the law of cost explains the relations of value that result from temporal and causal sequence, from the causal interdependence of successive factors.
By means of the former, the meshes of the complicated network represented by the mutual-value relations of the cooperating factors are disentangled, so to speak, in their length and breadth; by the latter in their depth; but both processes occur within the all-embracing law of final utility, of which both laws are only special applications to special problems.Böhm-Bawerk, Positive Theorie, p. 201.
Thus prepared, the Austrian economists finally proceed to the problems of distribution. These resolve themselves into a series of special applications of the general theoretical laws, the knowledge of which was obtained by a tedious, but scarcely unfruitful, work of preparation. Land, labor, and capital are complementary factors of production. Their price, or what is the same thing, rate of rent, wages, and interest, results simply from a combination of the laws that govern the value of the materials of production, on the one hand, with the laws of complementary goods on the other hand.
The particular views of the Austrians on these subjects, I will here omit. I could not, if I would, give in this paper any proper statement of their conclusions, still less a demonstration of them; I must content myself with giving a passing view of the matters with which they are busied, and, where it is possible, of the spirit in which they work. I only briefly remark, therefore, that they have set forth a new and comprehensive theory of capitalBöhm-Bawerk, Kapital und Kapitalzins, 2 vols. vol. 1, Geschichte und Kritik der Kapitalizins-Theorien (1884); vol. 2: Positive Theorie des Kapitales (1889); differing from the older teaching of Menger's Grundsätze, pp. 143 et seq. [See also W. Smart's 1890 translation, Capital and Interest. into which they have woven a new theory of wages,Böhm-Bawerk, Positive Theorie, passim, and pp. 450–52. besides repeatedly working out the problems of the entrepreneur's profitsMataja, Der Unternehmergewinn (1884); Gross, Die Lehre vom Unternehmergewinn (1884). and of rent.Menger, Grundsätze, pp. 133 et seq.; Wieser, Der naturlichte Werth, pp. 112 et seq.; Böhm-Bawerk, Positive Theorie, pp. 380 et seq.
In the light of the theory of final utility, the last-named problem in particular finds an easy and simple solution, which confirms Ricardo's theory in its actual results and corroborates its reasoning in many details.
Of course, all the possible applications of the law of final utility have by no means been made. It is more nearly true that they are scarcely begun. I may mention in passing that certain Austrian economists have attempted a broad application of the law in the field of finance;Robert Meyer, Die Principien der gerechten Besteuerung (1884); Sax, Grundlegung (1887); Wieser, Der naturliche Werth, pp. 209 et seq. others to certain difficult and interesting questions of jurisprudence.Mataja, Das Recht des Schadenersatzes (1888); Seidler, "Die Geldstrafe vom volkswirtschaftlichen und sozialpolitischen Gesichtspunkt" in Conrad's Jahrbuch, N.F., vol. 20 (1890).
This is an excerpt from an essay that was originally published in the Annals of the American Academy of Political and Social Science, volume 1 (1891).
Everyone who is serious about ideas now has to deal with the issue of "intellectual property," especially given the advent of digital media and the state's war on the supposed violators of the intellectual rights of others. The situation has at once become very hopeful, with more sharing of ideas than ever before in history, and extremely grim, with the federal government pressuring every Internet-service provider to act as proxy enforcers of an unjust law — and twisting the arms of developing countries to adopt draconian, Western-style IP law. See Kinsella, "Stop the ACTA (Anti-Counterfeiting Trade Agreement)," The Libertarian Standard (April 11, 2010).
This debate, however, involves more than just IP issues. The discussion surrounding this topic has further clarified other issues, like the character of goods and property, the existence and centrality of nonscarce goods in economic life, and the role of learning in the evolution of society. This partially accounts for why the IP topic is so hot: it causes us to revisit fundamental issues over property, ownership, competition, and other areas we've mistakenly taken for granted. What follows is a summary of some fundamental ideas many of us batted around this summer.For some of these discussions, see the comment threads to the following articles and blog posts: "The Death Throes of Pro-IP Libertarianism" (currently at over 500 comments, probably a record for the Mises Blog); "Kinsella: Ideas are Free: The Case Against Intellectual Property: or, How Libertarians Went Wrong"; "The L. Neil Smith–FreeTalkLive Copyright Dispute"; "Replies to Neil Schulman and Neil Smith re IP)"; "Leveraging IP"; "The Creator-Endorsed Mark as an Alternative to Copyright"; "Locke, Smith, Marx and the Labor Theory of Value."
Scarcity and Scarce Goods"Why are tangible goods property?" This is a central question of Stephan Kinsella's Against Intellectual Property. The reason for property is that
there can be conflict over these goods by multiple human actors. The very possibility of conflict over a resource renders it scarce, giving rise to the need for ethical rules to govern its use. Thus, the fundamental social and ethical function of property rights is to prevent interpersonal conflict over scarce resources.
On this point, we can cite Hoppe's Theory of Socialism and Capitalism, where Hoppe writes with singular clarity: "only because scarcity exists is there even a problem of formulating moral laws; insofar as goods are superabundant ('free' goods), no conflict over the use of goods is possible and no action-coordination is needed.Hoppe, Theory of Socialism and Capitalism, p. 158, n. 120. The logic for this insight Hoppe draws from Rothbard, and the term "free goods" he takes from Mises.
Hoppe writes:
To develop the concept of property, it is necessary for goods to be scarce, so that conflicts over the use of these goods can possibly arise. It is the function of property rights to avoid such possible clashes over the use of scarce resources by assigning rights of exclusive ownership. Property is thus a normative concept: a concept designed to make a conflict-free interaction possible by stipulating mutually binding rules of conduct (norms) regarding scarce resources.A Theory of Socialism and Capitalism, p. 18.
Even in the case of the Garden of Eden, where superabundance would mean that all things we ever wanted were in our grasp, Hoppe explains that there would still be a need for property rights. This is because the human body itself is scarce: choices about who can use it and how it can be used necessarily exclude other choices. One cannot simultaneously eat an apple, smoke a cigarette, climb a tree, and build a house. Likewise, as Hoppe notes
because of the scarcity of body and time, even in the Garden of Eden property regulations would have to be established. Without them, and assuming now that more than one person exists, that their range of action overlaps, and that there is no preestablished harmony and synchronization of interests among these persons, conflicts over the use of one's own body would be unavoidable. I might, for instance, want to use my body to enjoy drinking a cup of tea, while someone else might want to start a love affair with it, thus preventing me from having my tea and also reducing the time left to pursue my own goals by means of this body. In order to avoid such possible clashes, rules of exclusive ownership must be formulated. In fact, so long as there is action, there is a necessity for the establishment of property norms. Ibid., p. 20–21. Thus, "This 'ownership' of one's own body implies one's right to invite (agree to) another person's doing something with (to) one's own body: my right to do with my body whatever I want, that is, includes the right to ask and let someone else use my body, love it, examine it, inject medicines or drugs into it, change its physical appearance and even beat, damage, or kill it, if that should be what I like and agree to." P. 22.
A property right in one's scarce body is a precondition for action even in the face of superabundance. Hoppe goes so far as to say that the body is the "prototype of a scarce good." Here he agrees with Jefferson's teacher Count Destutt de Tracy: "property exists in nature: for it is impossible that every one should not be the proprietor of his individuality and of his faculties."A Treatise on Political Economy, written in 1801, translated by Thomas Jefferson and reprinted by the Mises Institute (2009), p. 125. For further elaboration on Hoppe's views on body-ownership, see Kinsella, "How We Come To Own Ourselves," Mises Daily (Sep. 7, 2006), quoting Hoppe's 1985 comments:
The answer to the question what makes my body 'mine' lies in the obvious fact that this is not merely an assertion but that, for everyone to see, this is indeed the case. Why do we say 'this is my body'? For this a twofold requirement exists. On the one hand it must be the case that the body called 'mine' must indeed (in an intersubjectively ascertainable way) express or 'objectify' my will. Proof of this, as far as my body is concerned, is easy enough to demonstrate: When I announce that I will now lift my arm, turn my head, relax in my chair (or whatever else) and these announcements then become true (are fulfilled), then this shows that the body which does this has been indeed appropriated by my will. If, to the contrary, my announcements showed no systematic relation to my body's actual behavior, then the proposition 'this is my body' would have to be considered as an empty, objectively unfounded assertion; and likewise this proposition would be rejected as incorrect if following my announcement not my arm would rise but always that of Müller, Meier, or Schulze (in which case one would more likely be inclined to consider Müller's, Meier's, or Schulze's body 'mine'). On the other hand, apart from demonstrating that my will has been 'objectified' in the body called 'mine,' it must be demonstrated that my appropriation has priority as compared to the possible appropriation of the same body by another person.
As far as bodies are concerned, it is also easy to prove this. We demonstrate it by showing that it is under my direct control, while every other person can objectify (express) itself in my body only indirectly, i.e., by means of their own bodies, and direct control must obviously have logical-temporal priority (precedence) as compared to any indirect control. The latter simply follows from the fact that any indirect control of a good by a person presupposes the direct control of this person regarding his own body; thus, in order for a scarce good to become justifiably appropriated, the appropriation of one's directly controlled 'own' body must already be presupposed as justified. It thus follows: If the justice of an appropriation by means of direct control must be presupposed by any further-reaching indirect appropriation, and if only I have direct control of my body, then no one except me can ever justifiably own my body (or, put differently, then property in/of my body cannot be transferred onto another person), and every attempt of an indirect control of my body by another person must, unless I have explicitly agreed to it, be regarded as unjust(ified).
But let's be clear what we do not mean by the term scarce in the sense that it applies to this discussion. Something can have zero price and still be scarce: a mud pie, soup with a fly in it, a computer that won't boot. So long as no one wants these things, they are not economic goods. And yet, in their physical nature, they are scarce because if someone did want them, and they thus became goods, there could be contests over their possession and use. They would have to be allocated by either violence or market exchange based on property rights.
Nor does scarcity necessarily refer to whether a good is in shortage or surplus, nor to whether there are only a few or whether there are many. There can be a single "owner" of a nonscarce good (a poem I just thought of, which I can share with you without your taking it away from me) or a billion owners of scarce goods (paperclips, which, despite their ubiquity, are still an economic good).
Nor does scarcity necessarily refer to tangibility only, to the ability to physically manipulate the thing, or to the ability to perceive something with the senses; airspace and radio airwavesSee B.K. Marcus, "The Spectrum Should Be Private Property: The Economics, History, and Future of Wireless Technology," Mises Daily (Oct. 29, 2004); Kinsella, "Why Airwaves (Electromagnetic Spectra) Are (Arguably) Property," Mises Blog (Aug. 9, 2009).are intangible scarce goods and therefore potentially held as property and therefore priced, while fire is an example of a tangible good of potentially unlimited supply.
Instead, the term scarcity here refers to the possible existence of conflict over the possession of a finite thing. It means that a condition of contestable control exists for anything that cannot be simultaneously owned: my ownership and control excludes your control.
Replication and Nonscarce GoodsIn contrast, there are nonscarce goods. A classic statement on them comes from Frank Fetter's Economic Principles:
Some things, even such as are indispensable to existence, may yet, because of their abundance, fail to be objects of desire and of choice. Such things are called free goods. They have no value in the sense in which the economist uses that term. Free goods are things which exist in superfluity; that is, in quantities sufficient not only to gratify but also to satisfy all the desires which may depend on them.
An example of a necessarily nonscarce good is a thing in demand that can be replicated without limit, so that I can have one, you can have one, and we can all have one. This is a condition under which there can be no contest over ownership. As Hoppe says, under these conditions, there would be no need for norms governing their ownership and use.
This nonscarce status might apply to many things but it always applies to nonfinite things, that is, goods that can be copied without limit, with no additional copy having displaced the previous copy and with no degradation in the quality of the copied good from the original good."Rivalrous vs. Non-Rivalrous," Mimi and Eunice, by Nina Paley
Jefferson himself made the lasting statement that clearly distinguishes the two types of goods:
If nature has made any one thing less susceptible than all others of exclusive property, it is the action of the thinking power called an idea, which an individual may exclusively possess as long as he keeps it to himself; but the moment it is divulged, it forces itself into the possession of every one, and the receiver cannot dispossess himself of it. Its peculiar character, too, is that no one possesses the less, because every other possesses the whole of it. He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me. That ideas should freely spread from one to another over the globe, for the moral and mutual instruction of man, and improvement of his condition, seems to have been peculiarly and benevolently designed by nature, when she made them, like fire, expansible over all space, without lessening their density in any point, and like the air in which we breathe, move, and have our physical being, incapable of confinement or exclusive appropriation. Inventions then cannot, in nature, be a subject of property. Thomas Jefferson to Isaac McPherson, Aug. 13, 1813, Writings 13: pp. 333–35.
The idea is not just the spawn of Enlightenment thought. St. Augustine also took note of the peculiar goods quality of words.
The words I am uttering penetrate your senses, so that every hearer holds them, yet withholds them from no other. … I have no worry that, by giving all to one, the others are deprived. I hope, instead, that everyone will consume everything; so that, denying no other ear or mind, you take all to yourselves, yet leave all to all others. But for individual failures of memory, everyone who came to hear what I say can take it all off, each on one's separate way. St. Augustine, Garry Wills, Viking 1999, p. 145.
Imagine if Jefferson's and Augustine's descriptions of ideas applied to finite things. Let's say that someone owns a magic bagel. He could give a friend a bagel and another would magically appear in its place, allowing him to keep his bagel at the same time. The very act of giving it away would create an exact copy of it. A neighbor could do the same. Potentially, everyone in the world could have an identical bagel — all equally delicious.
This magic bagel would then constitute what has been traditionally called a free good or what we are now calling a nonscarce good — something that can be possessed unto infinity and by an unlimited number of people without displacing or degrading the original. With free goods, or nonscarce goods, there is no conflict over ownership.
You could say that you have a property right in the magic bagel, but it would be meaningless because anyone could "take it" by the act of replicating it. It cannot be owned in the traditional sense. I could of course keep my magic bagel under wraps and never let anyone know about it. But that changes nothing about its magic properties. It remains a good that can be copied without limit. And my ability to keep the secret is a result of my property right in — my ability to control — the scarce resource of my body.
Under these conditions, the status of the bagel as a free good is due to its replicability. If it could not be so replicated, if its magic went away, it would become a scarce good. Once it became public, there would be a contest over ownership of that bagel (if I have it, you can't have it).
"Nonscarce goods do not need the assistance of prices to ration their availability. They are free gifts that can be shared the world over."So it is with all things: if there is a zero-sum contest over its possession, it is scarce; if there need not be rivalry over its ownership, and its capacity for copying and sharing is infinite, it is nonscarce.
Does that sound fanciful? With regard to bagels, it is. But what if something like the magic-bagel example becomes real? Yesterday we could replicate information with photocopiers and print any number of perfect copies with a laser printer; and now we can copy and reproduce documents and files digitally. What if so-called 3D printers become widespread? These are devices that can fabricate various material objects by using a "recipe." In principle one could see a bagel (or car) that he likes, find or create a blueprint or recipe for it, and have a copy printed using one's own 3D printer, energy, and raw materials.
One can only imagine the IP police stopping people from using their 3D printers to make useful tools and goods based on the idea that doing so is somehow "stealing" the property of others that is still sitting in their homes.
In any case, for now the technology for 3D copying and printing is in its infancy. Not so for digitally encoded information. For example, consider a file on your hard drive. It can be packaged up and sent via email. The file does not disappear. A perfect copy of that file appears in someone else's email. That person could similarly forward (a copy of) the file to another person. This can happen billions and trillions of times without compromising the integrity of the first file. In effect, this file is like the magic bagel, a nonscarce good. If the file is on a server, it can be accessed by billions of people, each of whom could similarly host the file until it multiplies without limit.
Consider the power of this nonscarce good. That file might contain a database with all the world's financial transactions for last month. The record of those transactions would be nonscarce. The file could contain images of all the paintings in the National Gallery of Art. These images would be nonscarce. It could contain videos of all college lectures given in the United States last semester. Again, nonscarce.
All of this is possible and practicable. We experience this every day. We do this every day. All the files on the World Wide Web, unless they have been specially coded to be otherwise, constitute free goods.
It seems clear that we are moving into a world in which we have to account for the existence of massive and growing numbers of goods that are not scarce, in the sense that they are potentially replicable into infinity. These goods fall outside the strict confines needed for rationing. There need be no conflict and hence no need for traditional property rights for them.
Goods, Scarce and NonscarceOne helpful way to understand this is to classify all goods as either finite and therefore normally scarce or nonfinite and therefore naturally nonscarce. This distinction appears from time to time in the history of thought. An example is Armen Alchian and William Allen in their book, Exchange and Production. "A good is anything that anyone wants. Anything is a good if at least one person wants it. There are two classes of goods: 1) free goods, and 2) economic, or scarce, goods." Belmont: California, Wadsworth, 1977, p. 24. Property rights are essential for scarce goods. It is these scarce goods that serve as means for action, while nonscarce goods that can be copied without displacing the original are not means but guides for action. An example is Armen Alchian and William Allen in their book, Exchange and Production. "A good is anything that anyone wants. Anything is a good if at least one person wants it. There are two classes of goods: 1) free goods, and 2) economic, or scarce, goods." Belmont: California, Wadsworth, 1977, p. 24. It would be ridiculous to speak of some kind of "social ownership" over scarce goods. Scarce goods can only be owned by one person at a time. Sure, you can share them, but that is just a means of allocating a scarce good that changes nothing about the intrinsic nature of the good. In the end, all attempts at socializing scarce resources lead to state ownership and the well-known chaos associated with it.
But let us return to the bagel, this time one without magic properties. What about the recipe and skills that made it? The recipe and skills can be copied by anyone. Anyone can watch and learn. The recipe can be shared unto infinity. Once the information in the recipe and the techniques of making it are released, they are free goods, nonscarce goods, or nonfinite goods.
What are some more examples of such naturally nonscarce goods? One person can share an idea and it can spread unto infinity, never reducing or degrading the quality of the original. Fire might be considered another example (as Thomas Jefferson said). A match can light a log without displacing the fire from the match. The times tables are another example: the grade-school teacher doesn't "give up" this knowledge when drilling it into the students. An image of anything qualifies too. One person can look at another and memorize what he or she sees, without somehow taking or replacing the original. A tune is the same way. It can be shared and replicated without limit. I can sing a song, and you can sing the same song without taking the song from me.
"I can sing a song, and you can sing the same song without taking the song from me."These goods are all nonscarce and thereby require no economization. Once they are released, they need not be priced. There is no "structure of production" attached to their reproduction or allocation (hence there is no "structure of production" for the dissemination of ideas).
To be sure, nonscarce goods can be economized and thereby commercialized by rationing the scarce means of their distribution. For example, a professor, whose time and body are scarce, is paid to share nonscarce ideas. This is a service, but once the professor's ideas are shared, they enter into the realm of all nonscarce goods. What is paid for in fact is not the idea itself but the presentation, the time required to share, the labor services of teaching, all of which are scarce goods. For discussion of the proper classification of contracts for the "sale" of labor services, see Kinsella, "A Libertarian Theory of Contract: Title Transfer, Binding Promises, and Inalienability," Journal of Libertarian Studies 17, no. 2 (Spring 2003), at pp. 24–26.
It is the same with a book or article. What is scarce is the medium through which the idea is expressed, which is why books, articles, and web access cost money. The ideas conveyed in them, however, are copyable without limit.
This is not an insight that applies to digital media alone. This is true regardless of the technology involved. Whether we are talking about a scribe working on velum in the 8th century or a writer working on a web-based document in the 21st century, the ideas conveyed in the words, and the image of the words themselves, are nonscarce goods, while the medium through which they are conveyed is scarce. The range and importance of nonscarce goods has been vastly expanded by the existence of digital media.
As to whether a good is naturally scarce or nonscarce, the test here is simple. If the good can be taken (shared) without displacing the original, it is always nonscarce. If taking the original means that it can no longer exist in the possession of the original owner or possessor, it is a scarce good. All goods fall into one or the other category. All nongoods (unwanted things, necessarily a contingent category) can of course be similarly classified.
Scarce The matrix is presented as a tool for mental experiment only — if anything is a nongood (necessarily a subjective idea), it is also by definition nonscarce, since all (nonexistent) demand for it is satisfied. Nonetheless, the typology illustrated in the matrix helps in categorizing the attributes of goods discussed in this article.NonscarceGoodBagel, Factory, Shoes, People, DeskRecipe, Idea, Tune, Image, Skill, FireNongoodMud Pie, Poison Soup, Slug, Road KillBad Idea, Awful Sound, Gibberish Text At the same time, it is also true that most things are bundles of scarce and nonscarce goods. A book is a nonscarce text conveying nonscarce ideas on scarce paper and taking up scarce space on a shelf. A key that unlocks a door is made of scarce metal but its functioning is due to the nonscarce shape of the cut of the key, a shape that is infinitely copyable.
A concert by Lady Gaga is a scarce human body backed by scarce instruments and microphones producing music and sound, which immediately become nonscarce in the performing and hearing. Tying a shoe employs scarce laces with scarce hands guided by replicable (nonscarce) skills and techniques.
Replication and CivilizationNonscarce goods do not need the assistance of prices to ration their availability. They are free gifts that can be shared the world over. How important are these goods? Given that they are inclusive of all information, art, know-how, and anything else that can be possessed and copied without displacement, they are hugely important. Without these gifts, the whole of learning, imitation, and world culture would come crashing down.
We are not truly human without being part of human civilization; and there can be no civilization and progress without the spread, dissemination, and accumulation of knowledge. To be human is to be part of a learning society, a communicating society, an information-sharing society. Society is emulation-based.
As it stands, the existence of the nonscarce good is the basis of all intellectual progress, the foundation of technological and artistic progress, and thereby a boon to civilization. It is also at the core of enterprise. Entrepreneurs succeed by first imitating others who have succeeded. Their nonscarce experience and ideas are first copied and then improved, with the goal of profit. The example of success that entrepreneurs follow is itself a nonscarce good. Anyone with the means to do so is free to copy the successful idea and replicate it. The nonscarce good is the fuel of the competitive process.
In contrast, a scarce good cannot be shared without limit. It is necessarily owned and controlled by only one person at a time; even the attempt to share implies displacement (while I have it, you do not). To acquire it requires either homesteading unowned resources or stealing, transforming, or contractually acquiring (trading for) already-existing resources. As Hoppe has explained, "One can acquire and increase wealth either through homesteading, production and contractual exchange, or by expropriating and exploiting homesteaders, producers, or contractual exchangers. There are no other ways." Quoted in Kinsella, Intellectual Property and Libertarianism, Mises Daily (Nov. 17, 2009). But production presupposes the producer already owns the property that he transforms into something more desirable or useful. The only ways to acquire a particular scarce resource is to either homestead it, acquire it contractually, or steal it. (One may also transform already-owned property into the desired configuration.)Trading is what gives rise to rationing and allocating by the price system.
"To be human is to be part of a learning society, a communicating society, an information-sharing society. Society is emulation-based."Again, it would be preposterous to speak of socialism in scarce goods, because it is physically impossible to imagine two simultaneous owners of the same scarce good. As Hoppe observes, "Two individuals cannot be the exclusive owner of one and the same thing at the same time." Hoppe, "How is Fiat Money Possible? — or, The Devolution of Money and Credit," Review of Austrian Economics 7, no.2 (1994), p. 67. See also Hans-Hermann Hoppe, Jörg Guido Hülsmann & Walter Block, "Against Fiduciary Media," Quarterly Journal of Austrian Economics 1, no. 1 (1998), n.5: "Even partners cannot simultaneously own the same thing. A and B can each own half of a household, or half the shares in it, but they each own a different 50 percent. It is as logically impossible for them to own the same half as for two people to occupy the same space. Yes, A and B can both be in New York City at the same time, but only in different parts of it." However, it is possible to speak of something like "socialism" for a good that is nonscarce by its nature, precisely because it can be infinitely copied.
The nonscarce good is private so long as it is never revealed; it must remain a secret. Once the secret is out, the good becomes part of the commons (or socially shared, if you will) because everyone who encounters it can use it. Technology has worked to create ever more goods that have become part of the nonscarce category, and this might be seen as a major feature of technological development for all time.
Austrians on "Free Goods"Austrians have always, if sometimes only implicitly, recognized the existence of the nonscarce good, which is precisely the good in question with regard to intellectual property. Menger's 1871 book, Principles of Economics, begins with the definition of a good that excludes the concern over scarcity. Something is a good, in Menger's view, when it is causally capable of satisfying a human need. This is a very broad definition.
For something to be a good, said Menger, there must be human knowledge of this cause-and-effect connection, along with command over the thing so that the relationship between cause and effect can be realized. Among these goods he includes goodwill, family connections, friendship, love, religious and scientific fellowships — all of which fall into the class of things that can be replicated without displacement. Only later in the opening chapter, when discussing the issue of property, does Menger introduce the notion of scarcity and hence the need for economizing.
Seeing property as a subclass under the larger division of goods implies the existence of what Ludwig von Mises called a "free good" — something that is "available in superfluous abundance which man does not need to economize." Human Action, p. 93 Mises says that though they are "not the object of any action" they are useful and even essential for production. Ibid., p. 128. Giving the example of a recipe, he writes that these free goods, or nonscarce goods, render "unlimited services." A free good "does not lose anything from its capacity to produce however often it is used; its productive power is inexhaustible; it is therefore not an economic good."
But it is no less important: "These designs — the recipes, the formulas, the ideologies — are the primary thing; they transform the original factors — both human and nonhuman — into means.Ibid., p. 142. Ideas and information are nonscarce goods but they serve as guides to action in the use of scarce means, to transform scarce things in the world to achieve the actor's desired end. As Mises wrote, "Action is purposive conduct. It is not simply behavior, but behavior begot by judgments of value, aiming at a definite end and guided by ideas concerning the suitability or unsuitability of definite means."Ultimate Foundation of Economic Science, p. 34 (emphasis added). See also Guido Hülsmann, "Knowledge, Judgment, and the Use of Property," Review of Austrian Econonomics 10 no. 1 (1997), p. 44.
Murray Rothbard elaborated: "There is another unique type of factor of production that is indispensable in every stage of every production process. This is the 'technological idea'." Man, Economy and State, p. 75. Rothbard points out that once the idea comes about, it no longer has to be produced. It is an "unlimited factor of production that never wears out or needs to be economized by human action." This is precisely what a nonfinite, nonscarce good is: an unlimited factor of production.
Fetter also glimpses that ideas themselves are nonscarce goods:
The gain to the general welfare, however, can result only when the new inventions are actually embodied in machines. An invention is only an immaterial idea, and the machines in which inventions are incorporated are wealth which has a capital value. Further, a gain can result only when the usance of the machines is not so high as to absorb the larger part of the gain in efficiency. Not all labor-saving inventions call for more elaborate or more costly machines. Some are merely better methods, and require no more equipment — or even less. Some of them are simpler and less costly than the forms they displace. These (unless patented) are free goods, uplifting the efficiency of production "without money and without price."Fetter, p. 465.
Although Fetter assumes the existence of patent rights and does not question their legitimacy, he recognizes that methods — which are merely recipes, a type of information — are nonscarce goods (he calls them "free goods") that are freely available and increase efficiency and productivity — that is, unless they are patented, thus making them artificially scarce.
One of the longest and most searching essays on this topic is by Eugen von Böhm-Bawerk, in his article "Whether Legal Rights and Relationships are Economic Goods." Eugen von Böhm-Bawerk, "Whether Legal Rights and Relationships are Economic Goods," trans. George D. Huncke, in Shorter Classics of Eugen von Böhm-Bawerk (South Holland, Ill.: Libertarian Press, [1881] 1962), discussed in Gael J. Campan, "Does Justice Qualify as an Economic Good?: A Böhm-Bawerkian Perspective," The Quarterly Journal of Austrian Economics 2, no. 1 (Spring 1999). In this piece, Böhm-Bawerk points to several features of things that make them economic goods, among them physical possession and "the power of disposal and control." The notion of scarcity as a precondition for calling something an "economic good" is presumed but never stated outright. However, Böhm-Bawerk added critical elements to the idea of the good, noting that personal services must also be included in this category. Whether such are truly goods is not inherent in the service itself but depends on the subjective response to that service, thus introducing to the idea of a good a subjective component. Here Böhm-Bawerk keenly observes the interplay between materially scarce and subjectively nonscarce goods:
Be it granted that the poet’s soul must have originated thought and emotion, and be it further granted that only in another soul and through intellectual powers can those thoughts and emotions be reproduced, but the path from soul to soul leads through the physical world for one stretch of the journey and on that stretch the intellectual element must make use of the physical vehicle, that is to say, of the forces or powers of nature. The book is that physical material vehicle.Böhm-Bawerk, "Whether Legal Rights and Relationships Are Economic Goods," pp. 25–138.
As Joseph Salerno notes, "Böhm-Bawerk employed the example of the production and consumption of a poem to illustrate that the good is inextricably bound up with the want-satisfaction process that traverses and links the objective and subjective realms."Joseph Salerno, "Böhm-Bawerk's Vision of the Capitalist Economic Process: Intellectual Influences and Conceptual Foundations," New Perspectives on Political Economy, Volume 4, Number 2, 2008, pp. 87–112.
Scarce Goods, Nonscarce Goods, Progress, and InterventionWhy does all of this matter? It is interesting on the level of theory but it is also critically important as a practical matter. Enterprise in our time is increasingly dependent on a clear understanding of the difference between scarce and nonscarce goods. In the current recession, for example, the bust hit scarce goods, and it is the scarce-goods sector that the government is attempting to stimulate. But the nonscarce sector, which is not subject to the structure of production, and therefore is resistant to business-cycle effects, continues to thrive and has been unaffected by the machinations of bad macroeconomic policy. (But it is affected by "intellectual property" regulation.)
Institutions such as Google and the Mises Institute have discovered the secret of giving away nonscarce goods (search services and digital books) and restricting commercial operations to allocating only scarce goods (teacher services, physical books, and advertising space on screens).See Doug French, "The Intellectual Revolution Is in Process," Mises Daily (Sept. 11, 2009); Jeff Tucker, "A Theory of Open," Mises Blog (Jan. 7, 2010) and "up with iTunes U," Mises Blog (Jan. 29, 2010); and Gary North, "A Free Week-Long Economics Seminar," LewRockwell.com (July 24, 2010). This combination of giving away the nonscarce good and selling the scarce good has permitted both institutions to grow through service.
But this distinction is also exceedingly helpful for understanding economic theory. It clarifies the absolute necessity of property rights and free movement of prices for all scarce goods — exactly as classical economists have said. It also illustrates the need to completely de-control access to nonscarce goods and to permit the voluntary learning and sharing process to take its own course.The distinction between scarce and nonscarce goods is crucial. A signal example of the importance of making careful distinctions in fundamental economic concepts is Menger's clarification of price and value theory, which has profound implications with respect to other aspects of economics. As Professor Salerno explains:
Menger's intentions were to reconstruct classical economics on firmer foundations by grounding the supply-and-demand theory of price and the theory of monetary calculation in the choices and actions of consumers and to repair its superstructure by healing the rift between the theory of price and the theory of distribution. Menger boldly proclaimed his intention of subsuming all the branches of economics under a reconstructed price theory in his Preface to Principles, writing "I have devoted special attention to the investigation of the causal connections between economic phenomena involving products and the corresponding agents of production, not only for the purpose of establishing a price theory based upon reality and placing all price phenomena (including interest, wages, ground rent, etc.) together under one unified point of view, but also because of the important insights we thereby gain into many other economic processes heretofore completely misunderstood." (emphasis added by the present authors)Joseph T. Salerno, "Carl Menger: The founding of the Austrian School," in Randall T. Holcombe, 15 Great Austrian Economists (Auburn, Alabama: Mises Institute, 1999), at p. 80.
Nonscarce goods are a great gift courtesy of the structure of reality, a boon to humankind, a vast treasure of resources — tools for making the world a relentlessly better place.For elaboration, see the last three paragraphs of Kinsella, "The Death Throes of Pro-IP Libertarianism."
The failure to understand the distinction between scarce and intrinsically nonscarce goods might also help to explain the persistence of socialist ideology. For example, one possible explanation of the predictable socialist impulse of religious leaders, intellectuals, and artists is that their primary work consists in the production and distribution of nonscarce goods (salvation, ideas, and art) and that this accounts for the failure of the people in these professions to come to terms with the relentless reality of scarcity.
In summary, the world has given us two types of goods, one type that demands allocation through property and prices and one type that can be infinitely copied. In the production and distribution of scarce goods, there is no substitute for the commercial marketplace. And the notion that government should ever restrict replicable nonscarce goods or grant protection to a single monopolistic producer of nonscarce goods is contrary to freedom, material advancement, and social peace.
Special thanks to BK Marcus, Doug French, Jeffrey Herbener, Raymond Walter, David Gordon, Robert Murphy, and Joseph Salerno for comments.
Why value-subjectivism in economics doesn’t imply value-subjectivism in ethics, and might even imply the reverse. Recorded at Mises University 2010.
Benjamin M. Anderson Jr., who died on January 19, 1949, was born on May 1, 1886, in Columbia, Missouri. At the University of Missouri, from which he took his A.B. degree in 1906, his interests were predominantly intellectual and logical.
He was active in the Athenian debating society and soon earned a reputation there for his ability to pounce upon a logical or factual weakness in an opponent's position. He was one of the four presidents of the society for the year 1905–06.
He also developed at this time a passion for chess, which he retained throughout his life. He became so good at the game in these early days, indeed, that he seriously thought of making a career of it. Out of this interest came a warm friendship with José Capablanca, the world chess champion from 1921 to 1927, at whose suggestion he contributed a brilliant 25-page preface to "Capa's" book, A Primer of Chess, published in 1935.
Anderson took his master's degree at the University of Illinois in 1910, and his PhD in economics, philosophy, and sociology at Columbia in 1911. The wide range of knowledge and intellectual interests that he had developed at this time is indicated not only by the three subjects in which he took his doctorate but by a glance at his teaching career.
He became professor of history at the State Normal School at Cape Girardeau, Missouri, in 1905. He was professor of English literature as well as economics at the Missouri Valley College at Marshall, Missouri, in 1906. He was head professor both of history and economics at the State Teachers College in Springfield, Missouri, between 1907 and 1911.
In the study in his home, when I first knew him, I remember two pictures — one of John C. Calhoun, and the other of John Bates Clark. He had been deeply influenced in his political thinking, he told me, by the states' rights and other basic doctrines of "the master logician of South Carolina," while he owed his greatest debt in economic thought to John Bates Clark, under whom he had studied, and whom he considered the greatest economic theorist that this country had ever produced.
The first of his economics teachers to make a deep impression on Benjamin Anderson was Professor Jesse E. Pope, in whose seminar, in 1904 and 1905, he began his investigations in the "quantity theory" of money. His Social Value was begun in Dean Kinley's seminar at the University of Illinois in the term 1909–10. In its first form this monograph won a $400 prize offered by Hart, Schaffner, and Marx. (The judges were J. Laurence Laughlin, John Bates Clark, Henry C. Adams, Horace White, and Edwin F. Gay.)
This study was elaborated and completed as a book at Columbia University in 1910–11, and Anderson submitted it to the Faculty of Political Science as his doctor's dissertation. His chief obligations at Columbia University in that study, he declared in a preface, were to Professors Seligman, Seager, John Dewey, and Giddings.
It would be impossible to make even an adequate list of the writers who influenced Anderson's thought more indirectly. In his early books there are frequent references to Böhm-Bawerk and Wieser, Urban and Tarde, Jevons and Pareto, Wicksteed and H. J.Davenport, Wesley C. Mitchell and the sociologist C.H. Cooley. And among the practical men of the banking world with whom he later came in contact he always expressed a particular admiration for A. Barton Hepburn.
"He that wrestles with us," wrote Burke, "sharpens our skill. Our antagonist is our helper." The two writers whose work chiefly played this role for Anderson, by stimulating his criticism, were Irving Fisher and John Maynard Keynes.
It was mainly against the quantity theory of money as formulated by Professor Fisher that Anderson's own exposition of The Value of Money was directed.
And his criticism of Fisher, vigorous as it was, involved a sort of admiration. He deliberately chose Irving Fisher's Purchasing Power of Money as the chief target for his criticisms because it was "the most uncompromising and rigorous statement of the quantity theory to be found in modern economic literature"; because it followed "the logic of the quantity theory more consistently than any other work," and because it had received such enthusiastic recognition "as to justify one in treating it as the 'official' exposition of the quantity theory."In later years it was the influence of John Maynard Keynes that most provoked Anderson's critical opposition. He never, unfortunately, wrote an entire book analyzing the Keynesian, theories. But he replied brilliantly to one central Keynesian tenet in an eight-page appendix embodied in the symposium Financing American Prosperity (1945) entitled: "A Refutation of Keynes' Attack on the Doctrine that Aggregate Supply Creates Aggregate Demand."
He once told me an amusing story of a conversation with Keynes. In connection with the latter's theory of stimulating consumption to cure a slump, Anderson asked him, "Why wouldn't it be a good idea to raise white elephants in a period of depression"? And the British economist, quite unabashed, replied "That would be just the thing."
Anderson's contribution to economic theory is summed up in his two books: Social Value and The Value of Money.
He originally thought of his "social value" concept as a rival of or substitute for the individualistic marginal-utility theory as developed by the Austrian school. It seems to me that it is, rather, an exposition of the social presuppositions necessary to the marginal theory. It is an explanation of the essentially social conditions which go to form both the individual's own marginal valuations and prices in the market. His analysis, in other words, supplements rather than supersedes the Austrian.
Anderson was clearly right in rejecting the notion of the isolated "individual monad"; in emphasizing the intimate interrelation of the minds of individuals to each other, their inextricable interaction and interdependence. The thought process even within the "individual mind," as he pointed out, is a social process. "We think in words, and, indeed, in conversations." He was right in emphasizing with Cooley that through the social apparatus of language, literature, music, custom, tradition, conversation, "every thought we have is linked with the thought of our ancestors and associates, and through them with that of society at large."
But the question may be raised whether, in going on to the conclusion that "there is a mind of society, a psychical organism, a social mind" he was not perhaps hypostatizing a metaphor, taking a heuristic simile too literally. However that may be, he made it clear that a purely individualistic concept of marginal utility was inadequate, and that it was above all not an adequate tool of thought when it came to the explanation of the value of money. And he was also explicit in emphasizing that the unity of the "social mind," as he conceived it, was "primarily a unity of function."
Certainly this is an essential key to the understanding of many economic problems. Even a relatively simple assembly job like an automobile cannot be understood merely by studying its parts individually. The human body cannot be understood merely as an assemblage of its individual organs or cells. Both the automobile and the human body function as a unit.
A great society, with its institutions, mores, values, and elaborately interdependent division of labor, also to a large extent functions like a single organism and cannot be understood merely as a collection of the individuals who compose it. It is true, of course, that we cannot solve many economic problems unless we make it our business to study the needs, preferences, and actions of these individuals; but in addition we must understand their functional interrelationships.
Anderson's great contributions to monetary theory in The Value of Money have been admirably summarized in Professor Beckhart's foreword to the 1936 edition. Anderson helped to bring about a much needed unification of monetary theory with general value theory. He explained, in a clearer way than any previous writer had done, the role of the quality as well as the quantity of money and credit in determining the value of the monetary unit.
He emphasized the basically psychological nature of the value of money, with all the subtleties and complexities that this implies. He showed that particular prices as well as the so-called "general price level" must always be explained from the side of the value of goods as well as from the side of the value of money.
Its simplicity and alluring mathematical precision have still kept the rigid mechanistic form of the quantity theory alive, but Anderson subjected its gross oversimplifications to so searching and devastating a criticism that it has never reconquered the prestige and almost undisputed sway that it held before he wrote.
The Value of Money, in brief, is one of the classics of American economic writing. I can think of few works in the field that are as consistently brilliant, rigorous, lucid, and engrossing. As a contribution to the theory of money it stands easily among the foremost half-dozen works ever produced on this continent.
The present work is destined to take a similar rank among American economic and financial histories. It is already the outstanding economic and financial history for the period it covers.
An economic history that does not correctly interpret the events it describes is usually worse than worthless. A writer who does not know how to interpret economic causation does not even know what facts to select and present. Anderson knew which facts to select and which to emphasize. Few economic histories have ever interlaced theory and interpretation so completely and successfully with the record of the facts.
The following pages are like a rich fabric in which the events constitute the warp and the theoretical interpretation the woof, the first supporting the second, and the second illuminating the first.
Its sense of drama, its unfailing lucidity, its emphasis on basic economic principles, its recognition of the crucial roles played by outstanding individuals, its realistic and detailed description of the disastrous consequences of flouting moral principles or of trying to prevent the forces of the market from operating combine to give this book a sustained readability seldom found in serious economic writing, in spite of the admirable early model set by Adam Smith.
Here is the economic history of the United States in the fateful period from 1914 to 1946. This history is quite properly seen not in isolation but as an integral part of world economic history; for the true, economic liberal, like Anderson, is never an economic isolationist or nationalist.
Throughout most of the period of which he writes he was the economist of the Chase National Bank. He made several trips to Europe, and was one of the American group that negotiated the standstill agreements with the banks of Germany.
This history, therefore, is written by a man uniquely qualified for the task. He combined a rare grasp of economic theory with an intimate knowledge of the events of these years gained as a close and privileged observer, and sometimes as an important adviser and participant.
It is a pity that he did not live to see the publication of this volume. But those of us who wish to understand the economic events of the great period that it covers can count ourselves fortunate that he lived to complete the composition of it.
[First printed in Benjamin M. Anderson Jr.'s Economics and the Public Welfare.]
"There is no unit of measurement for value and no apparatus that can compare how much something is worth to two different individuals."Many theorists have attempted to explain why some nations are wealthier than others. One recent explanation by psychologist Richard Lynn is both unusual and chilling at the same time. It is unusual because of its method, and it is chilling because of its unclear underlying motivation. My contention is that even though this explanation has stirred up quite a bit of controversy, it has no significant implications for either economics or ethics.
In his book IQ and the Wealth of Nations, Richard Lynn, professor at the University of Ulster, regresses national per-person gross domestic product (GDP) on results of IQ tests conducted in different countries. He finds a statistically significant correlation between average IQ scores and per-person GDP, and he concludes that this is evidence that national differences in intelligence are important determinants of the economic prosperity of nations.
Ultimately, Lynn's logic is as follows: Mentally able individuals are better at both coordinating individual actions and at developing and implementing new technologies than those who are less mentally able. As a result, countries populated with more mentally able individuals are wealthier. And, since intelligence is to a great extent genetically determined, our ability to improve this situation through better nutrition and education is severely limited. Lynn suggests instead that eugenics could be utilized to alleviate the problem.[1]
I take the conclusions of Lynn's book a bit personally, because it reminded me of an anthropology book that I used to own but have since lost. It was printed in 1941 under the sponsorship of the Nazi regime operating in the Balkans, and it was full of drawings of human skull measurements and comparisons of different "racial features." This book was quite similar to a 1921 book by Herman Lundborg, whose work was used as the basis for the Swedish government's eugenics program — a program that from 1935–1975 sterilized persons with "negative" genetic characteristics.
Both of my grandfathers were among the few survivors of the Yugoslavian Nazi concentration camps, which were run by people who had read too many "anthropological" books like those mentioned above. Thus, I naturally felt some discomfort when reading Professor Lynn's writings, especially knowing that the only reason I am now able to read anything at all is because the radical practitioners of eugenics were not thorough enough in their attempt to purify the genetic pool of the human race.
However, in this article I will not dwell on the question of the truthfulness of Lynn's claims. Instead, let us assume that everything he says about the IQ-GDP correlations of different nations is correct and then examine the implications for the sciences of economics and ethics.
Do Lynn's findings help us, in any way, to evaluate actions of individuals in different countries? Do they give a measure of the economic success of these individuals? Do these results have any general ethical relevance?
Value, Wealth, and Economic SuccessWealth is a meaningless term without the concept of value. If we know that the purpose of human action is to satisfy one's needs and wants, then the material wealth of two different individuals (let alone abstract entities such as nations) cannot tell us much about the satisfaction of their needs and wants. Wants and needs are subjective, unknown, and immeasurable by an outside observer.
We should thus be careful when interpreting empirical observations related to the quantity of goods and services produced in an economy. This is not to say that the GDP cannot tell us anything about a region. It simply means that GDP cannot tell us much about some of the most important economic concepts, such as value and economic success.
Most of today's economists endorse the subjective theory of value. According to this theory, the value of anything exists only in the mind of an individual. Thus, values held by two individuals cannot be compared except by observing an act of exchange. And even then, we can only make somewhat obvious statements — for instance, that in his exchange Jim values good A more than x dollars, while Janis values good A less than x dollars. To take it a step further, stating that Jim values good A more than Janis values good A simply lacks logical meaning.
There is no unit of measurement for value and no apparatus that can compare how much something is worth to two different individuals. This is the principle of the interpersonal incomparability of utility. Individual value scales cannot be superimposed and quantitatively compared. Since subjective value cannot be objectively measured, it cannot be objectively added, divided, or multiplied across individuals. Consequently, GDP is not a measure of "aggregate" value.
For example, if Jim's income is $4,000 and Janis's income is $1,000, does this mean that Jim's wants and needs are satisfied better than Janis's? We don't know. Likewise, if Jim tells you that, on a scale from one to five, his level of happiness is three, and Janis tells you that her level of happiness is four, this does not tell you that Jim is less happy than Janis — because Jim's level three and Janis's level three are not the same subjective state of mind.
Any comparison of subjective states requires the same frame of reference. Even if we know that one individual can buy more goods with his or her income than another, it does not follow that we may compare the two individuals' respective satisfaction. Not only do we not know what each person wants to buy, but even if we knew what each wanted to buy, we have no way of measuring how much satisfaction each one enjoyed in doing so. (This is one of the basic postulates of neoclassical economics, formally articulated by Carl Menger in his treatise Principles of Economics.)
The dubious nature of value measurements becomes even clearer when we note that many voluntary exchanges could never be included in the GDP. For example, friendship is a direct exchange of highly specific services that does not involve an exchange of money (and thus cannot be recorded or taxed in terms of money).[2] However, the provision of friendship is a productive activity like any other. The service is provided to other people because they value the service in the same way they value eating apples or watching a movie. Yet who can tell us the aggregate value of friendship produced in Argentina in 1998?
Another, even more obvious example is this article. The exchange between its author and the Ludwig von Mises Institute did not involve any exchange of money, and it will not be recorded as a productive activity in either the Canadian or the US GDP. However, both parties benefited from the production and exchange of the article. (It is my hope that there is a third party that will benefit as well — the readers.)
If one adopts the position that the satisfaction of one's needs and wants is the ultimate purpose of human action, then the economic success of one's actions can only be measured by ascertaining the degree to which one's needs are satisfied. But, since satisfaction cannot be measured outside the frame of reference of the given individual, the success of one's actions cannot be evaluated by anyone other than the same person whose actions are being evaluated.
Treatment of OthersAnother question we might ask is what implications Lynn's findings might have for how we treat others. It may, after all, be more "efficient" to offer less charity to those who are incapable of using that help effectively and to give more to those who are. This is, in fact, one of the subtle messages that Lynn is sending — I say "subtle" because this is not 1941, and messages of this kind require a certain degree of subtlety.
"Making one person's preferences count as the universal, normative principle ought to be considered "moral relativism taken to the extreme'."For example, Lynn and his North American counterparts, Philippe Rushton and Arthur Jensen, suggest that the efforts to increase the academic success of African Americans will lead to limited results because of the alleged inherently low IQ of this population.[3] Similarly, Lynn argues that foreign aid to Africa will result in only modest results.[4] The implication is that foreign aid is wrong, not because it represents forced charity or an illegitimate transfer of wealth, but because the recipients are unworthy according to Lynn's standards.
He also argues that the immigration policies of Western countries should either be more isolationist, to preserve the IQ of the domestic population, or target the high-IQ east Asian populations and discourage the inflow of (among others) low-IQ African populations. (Fortunately, the Canadian immigration officials did not look at Lynn's and Rushton's work before letting my family cross the border.)
These points are nuanced but their forcefulness is clear: Lynn has his standards and desires to see them implemented institutionally.
The Irrelevance of Lynn's FindingsEven in the unlikely event that Lynn's results are true, I am not persuaded by his normative conclusions. First, the law of comparative advantage tells us that in this world — in which no two individuals are identical — the possibilities for mutual cooperation are omnipresent. Unlike what is presented in some aggregate models, the true nature of comparative advantage is not national or racial, but individual.[5] Only individuals know their own production possibilities and preferences, which they express through voluntary, market transactions. This is why one's "nation" and "race" are not relevant economic categories within the framework of the subjective theory of value.
Basing economic policy on IQ levels overlooks the unique contributions many members of society have to offer. (Perhaps Professor Lynn never read the fable about the mouse and the lion. Being a "lion" is not a sufficient condition for ignoring or mistreating the "mice.")
Moreover, it doesn't follow from judgments about "efficiency" that one ought not to be charitable to those with fewer capabilities than others. Imagine that you had a mentally challenged child or sibling: would you refuse your cooperation because there is someone who could use that help "more productively"?
But aren't at least some generalized judgments accurate? For example, one of Lynn's supporters asks, "Who would argue that disease could be preferable to health or stupidity to genius? It's a case of moral relativism taken to the extreme."
In response, we should note first that "disease" and "health" are not precise or absolute terms; rather, they are abstract concepts. Human beings, on the other hand, have particular and specific preferences, expressed in action, that may often contradict more abstract value judgments. For instance, I can claim — and I am still waiting for someone to prove me wrong — that I would prefer to be ill and live following my own preferences rather than to be healthy and forced to follow someone else's preferences under a threat of violence.
If I think that the most valuable use of my time and resources is to cooperate with my child, sibling, neighbor, or even a man named Jim who lives ten thousand miles away, then there is no study that can prove I should instead cooperate with Janis because she scored high on some test. After all, Lynn's preferences concerning the genetic makeup of humanity do not qualify as a universal, normative principle. In fact, making one person's preferences count as the universal, normative principle ought to be considered "moral relativism taken to the extreme."
To be universal, a principle by definition needs to relate equally to everyone. Eugenic policies of the early-20th century were seen as a means to improve upon the natural evolution of humans. But the "genetic-hygiene" laws were chosen by a few to be imposed on everyone. It is self-evident that those imposing the standard on others are not in the same relation to these laws as are those upon whom they are being imposed.
This is the conceptual difference between natural selection and the practice of eugenics — natural selection applies to all humans equally. It was not brought into existence by any human; this is why, unlike the genetic-hygiene laws, natural selection is value free, and thus any analogy between the two is inappropriate.
Immanuel Kant, and, more recently, Murray Rothbard and Hans-Herman Hoppe provide examples of the human search for ethical principles that satisfy the universality requirement, where ought and is logically come together. The same way natural sciences discover how we ought to look at the world by discovering what the world is, the science of ethics discovers how we ought to look at other humans by discovering what they are.
$24 $17
Economics tells us what human beings are insofar as they act. According to Lynn, we could become more "efficient" if we started acting differently. However, no one can prove this claim since the litmus test for economic efficiency exists only in the mind of the actor. In fact, we see examples of human cooperation contrary to Lynn's prescriptions all the time: it cannot be denied that people choose their friends and associates using all sorts of criteria, not just IQ scores or racial features.
Value is in the mind of the individual: it is subjective. The value of individual ends can only be measured by the individual in question, and it cannot be compared across individuals. It would be a mistake to think that Lynn's method and findings can have any meaningful interpretation in the realm of economics, the science of human action, or in ethics, the science of the evaluation of human action.
IQ is not a measure of one's ability to meet one's own wants and needs, and neither is GDP a measure of the satisfaction of one's wants and needs. In fact, no such measure exists: you cannot measure the immeasurable.
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Notes[1] Richard Hoste, "The Coming Chinese Superstate: Richard Lynn's Eugenics," The Occidental Quarterly Online (July 2009). Eugenics is of course a rather unpopular and politically incorrect idea. Lynn argues for it in principle but in practice opts only for mild institutional methods of practicing it.
[2] Money is not necessary for the exchange of friendship services because the condition of the double coincidence of wants is met. For example, Jim offers his friendship services to Janis in exchange for her friendship services. This is a direct exchange.
[3] Richard Lynn and Tatu Vanhanen, IQ and the Wealth of Nations (Praeger Publishers, 2002), p. 194; J. Philippe Rushton and Arthur Jensen, "Wanted: More Race Realism, Less Moralistic Fallacy," Psychology, Public Policy, and Law 11, no. 2 (2005): 328–36.
[4] Lynn, IQ and the Wealth of Nations, p. 192–94.
[5] Predrag Rajsic, "Comparative Advantage: From an Individual to the Economy" (paper to be presented at the Agricultural and Applied Economics Association 2010 AAEA, CAES, and WAEA joint annual meeting, Denver, Colorado, July 25–27, 2010).
AppendixPages from a 1921 book by Herman Lundborg whose work was used as the basis for the Swedish government's eugenics program
Previously, I, Walter Block, published an article on the use of the word "capitalism." I defended the employment of this nomenclature in the promotion of libertarianism, criticizing the formation of a group, lead by my old and good friend, Sheldon Richman, called Libertarians Against Capitalism. I am now coauthoring this reply to Sheldon with Jackson, who wrote me a letter very supportive of my side of this debate; I have edited this letter of his and included it in this response.
In due course, Sheldon published a rejoinder to my article. As is his wont, it was thoughtful and knowledgeable. So much so, that it almost convinced me. But, not quite. However, he might well have made one good point, about which I was, I confess, ignorant. I had stated that the bad guys were trying to steal the word "libertarian" from us; but Sheldon, perhaps a better historian than me, has pointed out that we free enterprisers were the initial "thieves." (I place scare quotes around "thieves" to indicate that poaching of language is not akin to stealing real property. As Stephan Kinsella begin_of_the_skype_highlighting end_of_the_skype_highlighting begin_of_the_skype_highlighting end_of_the_skype_highlighting has so masterfully shown, there can be no such thing as intellectual property in the libertarian law code; thus, there can be no theft of it, either.) It was my supposition that Spooner and Tucker were the first to use this word in the modern (political economic) manner, but, alas, I may well have been mistaken in this.
I did some (belated) research on this question; see here, here, and here. The first two links still seem ambiguous to me; the latter clearly supports Sheldon's position. As well, I have been told that a forthcoming book of Murray Rothbard's letters, edited by David Gordon, buttresses Sheldon's interpretation. On the other hand, this essay would tend in the other direction, and I am not historian enough to come to a definitive conclusion. So, let me stipulate, arguendo, that I was wrong in my contention, and Sheldon correct. I nevertheless persist in thinking that this error of mine, and thus Sheldon's correction of me, if that is what it indeed is, is really irrelevant to the point I was initially making: that it would be a grievous mistake to jettison the word "capitalism" from our libertarian lexicon. I think Sheldon agrees with me as to the relative unimportance of the (well nigh possible) error of mine, as he says, "But let that pass."
Now we come to the crux of his rejection of "capitalism." Sheldon says, in response to my request that he disband this initiative of his:
Sorry, can't do it, old friend. It's not worth the candle. The word was tainted from the start — free-market radicals uses [sic] it disparagingly – and it has never lost its taint, despite the efforts of Mises and Rand. It creates confusion not clarity. We have perfectly good words for what we want: the free market and laissez faire, voluntarism and market anarchism. We don't need the poisonous word capitalism.
But the most widely understood meaning of "anarchism" is, surely, "chaos," or, maybe, "bomb throwing" (against innocent people). Libertarian anarchists, of course, mean by this word, absence of archy; that is, no arbitrary unjustified rule of one man by another. Should we therefore give up on the word anarchy because it is misunderstood?
A similar challenge to Sheldon's position emanates from the word "individualism." In our camp, this certainly evokes a positive reaction. Some libertarians go so far as to equate our libertarian philosophy with individualism, and to denigrate what they see as "collectivism" as its polar opposite. I don't go out that far on the limb at all (it is not for nothing that I am widely known, at least within the libertarian community, as Walter "Moderate" Block). For this would put us in opposition to voluntary collectives, such as the kibbutz, the monastery, the nunnery, the convent, even the typical nuclear family which lives according the doctrine of "from each in according to ability, to each according to need." It would also denigrate team sports (football, soccer, baseball, basketball) as collectivist, and unduly elevate individual sports (swimming, track, handball, tennis) as a matter of libertarian principle. Further, "individualism," too, is under dispute; it is also claimed by our political enemies. It would be a sad day if we ever had to give up on this word, but that, as I see it, is the logical implication of Sheldon's perspective.
"Free market" is a wonderful banner. I would not jettison it for all the tea in China, so to speak. However, it really doesn't do all the work we need it to do. As far as I am concerned, there is not one but rather three arenas in which we contend against our competitors on the political spectrum: not only economics, but also personal liberties and foreign policy. Someone who favors freedom only in the commercial field is not really one of us, if he is "weak" on the other two. For example, he favors economic liberties, but wants to put people in jail for prostitution, pornography, gambling, drug use, and supports US imperialism. There are plenty of "free-market" advocates like that; they are not one of us. They are, rather, conservatives, and are just as much the enemies of libertarianism as are the left liberals. If you ask a typical lefty what "free market" means to him, undoubtedly, he will associate it with exploitation of the poor. If you ask this of the modal mainstream economist, you will hear a litany of "market failure," and economic inefficiency.
Here is my edited version of my coauthor's brilliant letter to me (I agree with every word of it, or I would not have invited Jackson to coauthor this rejoinder with me):
I find the attempt to popularize phrases like "laissez-faire" or "market anarchism" so as to avoid the negative connotations of "capitalism" more than a little silly.
For those of us who are anarchocapitalists, the phrases are interchangeable; clarity is not an issue. I doubt there has ever been any confusion when one Mises Institute Senior Scholar says "capitalism" and another says "laissez-faire." The only reason I can find as to why one would attempt to change the vocabulary of our message would be to appeal to people who do not share our economic views. I cannot see this little ploy as anything but a waste of time.
The first reason I believe this to be foolish is that if anyone is under the impression that "laissez-faire" or "market anarchism" will be an easier pill for the general public to swallow, they need to do a bit of thinking.
"Laissez-faire" will make the average Soccer-Mom-Mandi think of Dickensian orphans having to beg for pennies on a muddy street (in the rain) because they lost one or more limbs in a coal mining accident and their mustached robber-baron employer threw them out into the wilderness because of their reduced productivity. She will be overcome with a fear for the safety of not only her tow-headed children, but of all tow-headed children in the Good Ol' USA. As fearing for children makes her feel unpleasant, and as the phrase "laissez-faire" was used disparagingly by both her matronly 11th grade social studies teacher who inspired her and her EN 211 American Lit. professor who she had a crush on, she will not like it.
I also do not believe that "market anarchism" will accurately communicate the message of liberty and win the hearts and minds of the masses. If we were to take Teamster Union Randy the Welder from Local 102 and do a bit of word association, I would imagine we would end up with something like this: "Market"; "Wall Street." "Market"; "Exploitation." "Anarchism"; "Chaos." "Anarchism"; "Arson." "Market"; "Madoff." "Anarchism"; "Africa." "Market Anarchy"; "Workers of the World Unite." To the average American whose reason is constructed by either The Daily Show, pop music, or whatever blockbuster is playing at the cinema, the phrase "market anarchy" would lead one to think of a Hollywood-envisioned dystopian future in which a large pharmaceutical company controls every aspect of our lives so that a few privileged crooks at the top can live in ivory towers. I cannot see people flocking to this phrase.
If you want to proselytize to the masses, "capitalism" is your best bet. It's not threatening to most people as both Republicans and Democrats generally speak of it as a kind of good thing. It is what made "us" great and all that blather. The fact that it is commonly used and commonly misused is its best quality. Every time someone incorrectly equates capitalism to corporatism, mercantilism, bailouts, price fixing, subsidies, natural monopolies, central banking, etc. we are given an excellent opportunity to say "Well, that's not exactly what capitalism is … " We have the perfect icebreaker which enables us to wax poetic about how you agree that these things are unjust but are really examples of interventionist policies and state reallocation of resources not intrinsic qualities of capitalism. And then we can smoothly transition the conversation into free market solutions and extol the virtues of economic liberty.
But now to the second reason I think this is pointless: the ideas of absolute liberty will never, ever, ever be popular to the masses. The values that have led us to our vision of rights, justice, and liberty are less popular than the values that lead others elsewhere. There is something within many people that finds a calming satisfaction in dependence. Depending upon the state does offer a lot of stability to many people who would rather not be bothered with trying to steer a course through the "tumultuous sea of liberty." Trying to put a pretty bow on our ideas by abjuring all words with negative connotations will not help promote liberty. If anything, we should focus on bracing the remnant, as it were. The people who will find the message of liberty appealing will do so because of the philosophy, not because of the label, indeed, in spite of the label.
I have a hunch that making a big ado about not supporting "capitalism" because the word is misused and preferring to support whatever alternative word its critics agree upon will further alienate proponents of economic liberty, on the part of both like-minded individuals and potential converts. People who do this will just look pedantic, as if they are trimming their sails to be agreeable. "Um … yeah, I like supported Capitalism before it was cool … then everyone else started digging it. But they didn't really get it, ya know? So now I'm into Anti-Capitalist-Market-Anarchy. It's really rare, I doubt you've heard of it."
Now, back to me. This is Walter Block writing again. While my coauthor and I are taking on Sheldon Richman on this issue, we might as well widen the debate and consider the mistaken views of some others.
According to one contributor to Sheldon's web: Since "leftists like Noam Chomsky and right-wingers like Glenn Beck keep calling themselves 'libertarian,' let's ditch that moniker, too, and reclaim 'liberal' to mean both personal and economic liberty." (By the way, Milton Friedman is another who promiscuously used the word "libertarian" to apply to himself. On this, see here, here, and here.) But, if we are losing "libertarian" what makes us think we can re-attain "liberal"? Why not play defense as well as offense? Try to keep both. The more words we can use to express ourselves the better. We already have "capitalism." Sheldon is willing to jettison it even when no one else is trying to seize it from us.
In the view of one over-the-transom remark: "Since the word "capitalism" does not have the meaning we intend, (we should) cease using it incorrectly. From its historical roots and etymological derivation it does not and has not meant 'free markets.'" Yes, but the meanings of words change according to usage. There is no intrinsic meaning of a word. For example, black people have been called the N word, negroes, Negroes, African-Americans, blacks. The same object, different appellations. Even the objection mentioned just above takes cognizance of the malleability of language, as this one does not.
"I'm as much in favor of 'lucid discourse' as is the next fellow, I suppose. But there is something I rank even higher: promoting liberty."The next objection comes from Clarence B. Carson who published "Capitalism: Yes and No" some 25 years ago in the Freeman. He praises "lucid discourse" and on this ground prefers "free enterprise" to "capitalism" as a description of our perspective. Well, I'm as much in favor of "lucid discourse" as is the next fellow, I suppose. But there is something I rank even higher: promoting liberty. And when the two diverge, as I claim they do in this case, my way forward is clear. Yes, "capitalism" may be more "in your face" than the "free enterprise" that was criticized above. And, some people may be put off by it, preferring more gentle terminology. But if there is anything I have learned from the methodological individualism taught by Mises, it is that people are different. Other people may need the "slap in the face" that, on this supposition, only "capitalism" can supply.
In Carson's view, there is a commonly accepted understanding of "free market" and it is a pretty good one: "A free market is a market open to all peaceful traders." This sounds good, but, I fear, Carson is living in a dream world, at least based on the common understanding of this word, in terms of exploitation. In contrast, he avers, "capitalism … does not have a commonly accepted meaning." Well, yes, but, it has been used effectively, and neither does his favorite appellation, "free enterprise."
I don't really regard the debate over nomenclature as a substantive one. It merely concerns strategy, branding, labeling. And, as with all such issues, it is difficult to say which side is definitively correct. If we win, and economic freedom is maximized, will it be because of, or in spite of, our positions on this question? I think it will be difficult to ever know for sure. However, my "instinct" is that we should keep for ourselves as many words as we can.
The most powerful argument on this score I save for last. Sheldon Richman states: "(Capitalism) has never lost its taint, despite the efforts of Mises and Rand." Yes, yes, but as my coauthor and I have shown above, every other word we use is also "tainted," or problematic on other grounds. What is "tainted" in the minds of the people is not the word. Once they even partially understand the concept, the booboisie doesn't much like it.
"What are you, crazy?" they would say. "Turning back the clock and getting rid of welfare, unemployment insurance, the central bank, the minimum-wage law, social security, protective tariffs? We'd have mass starvation. Not make war all over the place? How else can we protect ourselves? You people are insane."
So, I ask, who have been the people in the recent past who have done the most to promote our movement, whatever we call it? And, surely, it cannot be denied that Rand has converted the most ordinary people to our movement, and that Mises, along with Rothbard have made the most serious inroads amongst professional scholars. So, here we have Richman, who has had, oh, I don't know, an impact of one millionth of a per cent of Rand plus Mises, criticizing them for poor word usage. (I am not trying to denigrate Sheldon here; my own impact has been much more like his than these two GIANTS of our movement.) I hope and trust no one thinks me guilty of an ad hominem argument here. I am not saying Richman is wrong, and Rand and Mises are right because they are more famous than him. What I am saying, instead, is that one of the vehicles used by Rand and Mises in their successful promotion of liberty is the word "capitalism." Surely, this must count importantly in our debate.
Ayn Rand converted more people to libertarianism than anyone else, and she used that word often, and with great effect. Indeed, if there was any one word associated with her, it was "capitalism." Are we really to believe that she would have converted even more people without the ceaseless and unrelenting use of this nomenclature? Although it is difficult to draw certain conclusions from contrary-to-fact history, it is difficult to see how this could have been the case then, or, indeed, is at present. If there is one description of Ayn Rand that strikes to the core of her being, it is "in your face." She was no shrinking violet. She made the case for the freedom philosophy in the most aggressive manner possible, bless her. And, "capitalism" was a crucial element of that effort. It makes far more sense to follow her in this regard than to jettison this word in an attempt to be historically "accurate," or indeed, for any other reason — that is, if we really want to promote liberty efficaciously.
[Chapter 6, The Market for Liberty]
Most social problems which perplex national leaders could be solved fairly simply by an increase in the amount and type of property owned. This would entail the equally important, general recognition that ownership is and must be total, rather than merely a governmental permission to possess and/or manage property so long as certain legal rules are complied with and "rent" in the form of property taxes is paid. When a man is required to "rent" his own property from the government by paying property taxes on it, he is being forbidden to fully exercise his right of ownership. Although he owns the property, he is forced into the position of a lessee, with the government the landlord.
The proof of this is that if he fails to pay the taxes the government will take his property away from him (even though it is his property and not the government's), just as a landlord would kick out a tenant who failed to pay the rent. Similarly, if a man must comply with laws dictating the use or upkeep of his property (or any other rule except that of not using the property to initiate force or fraud against others), he is being forbidden to fully exercise his right of ownership.
Because a man must use his time — which is part of his life — to acquire, utilize, and care for property, he has a right to own and control that property fully, just as he has a right to fully own and control his life (so long as he doesn't use it to coerce any other man). Any form of property tax or regulation denies the individual's right to fully control his own property and, therefore, his own life. For this reason, taxation and regulation of property is always wrong — taxation is theft and regulation by initiated force is slavery.
In a governmentally controlled society, the unrestricted enjoyment of property ownership is not permitted, since government has the power to tax, regulate, and sometimes even confiscate (as in eminent domain) just about anything it pleases. In addition, much potential property is not permitted to be owned. In a laissez-faire society, everything which was valued and rationally claimed would be owned, and this ownership would be total.In the case of joint ownership, each owner would have total ownership of a part of the whole, and his part would be specified in the voluntary agreement with the other owner or owners.
Property is anything which is owned. Ownership is the right to possess, use, and/or dispose of anything to which one has a moral claim. Property may be acquired by producing it, by exchange with others, as a gift, or by claiming an unowned value. The claiming of unowned values is the way in which all property originally came to be owned.
An unowned value cannot become one's property simply because one makes a verbal (or written) statement claiming it. If it could, you could say right now, "I claim the ocean bottoms of the entire earth and all the surface of the moon," and provided you were the first to make the claim, they would be yours. Obviously, this would lead to a welter of contradictory and unenforceable claims.
In addition to making a verbal claim, something must be done to establish that claim as having a basis in reality. In the case of portable items, there is no problem. Anything which can be transported by either hand or machine can simply be moved by the new owner and placed within the confines of some other piece of his property—his suitcase, car, house, or land. The newly claimed item may also be marked in some way to furnish more evidence of ownership (the owner's name, initials, or some sort of serial number or symbol is frequently used).
Non-movable items, such as a fully grown tree, a dam, or a piece of land, present a different kind of situation. All non-movable items may be considered as land, since even if the item itself is not land it cannot be separated from the land on which it stands. Since a non-movable item can't be carried away, it must be marked as the new owner's property where it stands. Because a non-movable item always occupies some land space, the land, too, must be marked.
All land is contiguous to other land (including islands, as can be seen if one considers the fact that submerged land is ownable). This means that the most important things to mark are the boundaries. This may be done by fencing, by a series of signposts at intervals, or in any other way which leaves a clearly visible evidence of possession on the land itself. Obviously, the better job of marking one does, the less likely one is to have trouble from someone with a conflicting claim.
Conflicting claims would be settled by bringing them before private arbitration agencies for binding arbitration. Since neither disputant would be able to sell the land, have much chance of renting it, or even any security of possession so long as his claim was in dispute, both parties would be impelled to bring the matter to arbitration. The free market arbitration agency, if it wanted to stay in business, would have to make as fair a decision as it possibly could. Both disputants would then be impelled to abide by the arbiter's decision, since a man who contracted to abide by the results of arbitration and then broke his contract would be announcing himself as unreliable, and no one would want to risk having any business dealings with him.
The fact that conflicting claims could arise and that they would have to be settled before impartial arbiters provides the answer to the question, "How well does a piece of property have to be marked to establish a man's claim to it?" Obviously, if the new owner wants his property to be secure, it has to be bounded (in the case of land) and marked clearly enough to establish his claim in the face of all possible conflicting claims. Suppose an eager prospector claimed a square mile of land in hilly, heavily wooded territory and marked it by erecting a six-foot tall signpost at each of the four corners. Six months later, a student who wanted the privacy of a quiet retreat came and fenced in two acres, part of which lay within the prospector's claim.
When the conflict was discovered and the matter brought to arbitration, the arbiters would very likely decide in favor of the student, even though his claim had been made later in time. It could reasonably be held that the student should not have been expected to know of the existence of the four signposts hidden in the woods and that, therefore, the prospector's "bounding" of his land had been insufficient to clearly establish his claim. Similarly, a man could land on a new planet, fence in a square mile, and then claim that, since the planet was a closed sphere, he owned all the territory outside the fence (that is, all the planet except the square mile enclosed by his fence). But he would find that no arbitration agency would decide in favor of his ridiculous claim if it were contested by a group of colonists who later landed on the other side of the planet (who could be expected to know nothing of the claim).
Different kinds of claims would have to be established by different kinds and degrees of bounding and marking, and each claim would be an individual case to be decided on its own merits. But the fact that all conflicting claims could be submitted to arbitration and that the integrity of the arbitration would be guaranteed by competition in a free market would insure the maximum justice humanly possible.
In a laissez-faire society, there would be no government to preempt the field of registering deeds. Businesses in a free market would take over this function, since it is a salable service. These companies would keep records of titles and would probably offer the additional service of title insurance (a service already offered by specialized insurance companies today).
Title insurance protects the insured against loss resulting from a defect in the title of the property he buys (as, for example, if the long-lost niece of a deceased former owner shows up and claims the property by inheritance). It would substantially reduce problems of conflicting claims, since title insurance companies would be unlikely to insure a title without first checking to make sure there was no conflict. In a free society, title insurance might also protect the insured against loss of his property due to aggression or fraud committed against him. In this case, the aggressor would be dealt with in the same manner as would any other aggressor.
There would probably be a plurality of companies competing in the field of title registration and insurance, so they would no doubt find it in their interest to maintain a computerized central listing of titles in the same way that other agencies now keep extensive files on the credit rating of consumers. In this way, they would be in the same relationship of cooperative competition as are present day insurance companies.
Because they would have competition, title insurance companies would have to be extremely careful to maintain a good business reputation. No honest person would jeopardize the value of his property by registering it with a company which had a reputation for dishonest dealing. If he made use of a shady company, other individuals and firms would have doubts about the validity of his title and would be reluctant to buy his property or to loan money on it. In a totally free market, companies would usually act honestly because it would be in their interest to do so.
An old and much respected theory holds that for a man to come into possession of a previously unowned value it is necessary for him to "mix his labor with the land" in order to make it his own.In this quote, "land" is used not in the common sense of real estate but in the economic sense of any nature-given original factor of production. But this theory runs into difficulties when one attempts to explain what is meant by "mixing labor with land." Just how much labor is required, and of what sort?
If a man digs a large hole in his land and then fills it up again, can he be said to have mixed his labor with the land? Or is it necessary to effect a somewhat permanent change in the land? If so, how permanent? Would planting some tulip bulbs in a clearing do it? Perhaps long-living redwood trees would be more acceptable?
Or is it necessary to effect some improvement in the economic value of the land? If so, how much and how soon? Would planting a small garden in the middle of a 500-acre plot be sufficient, or must the whole acreage be tilled (or put to some other economic use)?
Would a man lose title to his land if he had to wait ten months for a railroad line to be built before he could improve the land? What if he had to wait ten years? And what of the naturalist who wanted to keep his land exactly as it was in its wild state in order to study its ecology?
Of course, making visible improvements in the land would certainly help to establish a man's title more firmly by offering further proofs of ownership. It is also true that very little of the potential economic value of most land could be actually realized without some improvements being made (even a scenic wilderness area must have roads or helicopter landing fields or something to make it accessible to tourists before any profits can be made from it). But mixing one's labor with the land is too ill defined a concept and too arbitrary a requirement to serve as a criterion of ownership.
It has been objected that simply having to mark the boundaries of newly claimed property would permit a few ambitious people to acquire far more property than they could use. It is difficult to understand, however, what would be so objectionable about this situation.
If the first comers were ambitious, quick and intelligent enough to acquire the property before anyone else, why should they be prevented from reaping the rewards of these virtues in order to hold the land open for someone else? And if a large chunk of land is acquired by a man who is too stupid or lazy to make a productive use of it, other men, operating within the framework of the free market, will eventually be able to bid it away from him and put it to work producing wealth. As long as the land is privately owned and the market is free, the land will come to be allocated to its most productive uses and its prices will be bid down to market level.
Intangible property may also be marked in various ways. For example, a man may claim a certain radio wave length by broadcasting his claim to ownership on that frequency (provided, of course, that no one else has beaten him to it). Ideas in the form of inventions could also be claimed by registering all details of the invention in a privately owned "data bank." Of course, the more specific an inventor was about the details of his invention, the thought processes he followed while working on it, and the ideas on which he built, the more firmly established his claim would be and the less would be the likelihood of someone else squeezing him out with a fake claim based on stolen data.
The inventor, having registered his invention to establish his ownership of the idea(s), could then buy insurance (from either the data bank firm or an independent insurance company) against the theft and unauthorized commercial use of his invention by any other person. The insurance company would guarantee to stop the unauthorized commercial use of the invention and to fully compensate the inventor for any losses so incurred. Such insurance policies could be bought to cover varying periods of time, with the longer-term policies more expensive than the shorter-term ones. Policies covering an indefinitely long time period ("from now on") probably wouldn't be economically feasible, but there might well be clauses allowing the inventor to re-insure his idea at the end of the life of his policy.
One of the most far-reaching differences in a free market society would spring from the fact that anything which had the potential for being property would be owned. In our present society, there is an enormous amount of potential property which does not, in actual fact, belong to anyone. Such unowned potential property falls into two categories: (1) things that remain unowned because the legal system does not recognize the possibility of their becoming property, and (2) "public property."
Today's legal system, having been developed in prescientific times, recognizes that a man can own a piece of land beside an ocean but does not recognize that he can just as well own a piece of land under that ocean. And yet, as companies drilling for offshore oil have proved, there is no reason why a piece of land cannot be owned and used simply because it is covered by water. In a similar manner, lake bottoms, and, in fact, the lake itself, can be owned by one or by several individuals. Rivers are also potential property, as is the air space above and around your home, and, further up, the "corridors" of air space which airliners use in flying their regular routes.
Granted, new rules would have to be figured out governing the rights of, say, the owner of a section of river in relation to owners of portions of that same river upstream and downstream from him, but if a man can own something as nonmaterial as the copyright to a song, surely he can own a river! The problem is not that such things are by their nature unownable but that the legal system, trapped in its own archaic rigidity, prohibits them from being owned. In a free society, a man who could mine a section of ocean bottom could claim and use it without having to wait for a legislature to pass a law saying that it could be owned. This would remove a tremendous barrier to progress and to the production of wealth.
The other type of unowned potential property is what is usually known as "public property." The concept of "public property" has come down from the days when the king or local feudal noble owned the land and all those under his jurisdiction were merely allowed to hold pieces of it "in fief." Gradually, as feudalism and monarchy gave way to democracy, such royal property came to be thought of as belonging to the public as a whole and as being administered for the public by the government.
Ownership necessarily involves the right of use and disposal as the owner sees fit, barring coercion against others. Since the king was an individual, he could actually exercise control over royal properties, using them and disposing of them according to his desires. But "the public" is not an individual – it is merely the aggregate of all the individuals who happen to be living in a certain area at a certain time. As such, "the public" has no mind or will or desires of its own. It cannot make decisions, and so it cannot decide how to use or dispose of a piece of property. "Public property" is, in fact, a fiction.
Nor can the government morally claim to own "public property." Government does not produce anything. Whatever it has, it has as a result of expropriation. It is no more correct to call the expropriated wealth in government's possession its property than it is to say that a thief rightfully owns the loot he has stolen. But if "public property" doesn't belong to either the public or to the government, it doesn't actually belong to anyone, and it is in the same category as any other unowned values. Among the items in this classification are streets and highways, schools, libraries, all government buildings, and the millions of acres of government-owned lands which comprise the major portion of many Western States.The land area in the State of Nevada was 88.4% "owned" by the Federal Government (U.S.A.) in June 1968, according to the Statistical Abstract of the United States of 1969.
In a laissez-faire society, all property formerly "belonging" to government would come to be owned by private individuals and would be put to productive use. The economic boom this would be can be glimpsed from the following illustration: recently, several companies have sought to develop low-cost and plentiful power sources by tapping the energy of hot, underground water (the same thing that causes geysers and hot springs). There are several promising sources of this geothermal power, but most are on government land and the entrepreneurs were stopped because there are no laws permitting them to carry on such activities on "public property"!
As the laissez-faire society matured, it would eventually reach a state in which all potential property was actually owned. In the process of claiming unowned potential property and government "property," the present poor and dispossessed elements of our population would have plenty of opportunities to "homestead" on rural lands and in urban buildings formerly "owned" by various branches of government. This would give them a proprietary interest in something for the first time and teach them, as nothing else can, to respect the products of their own labor and of the labor of others – which means, to respect themselves and other men.
This situation of total property ownership would automatically solve many of the problems plaguing our present society. For instance, shiftless elements of the population, who had acquired no property and were not willing to work in order to earn enough money to rent living quarters, would be literally pushed to the geographic edge of the society. One can't sleep on park benches if the private owner of the park doesn't permit bums on his property; one can't search the back alleys for garbage if he is trespassing on alleys belonging to a corporation; one can't even be a beachcomber if all the beaches are owned. With no public property and no public dole, such undesirables would quickly "shape up or ship out."
Total property ownership would also lower crime rates in the same manner. A private corporation which owned streets would make a point of keeping its streets free of drunks, hoodlums, and any other such annoying menaces, hiring private guards to do so if necessary. It might even advertise, "Thru-Way Corporation's streets are guaranteed safe at any hour of the day or night. Women may walk alone with perfect confidence on our thoroughfares." A criminal, forbidden to use any city street because all the street corporations knew of his bad reputation, would have a hard time even getting anywhere to commit a crime.
On the other hand, the private street companies would have no interest in regulating the dress, "morals," habits, or lifestyle of the people who used their streets. For instance, they wouldn't want to drive away customers by arresting or badgering hippies, girls in see-thru blouses or topless bathing suits or any other non-aggressive deviation from the value standards of the majority. All they would ask is that each customer pay his dime-a-day and refrain from initiating force, obstructing traffic, and driving away other customers. Other than this, his life-style and moral code would be of no interest to them; they would treat him courteously and solicit his business.
Another aspect of total property ownership is that it would make immigration laws unnecessary and meaningless. If all potential property were actually owned, any "immigrant" would have to have enough money to support himself, or a marketable skill so he could go right to work, or someone who would help him out until he got started. He couldn't just walk into the free area and wander around – he'd be trespassing. Those who were skilled and ambitious would come; those who were lazy wouldn't dare to. This is much more just and effective than the present "national quota" system.
The pollution problem would also be well on its way to being solved. If I own the air space around my home, you obviously don't have the right to pour pollutants into that air space any more than you have a right to throw garbage onto my lawn. Similarly, you have no right to dump sewage into my river unless we have a contract specifying that you may rent the use of my river for such purposes (and that contract would have to include the consent of all those individuals who owned sections of the river downstream from me, too). Since pollution is already a problem in many areas, it would have to be understood that anyone buying a piece of property, by his act of buying it, consented to the average pollution level at the time of the sale but had the right to see that others kept it free of any further pollution.
Initially, this would mean that established companies could not increase the level of their pollution, nor could new companies begin polluting. But as pollution control methods and devices became common and relatively inexpensive, the established companies would seek to reduce and even to eliminate their pollution in order to keep from losing their employees to new industries operating in pollution-free areas. Pollution problems could not continue to exist in a competitive, laissez-faire, free market environment – an environment which governments destroy.
Total property ownership, contrary to the current popular belief, is the only feasible way of conserving natural resources. The conservation of resources is a subject badly befogged by misconceptions and unclear thinking. For example, it is contended that the market wastes scarce resources, thus robbing future generations of their use. But by what criterion does the critic decide which employments of resources are permissible and which are merely waste? If it is wrong to use up resources to produce some things consumers value, how can it be right to use them to produce any such things? And if natural resources must be saved for future generations, how can they ever be used at all, since each future generation still has a theoretically infinite number of future generations coming after it, for which it must save?
The only answer to the problem of scarce resources is to leave it up to free men trading in a free market. This will insure that resources are used in the most value-productive way possible and that they are used at the rate which consumers desire. Besides this, the technology stimulated by a free market continually uses natural resources to discover new natural resources.
This means more than just the discovery of new deposits of previously valuable resources, such as vast new oilfields. It also includes the discovery of how to use previously valueless resources, often to replace a scarcer resource in some area of use, thereby conserving it. An example of this is the many new uses of glass and plastic, some of which can replace steel and other metals derived from scarce resources.
There is a curious misconception that to prevent the wholesale waste of natural resources it is necessary to remove control of them from the hands of "greedy capitalists" and give it to "public-spirited government officials." The ridiculous fallacy of this position becomes obvious when one considers the nature of the control exercised by a government official.
To the extent that he has control over a natural resource (or anything else), a government official has a quasi-ownership of it. But this quasi-ownership ends with the end of his term in office. If he is to reap any advantage from it, he must make hay while his political sun shines. Therefore, government officials will tend to hurriedly squeeze every advantage from anything they control, depleting it as rapidly as possible (or as much as they can get away with).
Private owners, because they can hold their property as long as they please or sell it at any time for its market price, are usually very careful to conserve both its present and future value. Obviously, the best possible person to conserve scarce resources is the owner of those resources who has a selfish interest in protecting his investment. The worst guardian of scarce resources is a government official —he has no stake in protecting them but is likely to have a large interest in looting them.
Among the resources which would be conserved best under a system of total property ownership are wildlife and scenic recreation areas. Consumer demand for parks, campgrounds, wildlife sanctuaries, hunting grounds, natural scenery, etc., is evident from a study of recreational patterns. In a free-market society, just as much land would be set aside for these purposes as consumer demand warranted.
A system of total property ownership would be based on the moral requirement of man's life as a rational being,That man is a rational being means, simply, that he is capable of rational thought and behavior; it does not mean that he will automatically think and behave rationally since, for this, he must make the choice to do so. Since man's consciousness is volitional, he is free to (1) not choose and to (2) choose not to think, as well as being free to choose to think. To survive, man must think; the choice to do so must be made by each person, individually and independently – by himself, alone. The choice to think or not can only be made by individuals; society does not have a brain to think with. as man's survival is sub-human to the extent that the right to own property (beginning with self-ownership) is not understood and respected. (As a matter of actual fact, life itself would not be possible if there were no right to own property.) A system of total property ownership in a free society – i.e., in a society in which the right to own property is generally understood and respected – would produce a peaceful environment in which justice was the rule, not the exception (as it is today).
An environment of justice is based on the moral principle of "value for value" – that no man may justifiably expect to receive values from others without giving values in exchange (and this includes spiritual values, such as love and admiration, as well as economic values). Some people express shock and even horror at the thought of having to make some sort of payment for every value they receive. They seem to prefer, for example, to pay for their use of roads via taxation (even though this method is demonstrably more expensive) in order to be able to pretend to themselves that they are actually getting the service free.
Upon examination, such people usually prove to be suffering from a deficiency of self-esteem – lacking a sense of personal efficacy and worth, they feel a sneaky, unadmitted doubt about their ability to survive in a world where they will never be provided with the unearned. But their psychological problems do not alter the nature of reality. It still remains a fact that the only moral way for men to deal with one another is by giving value for value, and that the man who seeks the unearned is a parasite. The man of self-esteem realizes this and takes pride in his ability to pay for the values he receives.
From an examination of the areas covered in this and the preceding chapter, it is clear that a non-governmental, free-market society would, by its very nature, foster responsibility, honesty, and productivity in the individuals who lived in it. This would cause a substantial improvement in the moral tone of the culture as a whole, and a sharp drop in the crime rate. Nevertheless, since human beings are creatures with a volitional consciousness and are thus free to act irrationally if they so choose, there can be no such thing as a Utopia. A free-market society would still have to have means for the arbitration of disputes, the protection and defense of life and property, and the rectification of injustice. In the absence of government, institutions to provide these services would arise naturally out of the market.
This article is excerpted from chapter 6, The Market for Liberty.
In this article I will revise Mises and Hayek’s thesis about the proper categories of economics. In their view, classical economics was successful in identifying the right concepts of economic science, but its aggregative (universalistic) and objective approach was not satisfactory.
Volume 22, Number 1 (2010)
Utility is the importance that we attach to things. We make choices on the basis of this importance. Indeed, in economic terms, "utility," "importance," and "value" are synonyms. We choose what is more important to us and give up what is less important. Utility is subjective.
Carl Menger (1840–1921) is the father of this subjective theory of value. He states, "value is therefore nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being."
There is no economist — except those who adhere to the failed labor theory of value — who denies this proposition. However, it seems there are many who, along the way, have forgotten what Menger meant by "diminishing marginal utility."
This essay is based on the following postulates of the subjective theory of value: (1) utility is always marginal, and (2) something has utility only if it satisfies a human end.
The law of diminishing marginal utility simply states that every additional unit of a homogeneous good or service is worth less than the previous unit. This law follows directly from the fact that we attach different value to different things, the fact that we choose more valuable things over less valuable things, and the fact that we exist in time. The first unit of a homogeneous good or service is the most valuable because we use it for the satisfaction of the most important end.
The second unit goes for satisfaction of the second most important end. Thus, the second unit is less valuable than the first unit. The third unit is less valuable than the second for the same reason, and so forth.
Murray Rothbard, in his article "Toward a Reconstruction of Utility and Welfare Economics," and in his treatise Man, Economy, and State, elaborated on the law of diminishing marginal utility. Art Carden, in "Diminishing Marginal Utility: It's a Law," further clarifies why diminishing marginal utility is "more than merely empirically demonstrable: it is irrefutably true."
This law applies to everyone, because claiming that a person would choose something he or she values less over something he or she values more defies the laws of logic. The act of choice is an expression of preference. Preference is not a psychological concept but a logical one, and it can be summarized simply as follows: I choose, therefore I prefer.
Risk Aversion, Risk Neutrality, and Risk LovingnessMainstream economics explains risk aversion using diminishing marginal utility. This approach was promoted in the works of Milton Friedman and Leonard Savage.
Risk aversion is defined as follows: A person is risk averse if he or she prefers a certain outcome over an uncertain one, with the same expected money outcome. For example, a person would be considered risk averse if he or she preferred receiving $3,000 for certain instead of a fifty-fifty gamble where he or she could get either $1,000 or $5,000. This is explained using diagrams similar to the one shown in Figure 1.
It is said that a risk-averse person has this preference because his or her expected utility (EU) of the gamble (point A) is less than the utility of a certain money income of $3,000 (point B). And this is because the utility function has a negative second derivative, which is assumed to be the same as diminishing marginal utility.
Figure 1A diminishing-marginal-utility functionIt is then said that most people are risk averse, but some are risk neutral, and some are risk loving. Risk neutrality is then explained using a constant-marginal-utility function, and risk lovingness is explained using an increasing-marginal-utility function.
Figure 2 is a graphical representation of a risk-neutral person's preferences within the Friedmanite framework. This person's preferences are described using a linear, neutral, utility function.
This means that the utility of an additional dollar does not change with the amount of money the person already possesses. He or she values each additional dollar just as much as the previously acquired dollar. It turns out that he or she would be indifferent between the same fifty-fifty gamble that was rejected by the risk-averse person from Figure 1, and a certain gain of $3,000. This is explained by indicating that the expected utility (EU) of the gamble (point F) is identical to the utility of a certain gain of $3,000 (point E).
Figure 2A constant-marginal-utility functionFinally, there may be a person who would choose to take this gamble, in which he or she may end up having either a $1,000 or $5,000 with equal probabilities. This person would be called risk loving, and his or her utility function is shown in Figure 3.
This is an increasing-marginal-utility function, and it is characterized by an increasing slope. It is supposed to describe preferences where a person values each additional dollar more than the previously acquired dollar. The explanation for this person's choice is that the expected utility (EU) of the gamble (point C) is higher than the utility of a certain gain of $3,000 (point D).
Figure 3An increasing-marginal-utility functionThere are at least two problems with this explanation. First, utility, as a subjective state of mind, does not conform to algebraic operations. Thus the meaning of "average utility" is unclear.
Second, there is no such thing as constant or increasing marginal utility, as is assumed by the use of a utility function. In the Austrian approach, there can only be diminishing marginal utility. This truth was established by the two principles at the beginning of this article.
How Then Do Austrians Explain Gambling?To reiterate, in order for every unit of a homogeneous good to have value, each unit needs to satisfy an end. All ends are ranked on a scale in the order of decreasing importance. We use the first unit of a good to satisfy the most important end. The second unit is used for the end that is next in importance, and so forth. Each additional unit is less valuable to us because it is used for an end of lower importance. Thus, marginal utility is always diminishing.
In the language of mainstream economics, this would mean that everyone is risk averse and no person would ever accept a gamble in which he or she could either win or lose the same amount of money with equal probabilities (i.e., the so-called fair gamble). There is no need for sophisticated empirical observation to notice that something went wrong here.
What went wrong is that in Friedman's approach, there is an attempt to decompose the utility of an activity — gambling — into the money segment and an abstract risk segment. Then, depending on the contribution of the risk segment to the utility of the whole gamble, people are classified into different categories.
But this is incompatible with the Mengerian definition of utility in several ways. First, as Menger stated, we attach utility only to things that we see as means of satisfying an end. Playing a round of roulette is an end. This end could be satisfied by going to a casino. Thus, utility would be attached to going to a casino and playing the round of roulette. On the other hand, experiencing risk is neither an end nor means because it is not clear what risk is nor how it is to be experienced.
Second, it is not clear how utility, as a subjective state of mind, could be meaningfully decomposed into segments by an external analyst. Third, and perhaps most important, explaining differences in preferences across individuals is simply outside the scope of economics.
To illustrate how the Austrian perspective on gambling and risk differs from Friedman's approach, imagine the following situation: A person, Jim, is approached by his friend, Janis, and asked if he wants to play a game. In this game, Jim and Janis would each put $2000 on the table. Then they would take one coin, and each pick heads or tails. The person whose pick ends up on the top gets all $4000 lying on the table. Suppose also that Jim had $3000 in his pocket at the moment he met Janis.
Following the logic of mainstream economics, Jim is facing a set of monetary payoffs identical to those in figures 1 through 3. Depending on his risk type, constructed by conveniently picking different utility-of-money functions, he may accept or reject the gamble, or even be indifferent.
In the Austrian perspective, Jim's decision is put into a different context. He could either say no to Janis and use his time and money to do something else, or he could say yes and enter this game.
When making his choice, Jim will consider all the attributes of the offered game. The act of choice is an expression of preference for the whole package that comes with the game. Its attributes — number and magnitude of possible payoffs, uncertainty of the payoffs, etc. — are not goods.
Thus, one cannot talk about preferences for risk independently of the real human activity that has risk as one of its attributes. One can, however, talk about preference for the activity — i.e., gambling. Still, there is no need (and even no way) to explain how this preference came into existence or how it is affected by the different attributes of the activity in question.
If Jim chooses to join in and play the game, an Austrian economist would say that his expected marginal utility (because utility is always marginal) of the game was higher than the expected marginal utility of anything else Jim had thought of doing instead, using his limited time and resources. The gamble was higher on his value scale.
But the thought mechanism that leads Jim to position the gamble above all other alternative uses of his time and resources is outside of the Austrian area of concern. In other words, it is not important why he likes the game. For example, Murray Rothbard, in Man, Economy, and State, describes gambling as a purposeful attempt to create uncertainty just for the fun of it.
MP3CD$20 $15
Audiobook read by Jeff RiggenbachThus, it is not necessary to go further than saying that some people gamble because they like it. This is why, for Austrians, there is no need to construct an artificial, ad hoc thought process that would supposedly predict human behavior. Human action, not prediction, is the centre of the Austrian approach.
In conclusion, when it comes to the origins of attitudes toward risky events, some economists have stepped into the territory of another discipline — psychology. The thought mechanisms that lead some people to like (or, as economists say, have preference for) gambling are of no more economic interest than the reasons why some people like going to soccer games while others like to stay at home. Answering such questions may be a job for psychologists, but it is not one for economists.
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Being ill is not a phenomenon independent of conscious will and of psychic forces working in the subconscious. A man's efficiency is not merely the result of his physical condition; it depends largely on his mind and will, writes Ludwig von Mises (1881–1973).
This audio Mises Daily is narrated by Jeff Riggenbach.
The freedom of a person to act according to his will in his property implies by symmetry that aggressions against others are ethically unacceptable. An illegitimate aggression is any sufficiently intense adverse physical interference caused by a person on another's property.
A problematic and possibly important case is the alteration of environmental conditions as in a hypothetical climate change, which could have both positive and negative effects depending on the subjective valuations and particular circumstances of human beings. If climate change is considered a problem, it does not follow automatically that it has to be stopped or minimized at whatever cost it takes: humans are especially good at adaptation, and government does usually more harm than good.
Freedom, Property, and AggressionA normative ethics with universal, symmetric, and functional rules is based upon the fundamental principle of property rights. The ethics of freedom and property rights is the natural law, the system of norms adequate to human nature that permits harmonious and peaceful social coexistence and development by avoiding, minimizing, or solving conflicts as much as humanly possible.
Property is the domain of legitimate decision by the owner, the space in which each person is free to act according to his preferences without violent interference from others, whose valuations in this regard are ethically irrelevant. All peaceful actions by the owner in his property are permitted, and no actions are obligatory (there are no natural positive duties).
The right to property is a negative right of noninterference. Humans do not have natural positive rights that imply that others must do something for them, and there are no natural duties towards others (present or future). Positive rights and duties arise by means of contracts.
Freedom does not mean absolute absence of restrictions: my freedom ends where the freedom of others begins; my property is finite and limited by other people's properties. Freedom and property rights are equivalent to the nonaggression axiom: the initiation of force is not legitimate; force may be used only for defense and justice. Aggression, the invasion of the property of others without their consent, is forbidden. The aggressor must repair the damages and compensate the victim.
Aggression is not only the narrow-sense notion of criminal violence performed by a person against another one and his possessions (murder, assault, injuries, rape, kidnapping, theft). Aggression in an abstract sense is any sufficiently intense adverse or noxious physical interference caused by a person or his possessions on another person's property.
"The more actions are considered illegitimate aggressions, the more use of force is justified."Being the owner of something is not always good: property does not only imply the right to enjoy and use means of action. Property can be bad: the owner is responsible for the damages that his actions and his possessions could cause on others (intended or unintended, known or unknown, foreseen or unforeseen). All actions imply the production of undesired residuals or waste that must be taken care of by the owner so that they do not damage others.
All real things are directly or indirectly interconnected by fundamental forces, so that a change in one entity causes some effect, small or big, on other entities. But ethical rules refer only to changes and effects caused by human action that can damage others and create conflicts.
These interactions can involve matter (solid, liquid, gas; macroscopic or microscopic particles), energy (heat, electromagnetic waves, pressure waves) or alterations of natural environmental conditions (luminosity, pressure, temperature, winds, humidity). Effects can be strong or weak, concentrated or diffuse, direct or indirect, local or global, frequent or infrequent, cumulative or noncumulative, instantaneous or delayed, temporary or permanent.
Due to the limitations of the human mind, reality is often studied in a simplified way as if it were linear and simple; but nature is in fact a complex network of entities and relationships. A cause can have multiple effects over different persons, some positive and some negative.
An effect can have multiple causes, natural or artificial, from one person or from many people doing the same thing (like breathing) or complementary things (like making and driving cars, or like producing and consuming energy). In chaotic nonlinear systems, small causes can have big effects (due to amplifiers, destabilizers, or positive feedback loops), but also big causes can have small effects (due to dampers, stabilizers, or negative feedback loops).
In order to be qualified as aggressions, real events must at least be physically detectable, psychologically perceptible, and relevant for human preferences. Objective real conditions do not automatically constitute problems. It is human valuations which perceive situations as opportunities or threats, benefits or damages, goods or bads. And it is the possible incompatibility of subjective human preferences that originates conflicts: what one likes another may dislike.
The specific contents of the notion of aggression are open and debatable; it is not a concept with sharp boundaries, it is partially fuzzy and arbitrary. It cannot be fully determined by deduction using pure reason, it depends on customs, traditions, conventions (blocking sunlight, high-intensity lights, high-volume sounds, pollutants). Some objective criteria can be used to determine whether an event is more adequately considered an aggression or not: intensity, directness, extension, duration, accumulation.
"There is no natural duty to preserve the environment, which has no intrinsic value because valuations are products of mental activity."A functional ethics of freedom needs to include responsibility principles and rules for legitimate defense. The traditional and sensible principles of justice place the burden of proof of aggression on the accuser, who must prove beyond reasonable doubt the guilt of the accused. It is not the accused who must prove his innocence (if it were so, every person should have proof of innocence for every action and moment in his life, because he could always be accused of something).
Legitimate defense may be invoked by the actual or possible receiver of the effects of an action if there is clear, present and provable danger, and not just if someone cannot fully assure that there is not. Defense becomes illegitimate (it becomes aggression) if it cannot be proved that there is a danger of real damage.
The precautionary principle proposed by many environmentalists demands that the initiator of an activity proves its complete harmlessness and that the government does not need to prove probable harm in order to stop it. Proving that something is absolutely innocuous is impracticable in new domains, where learning is performed by trial and error, and therefore this principle would paralyze innovation. Knowledge acquisition is costly, and full knowledge is impossible.
The notion of aggression is based on the consequences or results of actions (the real effects in the world), and not on the knowledge or intentions of the agents. Instinctive moral feelings tend to excuse or diminish responsibility if there is no intentionality or if the damages are unforeseen, secondary effects: this is so partly because moral feelings evolved as genetic instincts in past times when our human ancestors had little capabilities of action.
But with capital and technological accumulation, it is necessary to demand responsible use of powerful tools, and warn persons that their ignorance or lack of foresight will not excuse them for the damages they might cause. This kind of rule provides incentives for agents to fully consider all possible consequences of their actions, and not only the ones they intend to achieve, because they will be judged according to the real effects of their actions.
Property rights work very well when reality is easily separable, and when the effects of actions are direct, local, concentrated, and falling mainly on the owner and nearby others easy to identify. But elements of reality are often intertwined in messy ways. Solid macroscopic objects tend to stay in their stable positions; but fluids (liquids and especially gases) tend to move, and photons and thermal energy tend to flow; these factors spread and cross legal boundaries unless stopped by some physical barrier.
Externalities are effects of actions of an agent on the property of others; they can be positive (like gifts, not forbidden and not obligatory) or negative. An aggression is a negative externality. Diffuse negative externalities are problematic and difficult to regulate. Many victims could suffer a very small nuisance or loss from the actions of one agent: it might seem ridiculous to consider illegitimate actions that produce such small effects and it would be very costly for each of the victims to demand the agent to stop or to compensate them.
Externalities can become important due to the cumulative and persistent effects of small actions of many agents. In a clear aggression it is possible and relatively easy to determine who is doing what to whom, who must be stopped or who must compensate whom for what. In diffuse externalities it can be very difficult to determine and connect agents, actions, effects and receivers of effects.
Since aggressions imply damage, it might be naively considered that it is better to make it a very inclusive notion, so that many losses are avoided. But accepting that something is an aggression and forbidding it has consequences that might be worse than simply tolerating it. The more actions are considered illegitimate aggressions, the more use of force is justified.
Costs of the system necessary to detect and punish the aggressors and compensate the victims could exceed its benefits (always bearing in mind that it is extremely problematic to perform interpersonal comparisons and additions or subtractions of utility or social cost-benefit analysis). It might be better to learn to live with some changing realities — to adapt to them — than to try to avoid them. Especially because humans are good at adaptation, by means of which they have colonized most of the planet, in very different environmental conditions.
Automatically giving the State the responsibility to deal with diffuse negative externalities can be a huge mistake. The State is the monopoly of jurisdiction and violence, and it is often illegitimate (dictators, or even democratic leaders according to anarchists), very inefficient and possibly corrupt (lack of motivation or incentives and lack of knowledge or impossibility of socialism, public choice theory).
What is often called market failure is often just the result of inadequate determination of property rights. Markets are never perfect because human beings are limited in their abilities; proposing that the State fixes alleged problems that individuals cannot solve freely seems to forget that the State is also made up of humans, and perhaps not the best ones (bureaucrats are not disinterested angels, and the worst might get to the top).
Climate ChangeEthics concerns only human beings: there is no natural duty to preserve the environment, which has no intrinsic value because valuations are products of the mental activity of cognitive emotional agents.
Contamination above certain levels is usually considered an illegitimate aggression because pollutants directly damage human beings and have no beneficial effects. Climate change is related to the environment but it is very different from contamination.
Anthropogenic climate change might occur due to changes in land use and emission of greenhouse gases. Changes in land use can alter the reflectivity or albedo of the surface of the planet, and it seems hard to consider them an illegitimate action.
Carbon dioxide is a greenhouse gas that results from respiration and from burning fossil fuels; labeling it as a contaminant is an abuse of language, since it is necessary for photosynthesis and it is not toxic. Some human activities, like growing trees, take carbon dioxide off the atmosphere. It is extremely difficult to prove specific relationships between human carbon dioxide emissions, local climate changes, and their particular effects.
Climate change, be it global warming or cooling, has multiple possible causes and effects, and the valuation of the effects can be different in different parts of the planet. Cold regions may welcome warming and lament cooling, warm regions may welcome cooling and lament warming. Climate-change alarmists seem to be climate reactionaries accepting no change.
There is no optimal climate, and conflicts for the climate's determination may arise if humans achieve partial control over it. Even if humans are adapted to the present climate, this does not imply that it would be difficult to adapt to different climates if the changes are not excessive.
"There is no optimal climate, and conflicts for the climate's determination may arise if humans achieve partial control over it."Climate change could happen quickly on a geological scale, but it is slow on a human scale, permitting informed adaptation and planning for the future. Climate change mitigation policies have certain, huge costs in the present and would provide uncertain, small benefits in the future. The relatively poor of today would sacrifice to help the relatively rich of tomorrow.
Temperature is not the only phenomenon associated with climate change and it is possibly not the most relevant for human welfare, since humans live in wide ranges of temperature. Sea level, precipitations, and extreme weather events can be much more important.
Sea level can slowly increase due to global warming, but the process is very slow, so that protections can be prepared and capital amortized if necessary; freedom of migration can help relocate people whose lands become inhabitable. Precipitation should in general increase with global warming, although its distribution might change. And the dependence of extreme weather events on temperature is complex and little known.
For almost all human problems associated with global warming, the influence of climate on them is usually small if compared with other more important factors that can be more easily and efficiently dealt with. Climate change alarmists seem to ignore relatively simple solutions for the problems they raise. Humans are proactive, they do not passively submit to natural influences, and the avoidance of climate change is not necessarily the best option.
Fresh water is a problem where there are no property rights, markets and prices for water. Tropical diseases depend strongly on socioeconomic conditions. Undeveloped nations are poor mostly due to inadequate social institutions, not because of environmental conditions.
Heat waves can be dealt with by means of proper air conditioning (and global warming would reduce cold waves and their associated deaths). The extinction of species is mostly due to habitat destruction or invasion by humans (or direct killing, hunting or fishing).
Global warming catastrophists seem to forget other more important and urgent issues which compete for the allocation of the scarce resources demanded for climate-change mitigation. It is preposterous to declare global warming the worst problem for mankind when there is war, hunger, sickness, and poverty.
For some radical environmentalists and many politicians, climate change is the most important problem for human civilization, and they pretend to speak in the name of all mankind. But all problems seem to be extreme for them, because they have no notion of relative opportunity costs. Their moral language imposes duties on citizens who seem to be receiving orders about what they must do and what they must avoid no matter what.
Governments are supposed to be necessary to protect their citizens against aggressions, but they are very incompetent at this task, they often perform their own institutional aggressions by prohibiting perfectly peaceful and voluntary activities; and now with climate change they seem to consider anthropogenic global warming an illegitimate undesirable action.
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Some radicals even try to censor and criminalize dissent from skeptics, deniers, or minimizers. But thought and speech, even if wrong or false, are never real crimes. There may be special-interest groups on both sides of the debate fighting for their favorite public policies: not only oil, coal, and nuclear companies, but also heavily subsidized renewables.
While the official mainstream climate science may well be correct, its ignorance regarding economics, political philosophy, and law is huge. The most important entities for a human being are other human beings (for the good and for the bad), and not the environment. Humans can be especially damaging when organized politically and inspired by collectivism.
The possible damages of climate change should be compared to the possible damages of governmental bureaucratic intervention and political oppression. Maybe the whole global-warming scare is an excuse to increase the extension of political power or a distraction from other serious problems. Social institutions matter most, and they are very wrong now: a huge improvement is possible, and freedom is the answer.
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[Originally published in the Freeman, 1982.]
The publication of Adam Smith's The Wealth of Nations in 1776 is often considered the starting point of the science of economics. However, it was Menger's Grundsitze (1871), along with the works of Leon Walras and William Stanley Jevons that began the modern period of economic thought. Significantly, Menger's ideas provided the foundation for what is today classified as the Austrian School of economics. This important book of Menger's was not translated into English until almost eighty years after it was written. [It is offered anew by the Mises Institute. – Ed.]
Menger is perhaps best known for his development of marginal-utility theory, discovered almost simultaneously by Jevons and Walras. However, to comprehend fully the importance of Menger's achievement one must understand the context into which it fits. It was Menger who elaborated the logical foundations of marginal-utility theory and it was his Principles specifically that served as the basic textbook for the Austrian economists (Böhm-Bawerk, Mises, and Hayek in particular) who followed him.
Menger began his formulations with a stress on methodology. He treated economic as a science: "The phenomena of economic life, like those of nature, are ordered strictly in accordance with definite laws."
The purpose of the study of economics is to understand "the conditions under which men engage in provident activity directed to the satisfaction of their needs."
Due to the scarcity of available means, especially time, but also labor and resource goods, individuals must choose which ends to attempt to satisfy. Menger calls this choosing "economizing" and focuses his study on the economizing individual.
Value theory is central to economics: what gives a thing value? Is value intrinsic to an object, as early economists surmised? No, replies Menger, because "goods of the same kind and in the same place lose their economic character with changing circumstances."
Is the value of a good related to the amount of labor required to produce it, as Ricardo thought? No again, says Menger, for "experience tells us that many goods on which no labor was expended display economic character whenever they are available in quantities that do not meet our requirements."
Menger concludes that the
value of goods is entirely subjective in nature.Value is thus nothing inherent in goods, no property of them, nor an independent thing existing by itself. It is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence, value does not exist outside the consciousness of men.
Contained in the previous passage is what Israel Kirzner calls Menger's Law. It is an important aspect of Austrian economics. The value a person attaches to a good at his disposal is based upon the value he places on the end it will enable him to satisfy. If certain goods cannot in any way satisfy a person's ends, he will not attach value to those goods. If, however, someone lacks only one good that is necessary to satisfy a specific end that presently is valued more than any other end, and if no substitutes to that good are available, the value he attaches to the good (the means to his end) will be considerable.
From Menger's Law it follows that resource goods and producer goods are valued according to the value of the ends they serve. Furthermore, the ends they will ultimately serve are determined by the consumer. Therefore, the consumer is the source of value and the guiding force in a market economy. Austrian economic thought places consumer demand in the role of guiding the production in an unhampered economic system.
$24 $20
Although Menger is acclaimed primarily for his role in developing what is now known as marginal-utility theory, his writings on methodological individualism, subjective value, and the economic character of goods ("Menger's Law") deserve more attention. His Principles is so lucid and understandable that it can serve as an introduction to economics for the intelligent laymen with no background in the subject.
This new edition [with an introduction by F.A. Hayek and a new foreword by Peter G. Klein – Ed.] should guarantee that the work that has served as the basic text of successive generations of Austrian students and scholars will continue to improve economic understanding for years to come.
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[Create Your Own Economy: The Path to Prosperity in a Disordered World • By Tyler Cowen • Dutton, 2009 • viii + 259 pages]
Tyler Cowen has written an unusual book. From the title, one expects a book that addresses the current economic crisis and prescribes a remedy for it. Instead, Cowen concentrates on the traits and virtues of autistic people. If Cowen wants to write on this topic, why does he lead the reader to think he will discuss something else?
But Cowen's principal topic is not as irrelevant to the economy as one might first imagine. He contends that autistics often possess the ability to classify things in unusual and illuminating ways. They are especially good at seeing details ignored by others; indeed, Cowen points out, suggestions abound that many great thinkers have displayed autistic traits:
Charles Darwin, Gregor Mendel, Thomas Edison, Nikola Tesla, Albert Einstein, Isaac Newton, Samuel Johnson, Vincent van Gogh, Thomas Jefferson, Bertrand Russell, Jonathan Swift, Alan Turing, Paul Dirac, Glenn Gould, Steven Spielberg, and Bill Gates, among many others, are all on the rather lengthy list of famous figures who have been identified as possibly autistic or Asperger's [a related condition]. (pp. 25–6; A roughly similar, but not identical, list appears on pp.166–7)
Cowen applies some of the wisdom he gleans from the autistics to contemporary economic problems; and it is on one particular aspect of his treatment that I wish to concentrate. As we shall see, in doing so, I run the risk of being suspected of autism, at least by Cowen's definition; I too am concentrating on a few details.
Cowen makes a strong case for viewing autistics with sympathy, and his views on autism are the product of long study. But in his characterization of autism he seems to me to have taken a dubious turn. Cowen suggests that the personality problems often associated with autism do not form part of its essence. Autistics need not be isolated and withdrawn, able to communicate with others only with great difficulty. Indeed, some autistics may deal with others so successfully that their autism goes undetected.
Perhaps the personality traits most people associate with autism stem from a biased sample.
Medical professionals control the familiar definitions of autism and they meet those people or parents who come to them for help. It's no surprise that these people and their doctors are focused on life problems. At the same time, many of the autistics with relatively high social status don't want to affiliate with the concept, or, more frequently, they are genuinely unaware that they might qualify as autistic in some manner. (p. 23)
But this argument raises a problem. Once one drops personality disorders from the definition of autism, what is left? Evidently it is the ability to classify and the illuminating concentration on detail. Certainly these are highly desirable characteristics; and if they are the essence of autism, then Cowen is right that we have much to learn from those in this condition. But, taken this way, anything distinctive about autism has dropped out of the picture. All that Cowen would be saying is that to classify things in a creative way is a good trait.
An analogy will clarify my objection. David Shapiro has argued in his excellent Neurotic Styles that paranoids can often see details that "normal" people miss.Basic Books, 1999 [1965]. See chapter 3, "Paranoid Style," pp. 54ff. It would not be a good idea to conclude from this fact that paranoia should be defined to encompass only excellent perception of details, and to omit the behavior generally viewed as disordered.
There is an obvious response to this objection. Cowen might say that it is not any instance of creative classification or attention to detail that marks someone as autistic. Rather, there is a distinctive intellectual style that characterizes autistics. To show this, he needs first to delimit a sample of autistics; but in his discussion, he appears to do so by looking at autistics in the ordinary-language sense.
Cowen's autistics do possess the odd personality traits in question; so it is not clear on what basis he deems these personality traits inessential to autism. He might respond that the distinctive intellectual type associated with autistics in the ordinary-language sense may exist without the personality disorders; and if it does, people with this intellectual style still count as autistic. But, though readers must judge for themselves, I cannot see that he has succeeded in specifying a distinct manner of intellection.
Cowen thinks we can learn from autistics, but he does not think we should place unlimited reliance on unusual systems of classification, however creative they may be. Here he takes a lesson from Buddhism, which stresses the fleeting character of our concepts. "Most fundamentally, Buddhist philosophy is suspicious of complex forms of mental ordering and that is where Buddhism parts company with autism" (p. 94).Cowen cites a characteristically wide number of publications on Buddhism, but I'm surprised he makes no mention of the most elaborate discussion of Buddhism by a noted economist, Serge-Christophe Kolm, Le bonheur-liberté: bouddhisme profond et modernité, Paris, 1982.
In the course of his discussion of autism, Cowen makes a contribution that readers of The Mises Review will find of great value. He has given us a penetrating and subtle criticism of the use of behavioral economics to support government intervention in the economy.
Some behavioral economists, e.g., Richard Thaler and Cass Sunstein, argue in the following way: People often act irrationally. They let emotion overcome reason or commit straightforward mistakes in logic. Such "choices" do not reflect such people's true preferences. The state may justifiably act to nudge people toward what they really want. Such "libertarian paternalism" does not interfere with freedom in any objectionable way.See my review of Thaler and Sunstein, Nudge, in The Mises Review, Summer 2008.
Cowen raises two criticisms of this argument. First, the "mistake" may not be an error but rather reflect someone's idiosyncratic classification. If the state "nudges" people out of a choice based on such a classification, it will add error rather than remove it. Further, even if someone has in fact made a mistake, the error may be the inevitable product of some scheme of classification that on the whole works well.
Behavioral economists sometimes write of human beings as subject to "framing effects," meaning that the presentation of the alternatives influences our choices.… Usually the presumption is that framing effects are to be avoided. To be sure, many framing effects are irrational but framing effects help put the guts into our lives. We spend time and energy framing things in the right way so that we can enjoy them more or learn more from them (p. 6).
Once more, heavy-handed interference will disrupt things, not make them better.
Cowen also suggests that a similar mechanism serves to block a related criticism of the free market. John Kenneth Galbraith, echoed by many others, claimed that consumers on the free market are not at all sovereign, as Mises contended. Quite the contrary, mass advertising campaigns ensure that consumers will choose what businessmen decide to produce. Cowen notes that consumers can shield themselves from the effects of such advertising by availing themselves of specialized markets.
In this connection, the Internet enables people to find such markets much more efficiently than was previously possible. "The competitive pressures from free fun on the web affect marketing prospects for virtually all goods and services, again because there is competition. If you're trying to addict me to drinking expensive bottles of red wine, such a habit now has some especially cheap competition, again as can be found on the web" (p. 142). Cowen's discussion of the advertising argument is one of the best since Hayek's classic, "The Non Sequitur of the 'Dependence Effect'."
Cowen invokes Hayek to argue that, instead of using the state to "correct" people's behavior, thus enabling them to realize their true preferences, it is far better to confine law to a strict system of general rules:
Most of all Hayek is skeptical about the ability of human beings to plan all outcomes in advance by using their reason. Hayek argued that a rich and largely unplanned order can blossom when society is governed by a relatively small set of abstract rules.… You don't have to share Hayek's conservative and libertarian version of this blend to find this an appealing vision. (p. 201)
Cowen, in his typically understated way, has in these instances ably defended a view consistent with libertarianism. I suspect that he has not deviated from his Austrian and libertarian roots as much as is sometimes imagined, though he is by no means a libertarian of the strict observance. But though his arguments just canvassed have great value, I sense in them a danger. If pushed too far, his line of thought could lead to an undue subjectivism, in which people's perceptions and classifications, rather than what actually occurs, would be the sole issues of importance.
I do not say that Cowen has succumbed to this danger, but his discussion of Robert Nozick's "experience machine" brings out what I have in mind. Nozick imagines a machine that will enable someone plugged into it to have any experiences he likes. If you were able to use the machine, would you do so? Nozick suggests that people would often refuse. Does this not show, against at least some versions of hedonism, that there is more to value than experiencing things "from the inside"?
Cowen responds that in some circumstances, people would choose to enter the experience machine. No doubt he is right, but to stress this fact is to ignore the thrust of Nozick's argument. Nozick's point is not that we would never choose to enter the machine but that we sometimes wouldn't, which suffices to show that value cannot be reduced to subjective experience.
But this is not the key indication of what I take to be Cowen's unduly subjectivist turn. This emerges rather from his suggestion that Nozick's argument rests on a questionable appeal to an "authentic" world, bereft of human ideas. Cowen suggests that we have no access to a world-in-itself; our perception is inevitably structured by our concepts and theories.
I don't think the so-called real world is very "authentic" at all. No one who refuses to plug into the machine is in fact choosing or defending pure authenticity. (p. 144)
But Nozick's argument does not depend on a direct realist theory of perception. Quite the contrary, it need only appeal to our ordinary notion of the actual world. So long as there is a distinction between doing something and imagining it, and we think this distinction important, Nozick's argument works. Cowen, by neglecting this point, is in danger of having constructed a defense of individuality that severs us from the world.
Nevertheless, he has given us a book of great value, and in it his remarkable range of reading is much in evidence.
I noted a few mistakes: the birth of the concept homo ludens did not come "a few decades ago, when my social science colleagues investigated our game-playing nature" (p. 13) — indeed Johan Huizinga's book entitled Homo Ludens was published so long ago as 1938; Harold Innis was an older colleague of Marshall McLuhan, and his notion of "the bias of communication" came before McLuhan's "the medium is the message," not later (p. 65); finally, though Armen Alchian wrote much less than some economists, e.g., Samuelson and Arrow, it is not accurate to say that he "published a relatively small number of articles in his career" (p. 49) — Liberty Fund has issued two thick volumes of his papers.
This review first appeared in The Mises Review, Summer 2009.
What Determines the Price of Gold?The outlooks of gold analysts are diverse. After reading the latest WGC report, Mineweb is bullish: "Gold demand tops US$100 billion and mine supply remains under threat." John Nadler, however, is bearish, citing the expected "additional 400–500 tonnes per annum" that will result from the exploration boom of the last few years. Tom Barlow even asks, "Are we running out of gold?"
I choose these examples not to pick on these authors. I could have just as easily chosen a hundred other examples: the vast majority of analysts who cover the gold market focus on mine supply as one of the main drivers of gold-price forecasts. I use these examples only to illustrate the ubiquity of this view.[1] However, while analysts need something to analyze — and the mining industry provides many analytical complexities — ultimately, their efforts are wasted. Mine supply has very little influence on the price of gold.
Anyone who agrees that the gold trade is a market would accept the premise that the price depends on supply and demand. Where most analysts go wrong is to analyze gold using what I will call the consumption model. This model counts the current year's mine production plus scrap (and, in some versions, central-bank sales) as supply, and the current year's purchases of jewelry, coins, bars, and industrial gold as demand.
Gold and the Consumption ModelThe consumption model is good way to forecast the price of a commodity that meets two conditions:
it is destructively consumed (or spoils), and
the annual production of the commodity is large in relation to existing, above-ground stockpiles.
Oil is a good example of a commodity that meets these conditions. It is refined and then irreversibly combusted. The oil price must enable the market to clear more-or-less current production with current consumption, buffered only by the oil sitting on tankers and in underground reserves. Reserves cannot do not hold more than a few months' supply, due to the high rate of oil consumption in relation to the storage capacity.
The consumption model does not explain price formation of a commodity where the two conditions are not met, because owners of the existing stocks own much more of the commodity than the producers bring to market. Consequently, they have far more influence over the price than do producers. Gold is the best example of such a commodity: gold is not consumed; people buy it in order to hold it; gold has the largest ratio of stock to annual production of any commodity.
In fact, it is estimated that nearly all of the gold ever mined in human history still exists. This supply grows by only 1 to 2 percent on an annual basis; or, if we look at the ratio from the other side, approximately 50–100 times the annual mine production is held in stockpiles.[2]
The consumption model would hold true if each year's gold were segregated into its own market, with no arbitrage from previous years' markets. But this is not the case: everyone who is buying, selling, and holding forms a single, integrated market. A buyer doesn't care whether he receives gold mined within the past year.[3] Gold miners are competing with all of the holders of gold stockpiles when they sell. Contrary to the consumption model, the price of gold does clear the supply of recently mined gold against coin buyers; it clears all buyers against all sellers and holders. The amount of gold available at any price depends largely on the preferences of existing gold owners, because they own most of the gold.
Looking at the supply side of the market, each ounce in someone's stockpile is for sale at some price. The offered price of each ounce is distinct from that of each other ounce, because each gold owner has a minimum selling price, or "reservation price," for each one of their ounces. The demand for gold comes from holders of fiat money who demand gold by offering some quantity of money for it. In the same way that every ounce of gold is for sale at some price, every dollar would be sold if a sufficient volume of goods were offered in exchange. While some dollar owners are not interested in owning gold at any price, those who are interested have a maximum buying price for each ounce that they might purchase. You can think of their buying prices for gold ounces as their reservation price for holding dollars.
How the Price of Gold Is FormedRothbard provides a detailed, bottom-up analysis of price formation in a market like this. I will demonstrate his model with a sequence of diagrams that show how the dollar price of gold is formed. As a first step, suppose that while gold trading had been suspended for some time, the preferences of some of the gold owners and nonowners changed. Thus, when the market opens, some of them wish to buy while others wish to sell.
Rothbard constructs supply and demand curves using the reservation prices of the individual buyers and sellers. The supply curve at each price is the total amount of gold ounces for sale by all gold owners at or above that price. The demand curve at each price is the total amount gold ounces that could be purchased with the dollars offered at that price (or below that price). The market-clearing price is that point where supply and demand are balanced.
Figure 1: Before TradingWhen trading opened, the market participants would converge on market-clearing price. Once a price had been established, all of the buyers offering at or above that price would buy, and the all of the sellers asking at or below that price would sell. Trading would continue until no one wanted to exchange gold for dollars or dollars for gold. At that point in time, the market will have cleared. Supply and demand curves would be as they are in Figure 2.
After trading, everyone has adjusted gold and dollar balances to their preferred levels. The market would show two quoted prices for gold: the best bid and the best offer. The best bid is the price offered by the marginal nonbuyer of gold, and the best offer is the price asked by the marginal nonseller of gold. More trading could occur only if a buyer increased their bid price, or a seller decreased their ask price, for at least one ounce.
Figure 2: After TradingSuppose that, from this new starting point, one gold owner lowered his asking price for one of his ounces below the best offer of the most marginal seller. A trade would then take place between the gold owner and the marginal seller. What would the situation be after the trade? The same as before, except that the best bid and best offer prices might be different. The new prices would depend on the reservation price of the buyer of the single ounce. If his reservation price were above the best bid but below that of the next most marginal seller, then the new buyer would become the marginal seller and would set the best offer price. But his reservation price might be much higher — enough to make another one of the existing gold owners the new marginal seller.
The miner is different from other gold owners in that he produces gold, while the other owners bought their gold. But from a price-formation standpoint, it doesn't matter how or where it came from; the miner can choose a reservation price, or not. Most miners do not have a reservation price; they sell at market.[4]
The gold analysts and I agree that, in a market, the marginal buyer and seller set the prices. It is also true that the miner is always a marginal seller because they sell at market. However, the entire population of suppliers and demanders must be considered in order to identify who the marginal buyers are and the price where the trades take place. All of the demanders influence the price through their decision not to offer a higher price. All of the (nonmine) suppliers influence the price through their decision not to ask for a lower price. To sell at market means to sell at the price set largely by those buyers and sellers who do have reservation prices. The problem with the consumption model is that it ignores the influence of the majority of sellers on the price.
How does the presence of sellers selling at market affect the price? The miner's presence affects the supply curve as shown in Figure 3.
Figure 3: Mine and Nonmine Supply Some trades will take place below what was the best bid before the miner entered the market, as shown in Figure 4.
Figure 4: Mining and SupplyOnce the miner has sold his stocks, we are back to the situation shown in Figure 2. What was the freshly mined gold is part of the new buyer's stockpile. There will be a new bid and ask price, which will take into account the reservation price of the person who bought the miner's gold. We cannot say what the new bid and ask will be: either could be above or below the price before the miner sold.
Some ObjectionsNow that I've explained how the price of gold is determined in the market, I will look at two of the objections I have received when I have presented the ideas above:
Mine supply is the only supply available to the market, because gold investors are primarily of the buy-and-hold mindset.If gold buyers typically have long holding periods, then is gold like oil that was burned or corn that was eaten? Is it gone forever and not part of the market?
Every asset is for sale at some price. While many small gold coin and bar buyers have a reservation price that is more than $10 above today's price, they do have a reservation price. There is a point at which other assets (stocks or bonds) or consumption goods (cars or houses) would start to look more attractive than holding the marginal ounce of gold. There can be no doubt that a good many gold owners would become sellers at $5,000, $10,000, or $100,000 per ounce.
Existing stocks of gold don't affect the price because they are not for sale at the current price.On closer examination, this is not really an argument: it is only a restatement of the definition of price. A price in a cleared market is that quantity of money below which nothing is offered for sale. While this is true, it does not provide any information about what the price will be. As discussed above, the price at which the first mined ounce is sold is set by the marginal nonseller and nonbuyers of gold.
Suppose, for example, that all of the gold owners had a reservation price of $5,000 or higher per ounce, with the buy prices of people holding dollars remaining where they are now. If that were the case, then once miners had sold their gold, gold would be offered at around $5,000 per ounce.
Conclusion$20 $14
While mining doesn't have much impact on the gold price, the reverse is not true: the gold price has significant influence on the mining industry. The economics of mining explains this. The cost of getting the gold out of the ground is sensitive to several factors, including the grade of the deposit, its depth below the surface, proximity to refining infrastructure, the cost of energy, the cost of labor, and other variables. The marginal cost of mining more gold above current production rises rather sharply. It would not be profitable for the gold-mining industry to increase production enough to have much impact on the total gold supply during any given year.
The consumption model of gold pricing ignores the influence of the majority of sellers on the price of gold. It counts only a minority of the sellers. The consumption model does include "scrap sales" (sales by those sellers whose reservation price was low enough to result in a sale). But the suppliers who did not sell outnumber those who did — by a large margin — and the selling price of those who did sell was primarily determined by those who did not.
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Notes[1] The sole exception that I can think of is a report from Credit Agricole, authored by Paul Mylchreest.
[2] You must register with the World Gold Council to download their supply and demand data. For a comprehensive set of statistics, including the total above-ground stockpiles, see Gold Market Knowledge.
[3] The time window of one year is entirely arbitrary — why not one week?
[4] Some miners sell at a predetermined price because they have entered into hedging contracts. This price could be above or below the market. Other miners (though very few) do have a reservation price. These miners stockpile gold if it is above their reservation price.
I was the teaching assistant for a course on the theory of property rights during the fall semester of 2002. We spent quite a bit of time discussing rent control, various rent-control cases, and the legal principles that informed judicial decisions surrounding rent-control cases.
One of these principles was an aversion to "windfall" profits. Windfall profits occur when an entrepreneur enjoys profits in excess of what he expected, usually as the result of a drastic change in market conditions.
People often point to the run-up in gas prices — some gas stations were charging over $3 a gallon — after the September 11 attacks as an example of firms enjoying windfall profits. The price per gallon is higher than the cost per gallon. This, it is argued, is unfair, especially when an entrepreneur/business owner enjoys profits that he doesn't have to "work" for.
We often discussed this in terms of what was called the rate-setting equation, in which the court set prices according to the formula
rate = operating cost + reasonable return
This ignores two things. First, the definition of "reasonable" is arbitrary. Second, expected prices determine the costs an entrepreneur is willing to incur. As a rule, people don't incur costs and engage in arbitrary productive activity irrespective of expected benefits. In short, the price one expects to receive for a product — say a gallon of gasoline — determines the prices he is willing to pay for factors of production, how he will produce the product, and the quantity he is willing to supply. Prices are not cost determined.
To better illustrate this principle, suppose you are a cotton buyer in 1860s England. Two boatloads of cotton arrive, one from the United States and the other from Egypt. Let's assume that Egyptian cotton and American cotton are perfect substitutes. As a merchant, do you care at all what it costs your suppliers to produce their wares? Suppose you're the one trying to sell the American cotton. Do your costs of production influence the price at which you agree to sell the cotton? At this point, all of your costs are sunk. (Economists are fond of the phrase "sunk costs are sunk," which is to say that there is no way to recover them.) As such, these costs shouldn't factor into your asking price.
Let's return to our discussion of windfall profits as it relates to rent-controlled apartments. The in-class examples concerned rent-control ordinances in Cambridge, MA and Berkeley, CA, which are reportedly nice places to live and where the demand for housing is stronger than in most parts of the country. The "windfall profits" rationale for rent control works as follows: suppose you've owned an apartment complex in Cambridge for 50 years. The apartments cost you $450 a month to maintain, and you can rent them out for $500 a month for a monthly profit of $50 each. Suppose now that the demand for Cambridge apartments skyrockets, and you can now charge $1,000 a month for the exact same apartment. The rent controllers maintain that it isn't fair that you can now enjoy such higher rents without really changing the product you offer or "working for it." Since people supposedly aren't entitled to what they don't "work for," the rent controllers step in and cap rental prices at $500 a month. Everyone should be happy because you're still earning a "reasonable" profit on each apartment, consumers are still able to get cheap apartments, and the Cambridge housing stock has not diminished.
Henry Hazlitt sums up the standard argument for rent control as follows:
Rent control is initially imposed on the argument that the supply of housing is not "elastic" — i.e., that a housing shortage cannot be immediately made up, no matter how high rents are allowed to rise. Therefore, it is contended, the government, by forbidding increases in rents, protects tenants from extortion and exploitation without doing any real harm to landlords and without discouraging new construction. (Economics in One Lesson, p. 111)
As the great proto-Austrian economist Frederic Bastiat points out, however, we should never merely take account of that which is seen. We must also consider that which is not seen — the hidden effects of a policy like rent control. And there is plenty that is not seen in the case of rent control.
First, there are the standard problems associated with holding prices below the market-clearing price, all of which are taken out of an everyday "Principles of Microeconomics" textbook. Queuing (people waiting in line for the good, in this case, apartments) and nonprice competition will set in. People will try to get apartments by making bribes or other side payments. Landlords may let their property deteriorate. Landlords may withdraw from the housing market and convert their apartments to offices. Et cetera.
But this is only the tip of the iceberg. Let's consider the normative issue first. In this situation, rent controllers objected to windfall profits for the landlord. But what of the renter who has the good fortune to secure for $500 an apartment for which someone else would gladly pay $1,000? This is just as much a windfall as anything else. Moreover, the rent-control board either consigns the second renter to the winds of fate — he will, in all likelihood, be banished to a waiting list — or shuts him out of the housing market altogether because his willingness to pay is not allowed to manifest itself through the market process.
Moreover, rent control distorts the structure of production by nullifying the valuable signaling role of profits. High profits induce others to enter a market. In this case, high profits signal that there is quite a bit of money to be made in the Cambridge housing market. One of the fundamental precepts of economics is that people respond to incentives; something has to induce people to engage in productive activity (supplying apartments, in this case). They don't just do so ad hoc. It may very well be that some people are willing to absorb heavy losses to supply cheap, high-quality apartments out of their compassion for the hardscrabble lives of Harvard, MIT, and Berkeley students and faculty who are trying to eke out a living in the unforgiving world that is academe.
Of course, what motivates most people is the prospect of being able to do more of the things they like, whether it is consuming Coca-Cola, alleviating third-world poverty, or reading economics articles. Regardless, wealth helps. Therefore, the prospect of increasing one's wealth is quite often the driving force that motivates behavior.
Let's look at who wins and who loses. The rent control board certainly wins; passing additional rent control measures usually solidifies their employment. Incumbent tenants and those lucky enough to get a cheap apartment win because they get a good at a price below that which would clear the market. People pushing for rent control "win" in the sense that they get to feel good about striking a blow for justice.
Let's look at what Henry Hazlitt had to say about attempts to hold prices below their market-clearing levels in his classic Economics in One Lesson:
Now we cannot hold the price of any commodity below its market level without in time bringing about two consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are both tempted to buy, and can afford to buy, more of it. The second consequence is to reduce the supply of that commodity. Because people buy more, the accumulated supply is more quickly taken from the shelves of merchants. But in addition to this, production of that commodity is discouraged. Profit margins are reduced or wiped out. The marginal producers are driven out of business. Even the most efficient producers may be called upon to turn out their product at a loss.
He continues:
If we did nothing else, therefore, the consequence of fixing a maximum price for a particular commodity would be to bring about a shortage of that commodity. But that is precisely the opposite of what government regulators originally wanted to do. For it is the very commodities selected for maximum price-fixing that the regulators most want to keep in abundant supply. But when they limit the wages and the profits of those who make these commodities … they discourage the production of the price-controlled necessities while they relatively stimulate the production of less essential goods.
And this is the consequence of the state attempting to control the price of any good. It is often objected that "necessities" such as food, housing, education, and health care are too important to be left to the wiles and whimsies of the market.
The reader may have seen a bumper sticker reading "health care is a right, not a privilege." This certainly makes for convenient political rhetoric, but when we get past the newspaper headlines, we see that we're dealing with issues of mind-boggling complexity.
The principles by which market forces allocate resources aren't particularly difficult to grasp. People agree to exchange because they expect to be better off as a result, and those who are willing to pay the most generally get their desired quantity of a good in question. So the market's mechanisms for allocating resources aren't that mysterious.
We run into problems when we start talking about a good being a "right" that should be provided by someone (presumably the state) irrespective of market forces or one's ability to pay. The most apparent problems arise when we start to consider exactly what the concept of a "good" entails.
Goods are extremely specific things. They are characterized by definite physical, spatial, and temporal characteristics — in other words, we're concerned with the "what, where, and when" of a good. For example, suppose I have an ice cream cone after lunch. The good "ice cream" is characterized by certain physical properties (it's a soft, cold substance of a particular chemical composition), certain spatial properties (in all likelihood, it's at our local Kroger), and certain temporal properties (after dinner).
While it isn't hard to wrap our minds around the goods-character of ice cream, serious difficulties become apparent when we start to think about more abstract classes of goods such as "health care" or "housing." First, "health care" and "housing" are descriptors used to classify broad arrays of goods and services that are very costly to measure and may not be interchangeable. If we go back to ice cream for a second, we see that one vanilla ice cream cone is usually a perfect substitute for another. Moreover, it's easy to substitute chocolate for vanilla, gelato for ice cream, and waffle cones for sugar cones. It isn't easy to substitute the services of a urologist for the services of a gynecologist (for example).
So what are we talking about when we talk about "health care?" Do we mean brain surgery? Do we mean basic physicians' services? Do we mean aspirin?
Similarly, what are we talking about when we talk about "housing?" Basic shelter might consist of a lean-to or a mud hut. Do we mean penthouses in midtown Manhattan? Most so-called progressives would say that the "housing crisis" is characterized by a shortage of "adequate" housing, but who is to decide what is "adequate?" My wife and I have a three-bedroom house. On some margins, this is more than adequate. On some margins, though, it is inadequate. I'd like to have a bigger desk, but the guest room is too small. We don't have space for another couch in the living room, but it would be nice. Do we have a right to all of this at someone else's expense?
Print $14 $12
Audio $30 $25
Market prices turn incomprehensibly complex relationships into very simple ones. Government policy does the opposite. It turns the simple into the extraordinarily complex, and, as Ludwig von Mises has argued in various places, government intervention in one aspect of the economy will displace resources, change prices, and likely lead to calls for government intervention in other areas of the economy. Establishing the boundaries and definitions of what constitutes "just" and "unjust" outcomes presents one set of problems, and measuring the valuable attributes of the goods and services that are to be regulated or subsidized presents another. At the very least, these problems should cause us to view government intervention with a skeptical eye.
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The Law of AssociationDirect ExchangeThere's Something LackingTwo's Company, Four's a Mini-MarketWinners, Losers, and the Market Process[This article is excerpted from chapter 4 of Economics for Real People. Rich, whom we meet in the introduction, is the book's equivalent of Robinson Crusoe; Helena Bonham-Carter is his Friday.]
The Law of AssociationRich has worked out the details of his solitary economy and has a somewhat comfortable existence. Then, one day he is walking along the beach, and who should he see approaching him but … Helena Bonham-Carter. (Stranded, perhaps, during the filming of the latest Merchant-Ivory production.)
His solitude broken, what does Rich decide to do? More generally, what factors would lead man to choose between an isolated existence and life in society?
One possibility is that Rich might react like a bear does when another bear enters its territory. He could, through the threat of or actual use of force, attempt to drive the intruder away. Now, he might refrain from doing so due to moral constraints or benevolent feelings. But there is another reason for him not to drive Helena off — as long as there are sufficient unused resources on the island, it will materially benefit both of them to cooperate rather than fight. They can initiate the vastly enriching processes of the division of labor and voluntary exchange.
Adam Smith pointed out the enormous increases in material production that came about through the division of labor. The example with which Smith opens The Wealth of Nations is pin manufacturing. A lone workman could "scarce, perhaps, with his utmost industry, make one pin in a day." But even 225 years ago, when Smith was writing, a small pin shop, dividing the manufacture into eighteen distinct tasks, allowed a ten-man shop to produce 48,000 pins in a day, or 4,800 per man.
The division of labor produces greater material output for three reasons. The first is that people live in parts of the world that differ from each other in many respects. Someone living in Florida is in much better circumstances to grow oranges than I am in New England. On the other hand, I'm in a better position to produce maple syrup.
The second benefit of the division of labor is that not everyone comes to the table with the same capabilities. A book on economics is not the place to attempt to resolve the nature/nurture debate, so we will simply say that, for whatever reasons, people enter the labor market with different aptitudes. I'm five feet nine inches tall and have trouble jumping over the Sunday New York Times, so I'm hardly suitable, even with "the right training," to fill in for Kobe Bryant should he need some time off from playing basketball.
Training is, however, the third benefit. The division of labor allows people to focus their efforts on building up certain skills and to ignore a vast array of other skills that are unnecessary to their jobs. The people who design personal computers usually have little knowledge of the aspects of the system for which they are not responsible. At the lowest levels of the system, chip designers employ their knowledge of quantum physics to achieve higher-speed components. Several levels above that, operating system programmers use their knowledge of the logical structure of the machine to create efficient code for writing disk files and displaying graphics. Another several levels of abstraction up, we find user-interface designers who specialize in creating a "look-and-feel" for a program that allows ease of learning and of use. None of these workers could accomplish their tasks if they also had to concern themselves with all of the other levels of the system. And lest you think that it is only an extremely complex device like a PC for which this is true, I recommend Leonard Read's famous essay, "I, Pencil," where he demonstrates that no individual in the world is capable of creating something as simple as a pencil on his own.
Some of the critics of modern industrial society bemoan just that specialization. People, they complain, become narrow-minded, mere cogs in a machine, and find their work boring and repetitive under a system of ever increasing division of labor. Economics cannot answer such complaints. As I've pointed out, it doesn't attempt to recommend one set of values over another. It can't say that those who chose a more interesting and varied life over greater material prosperity have chosen badly. However, economics can inform anyone who wishes to impose such a choice on all of society that without the division of labor the Earth could support only a tiny fraction of its current population. Perhaps those who survive the transition period will find their world more satisfactory than ours, but the billions who die during the transition might be forgiven for dissenting.
Smith recognized these various advantages of the division of labor, but left unsolved an interesting problem, which arose in discussions of international trade. The solution has implications far beyond that field, however, and it is worth our time to examine the problem.
Smith pointed out that it made no sense, for example, for Scotland to try to manufacture wine, although through the use of greenhouses it undoubtedly could do so. If Scotland produces wool and Spain makes wine, and the citizens of the two countries trade for the goods not available from domestic industry, both countries' inhabitants will be better off. But what of the case where one country, perhaps due to geographical disadvantage and an uneducated populace, is worse at producing everything than some other country is? Shouldn't the more backward nation erect trade barriers, allowing domestic industry to develop? How can it possibly offer the more advanced nation anything in trade?
The answer to this problem is Ricardo's law of comparative advantage, named after English economist David Ricardo. Although the initial application of the law was to trade, it is a universal law applying to all human cooperation. Because of the broad applicability of the law, Mises felt it was better named the law of association. In fact, it is easiest to understand this law at a personal level, after which its implications for trade become clear.
Let's use as an example a great athlete: Michael Jordan. Jordan's physical skills are truly extraordinary. There is little doubt that should he choose to apply them to, for instance, house painting, that he could be one of the best house painters in the world.
Yet it's doubtful that Jordan paints his own house. Although he could probably, with a little practice, do so far better than anyone he can hire, he still finds someone else to paint it for him. How can we explain that fact?
The law of comparative advantage is the answer. Although Jordan is better than his painter at both basketball and house painting, Jordan has a comparative advantage in basketball, while his painter has a comparative advantage in house painting. It's easiest to comprehend that arithmetically, by using wage rates as a basis for the comparison.
Let's say that Jordan can hire a house painter for $20 per hour. With a little practice, Jordan could be twice as efficient a painter as the man he has hired. We will imagine that he could market his own house-painting services for $40 per hour.
However, by playing basketball, we will suppose that Jordan can earn $10,000 per hour. Meanwhile, Joe, his painter, who can hardly sink a free throw, couldn't make more than $1 an hour playing basketball. (Perhaps some people will find his play amusing!) Jordan has a 2-to-1 advantage as a house painter, but a 10,000-to-1 advantage as a hoop star.
Perhaps Jordan plans on working twenty hours in a particular week. If he divides his time equally between painting his own house and playing basketball, his total output for the week can be valued at:
10 hours painting x $40 per hour = $400
10 hours basketball x $10,000 per hour = $100,000
Total output: $100,400
If Joe divides his time the same way we could value his production as follows:
10 hours painting x $20 per hour = $200
10 hours basketball x $1 per hour = $10
Total output: $210
Between them, Michael and Joe have produced $100,610 worth of output. Now let's examine the situation if, as we expect, Jordan hires Joe. Jordan's production can now be valued at:
20 hours basketball x $10,000 per hour = $200,000
Total output: $200,000
And Joe's at:
20 hours painting x $20 per hour = $400
Total output: $400
Their total output has risen to $200,400. But, more importantly for an understanding of the law of association, both of them are better off, at least in dollar terms. The painter, who was worse at both jobs, was still able to nearly double the value of his output by concentrating on painting, in which he had a comparative advantage, then by exchanging with Jordan. The law of association demonstrates that, even putting aside moral considerations, it is to everyone's material advantage to cooperate through the division of labor and voluntary exchange. It is the basis of the extended social order.
The application of this law to international trade is a straightforward extension of our analysis above. Even if a country is worse at producing everything than is some other country, it can still net a material gain by specializing in the areas where it has a comparative advantage and trading for other goods. It is only in the obviously unrealistic scenario where everyone is exactly the "same amount" better or worse than everyone else at every job that the law of association would find no application.
This law only shows that a material gain is available through specialization. It doesn't take into account any personal preferences other than material gain. It could well be the case that Jordan simply loves house painting, and would not for the world consider hiring someone else to paint for him, harking back to our discussion in Chapter 1 of the person who decides to do his own roofing. If people believe they are saving money doing their own home repairs, they are often mistaken. However, if they love doing the work, perhaps finding it a nice break from their regular job, they may be getting a psychic profit that outweighs their monetary loss.
Direct ExchangeLet's return to the beach, and the fateful meeting of Rich and Helena. Each of them realizes that his or her prospects for survival will be enhanced if they can develop a system of cooperative effort. Rather than producing for a general demand, Rich and Helena will find it best to agree in advance on a particular division of labor. Yet the basic principles of exchange will still apply to them. Following Carl Menger's directive to "reduce the complex phenomena of human economic activity to the simplest elements," we will first attempt to comprehend exchange in a simple setting, such as our little island economy.
Given that they have decided to cooperate, our two castaways next must decide how to cooperate. They come to an agreement that Rich, the more dexterous of the two, will make traps, while Helena, the more cunning, will do the hunting. Still, what is the best amount of each activity for them to perform? How can each of them be sure that he or she is getting a fair deal from the other?
Simply relying on goodwill does not work. The history of the Soviet Union illustrates the problems inherent in separating the performance of labor from the self-interest of the laborer. But even if the Soviet Union had succeeded in creating the New Socialist Man, only interested in the well-being of his fellows, there would have remained an insurmountable obstacle to efficient production. How can these altruistic fellows know exactly what should be produced, in what quantities, and employing what resources? I might spend my time creating finger paintings, in the belief that these will produce tremendous happiness for those around me. But if no one else likes them, I've not only wasted my time, I've also wasted the resources — paper, pigment, and so on — that went into the paintings. In the interest of pleasing those around me, I've actually caused them to suffer a loss in satisfaction, even compared to a situation in which I had merely loafed around. The same holds true even if folks love my paintings but are deeply unhappy that I've given up writing to indulge my artistic ambitions. In the balance, and given available resources, people want my writing more than they want my art. Absent a market price system, there is no way for consumers to inform producers of their relative values.
The route past that difficulty is interpersonal exchange. To ensure that they are actually benefiting each other, Rich and Helena must recognize that the other has a right to the goods he or she has acquired through his or her own efforts. As a corollary to that recognition, the exchanges they make must be voluntary. For every so many rats that Helena captures and gives to him, Rich agrees to trade a certain number of traps. If Helena threatens Rich with a club to get rats, we can bet the exchange is benefiting, in their own view, only one of them.
The law of diminishing marginal utility explains the exchange ratio that they will work out. Rich will trade traps for rats until the cost, as subjectively perceived by him, of producing one more trap exceeds the benefit, again as he subjectively perceives it, of the number of rats Helena will give him for that next trap. On the other side of the trade, Helena will trade rats until the subjective cost of the next rat she must give up exceeds the benefit she expects from having one more trap. The next trap that Rich considers trading and the next rat that Helena considers trading are the marginal units. It is the perceived benefits and costs of those units that determine the exchange ratio.
Let's imagine what is likely to happen in our island's rat and trap market. We begin with no rats caught and no traps made. At that point, the value to Rich of the first rat with which Helena can provide him is relatively high — after all, he may starve to death without it. Similarly, the value to Helena of the first trap is large. The first trap will increase her catch tremendously, as she can use that one on the most popular rat trail on the island.
We'll postulate that Rich is willing to give up his first trap for as few as three rats, while Helena is willing to trade as many as five rats to acquire that trap. We'll assume that they meet in the middle, and trade one trap for four rats.
The value to our traders of each succeeding unit acquired will be lower than that of the first one. As Rich's supply of rats increases, he will use each new rat in a way that is less important to him than the previous rat. Once he has had his fill for the day, he may begin to smoke the critters to preserve them for later. But he will not consider it as important that he have smoked rats as he considers it to have the rats that will keep him from starvation. And on the other side of the trade, Helena won't consider the second trap as valuable as the first — after all, she can only deploy it on the second most-frequented trail.
Each trap thereafter will be put to a use that she considers less important than the previous trap.
Similarly, each additional item given up by one of our traders will be more valuable to him or her than the previous unit surrendered. That is because they will first give up what are the least important uses, in their own valuation. It is not the traps or rats that are different when we consider subsequent trades: it is the fact that acting humans will first give up the least valued use of the good in question, then the next least valued, and so on. Each additional trap Rich builds requires him to sacrifice additional leisure time. With each sacrifice, his remaining amount of leisure is smaller. The initial units he gives up were nice to have, but soon he is cutting into rest he needs to stay healthy.
Therefore, after the first trade has been made and Rich has four rats, he is no longer as desperate for them. Similarly, having one trap, the next trap Helena could acquire will be less valuable to her. Let's imagine our traders' value scales for trading rats and traps are these:
We're assuming that Rich will require at least four rats for giving up a second trap (up from three for the first one), while Helena will give up at most four rats (down from five). Even though the value of the next units they can acquire has gone down for both Rich and Helena, they still have a trade from which each of them can profit. They will make the second trade, exchanging four more rats for a trap.However, our traders' valuations do not support a third exchange. Helena is only willing to trade three rats for a third trap, while Rich will not trade the third trap unless he gets at least five more rats. Trading will cease in this market. It has reached what we will call the plain state of rest (examined further in Chapter 6).
It is important to note that the fact that an exchange took place does not mean that the values of the goods traded were equivalent to the two participants. It is only the fact that they valued the goods in question differently that caused them to trade at all. Helena valued the two traps more than she valued eight rats, while Rich valued eight rats more than he valued two traps.
Carl Menger pointed out that to regard an exchange as occurring at a point of equal valuation leads to absurdities. If two people exchange when they consider the value of what they are getting to be equal to the value of what they are giving up, there is no reason that they shouldn't simply reverse the trade a moment later. If you sell your house for $200,000, then you valued $200,000 more highly than you did your house. Conversely, the buyer valued your house more highly than he did $200,000. Otherwise (ignoring transaction costs), there is no reason that, as soon as the exchange is made, you wouldn't immediately take the house back and give up the $200,000. In fact, if the exchange took place at a point of equal valuation, there is no reason you and the other party shouldn't swap the house back and forth any number of times.
However, if we contemplate exchange from the point of view of human action, we see that people do not exchange simply to have the pleasure of contemplating goods changing hands. Exchange does not arise from a "propensity to trade." In order for an exchange to take place, both parties must feel that they will be better off after the exchange. That is the prerequisite for all action — the actor must feel that the action will improve his state of satisfaction when compared to not acting. He is attempting to move from what is to what ought to be.
The above sheds light on a phrase that is in common use when discussing exchange. Who hasn't heard someone say, after purchasing some item, that the price he paid for it was a "rip-off"? Let's set aside the case where the speaker was deceived as to the quality or nature of the good — that is fraud, and really is a "rip-off." We'll take the good in question to be something of known and consistent quality — say, bottled, brand name beer. At work Monday morning, your friend says, "We went to a ball game over the weekend. Paid five dollars for a beer — what a rip-off!"
What does he mean? As long as he wasn't tricked or forced into buying the beer, and he really did go through with the purchase, he valued the beer more highly than the five dollars. Otherwise, why would he have gone ahead and bought it? If his five dollars meant more to him than the beer, all he had to do was put it back in his pocket and walk away. Given that your friend voluntarily gave up something he valued less than the beer, the vendor might make the exact same complaint — he was ripped-off as well! What your friend really means is, "I wish the beer had been cheaper." However, we all wish to give up less in order to gain more, in other words, to increase our profit. That is the universal basis of all human action. As we try to improve our own condition, we have no reason to expect that others, such as the vendor, are not doing the same.
There's Something LackingAs of yet, our human actors have no way to employ economic calculation in our little economy. Rich and Helena can compare specific quantities of specific goods and decide which bundle of goods they find more valuable. They can't, however, calculate how much they profited or lost in any exchange, either before or after the fact. We can say that Rich preferred eight rats to two traps, but there is no way to answer the question "How much did he prefer it?" The preference is something he feels. There is no measuring rod we can dip into his psyche to determine the "size" of that feeling. Certainly, he may perceive some satisfactions as more desirable than others. But, as we have pointed out, a phrase such as "I like that trap twice as much as the other" is simply a figure of speech. If someone tries to take it literally, we ask Rothbard's question: "Twice as much of what?"
Trying to calculate in terms of rats and traps will not work either. There is no arithmetical meaning to expressions such as "eight rats minus two traps," or "one trap plus three rats."
The attempt to use labor as the common unit of value, as did Marx and the British classical economists, doesn't succeed. The cost of Rich's labor is his subjective evaluation of what he had to give up in order to perform the work in question. The value to Helena of Rich's labor is her subjective valuation of the fruits of his efforts. To attempt to calculate profit and loss in terms of the ticking of a clock or the expenditure of energy is to miss entirely the economic aspect of what is occurring. Rich might expend just as much time and effort grinding existing traps into sawdust as building new traps, but, in our scenario, Helena certainly will not pay him to grind up traps! The fact that creating traps is valuable and destroying them isn't depends entirely on the valuation of those involved in exchanging them, and can't be determined by physical measurement. In fact, we can easily imagine a situation where the exact same physical activities have their valuations reversed. If our castaways found themselves in a situation where the rats had been hunted to extinction, but the island was littered with useless traps, building traps would have no value, while destroying them, in order to tidy up, would have value.
The lack of economic calculation does not hamper our little economy significantly. Only two people are trading all goods. Since a trader is the creator of his own value scale, he only has to get a sense of his partner's values in order to trade sensibly. But as an economy grows larger the absence of calculation will become a roadblock.
Two's Company, Four's a Mini-MarketNow, we must fast-forward the history of our island — let's christen it "Richland" — economy. We will move forward several generations. (We can imagine that Rich and Helena found yet another way to cooperate for their mutual benefit.) For some strange reason, the island has remained isolated from the global economy. But the population has grown, a village has been built, fields tilled, shops opened, and professions begun. A flourishing trade exists among the inhabitants.
The basics of exchange have not altered from our two-person economy. The addition of other people who might want to exchange complicates our picture, but does not alter it in any basic respect. It will behoove us to take a little time and study the multiperson situation, in order to be prepared for the further complications to come.
We'll imagine that goats were domesticated on the island, and that the cultivation of corn is now practiced. We have two goat herders, Kyle and Stephen, and two corn farmers, Emma and Rachel. For people living in a modern economy, there is an inherent difficulty in studying such a situation — we are not used to dealing with exchanges where goats and corn are traded directly for each other. Since we haven't yet brought money into the picture, we must think of the price of goats as their price in terms of corn, and the price of corn as its price in terms of goats. This type of exchange is called barter, or direct exchange. It takes some getting used to, but it is worth the effort in order to gain a better comprehension of how market prices are established.
Let us imagine that Rachel will pay up to four bushels of corn for her first goat, up to three for her second, and as many as two for her third. Emma will pay up to three bushels for her first goat, up to two for her second, and no more than one for her third.
On the other side of the market, Kyle will accept as few as two bushels of corn for his first goat, as few as three for his second, and as few as four for his third. Stephen will accept as few as three bushels of corn for his first goat, as few as four for his second, and as few as five for his third. So, we have
We can picture the market progressing as follows: First, Rachel trades three bushels of corn for Kyle's first goat offered — clearly, as Rachel prefers to surrender up to four bushels for that goat, and Kyle will accept as few as two, the trade is mutually beneficial. In this "round" of trading, another trade also takes place: Emma trades three bushels of corn for Stephen's first goat offered.Now, the possibility of another round of trading is considered. Emma will pay at most two more bushels for another goat. But neither Kyle nor Stephen is prepared to supply a goat at that price — Kyle demands at least three bushels for the next goat, while Stephen demands four.
Similarly, Stephen will supply another goat for a minimum of four bushels, but no one in the market is willing to bid four bushels for that second goat — Rachel will bid at most three, while Emma will bid at most two.
Therefore, Emma and Stephen drop out of the market. But Rachel and Kyle have one more mutually profitable trade to make — the trade where Kyle gives up his second goat for three more bushels of corn, and Rachel gives up three more bushels for a second goat.
In this scenario, Kyle's goat-demand for corn is greater than Stephen's — perhaps Stephen really loves goat meat, and so is more reluctant to give up goats. Kyle sells a second goat for only three bushels of corn, while Stephen would have sold a second goat only if he could have gotten at least four bushels. Similarly, Rachel's demand for goats is greater than Emma's — she pays three bushels of corn for her second goat, while Emma would only pay two bushels.
In any market, it is the buyers such as Kyle and Rachel — called the most capable buyers — who will acquire more of the goods in question. Because, for whatever reason, those buyers are willing to pay more, they will use this willingness to outbid the less capable buyers. Similarly, the most capable sellers, those who are the most anxious to move the goods they are selling, will move more of their stock than the less capable sellers.
It is the very nature of human action, the desire to improve our situation as much as possible, that propels the market process. Traders will exchange as long as they feel their trades are improving their situation, and no longer.
The principles of human action only guarantee that people will attempt to find all profitable exchanges. There may be trades available where the cost of finding the trading partner is simply too high, and would turn what otherwise might have been a profitable trade into a losing trade. There are other cases where potential traders simply fail to discover one another. Just over the next hill, there might be a corn farmer who would pay four bushels for a goat, if only he knew that goats were available. The market process does not guarantee that all traders who might be able to make profitable exchanges will always discover one another. But the human drive to better our circumstances implies that people will always be on the lookout for such opportunities. The search for potential profit opportunities that are not being taken advantage of is the role of the entrepreneur, which we will discuss at length in Chapter 7.
So the goat-corn market will establish a price of three bushels of corn per goat. At that price, Emma's demand is for one goat, and Rachel's is for two. From the perspective of the corn buyers, the market price is one-third goat per bushel. At that price, Kyle demands six bushels and Stephen demands three bushels. The market process will tend to establish a price that clears the market: all sellers willing to sell at the market price will be able to do so, and all buyers willing to buy at that price will also be able to do so. At the market price, Stephen and Kyle between them attempt to sell three goats, while Emma and Rachel, between them, attempt to buy three goats. And Emma and Rachel will attempt to sell nine bushels of corn, while Stephen and Kyle will attempt to buy nine bushels.
If these dynamics of supply and demand change, the market process will adjust the price to the new realities. Let's say that Stephen and Kyle get sick of eating corn. What's more, a farmer down the road has started growing squash, which they can eat instead. Their demand for corn will drop, and they will not be willing to offer as much goat per bushel as before — they find it better to spend some of their goats on squash. If Emma and Rachel still want goats, they will have to bid more for them. A new market price will emerge — let's say, four bushels per goat — and the market will clear at that new price. If Emma's and Rachel's value scales have not changed, then Rachel will buy one goat for four bushels, and Emma will not buy any. No one had to decree a higher price for goats in order to bring one about.
It is this seemingly magical property of markets that led Adam Smith to speak of the "invisible hand" guiding market participants. Without any central authority directing them, their own plans and desires tend to create a situation in which all those exchanges take place that both parties believe will benefit them. (As we have mentioned, human action, directed toward an uncertain future, always contains the possibility of error. After the fact, any trader might decide that he or she had made a mistake.)
Because market exchange is voluntary, it allows every participant to express the urgency with which he demands particular goods. It allows humans to cope with the scarcity of means through cooperation, rather than through violence and plunder.
Scarcity is a necessary condition of something being an economic good. Air is not scarce, and, therefore, it is free, and outside the scope of economics. We must not take "scarce" in an absolute sense, but instead consider scarcity relative to demand. There are few videotapes of me rapping — only one that I'm aware of — but they are not scarce in the economic sense, as the supply of one is infinitely greater than the demand of zero. No price will be paid for such a tape, or at least no price greater than the going rate for used tapes sold for retaping.
In the above scenario, Stephen would have been happy to buy more bushels of corn, if the price were lower. If corn were so abundant that it littered the ground everywhere in Richland, Stephen might use far more than the three bushels he actually purchased. But, given that corn is scarce, the market process sends it to whoever demands it most urgently. Kyle, for whatever reason — perhaps he likes corn more than Stephen does, or he has a plan for a new food product made from corn, which he feels will be a big hit — is willing to pay more for corn than is Stephen. Because of this, he acquires six bushels while Stephen only acquires three.
The demand we are speaking of is effective demand. In order to take part in voluntary exchange, we must offer others something that they value — we have to bring something to the table. Demand at the point of a knife and demand that is simply a wish for some good are altogether different from demand in the market.
Although we will take up the topic of intervention in the market process in Part 3 it will be instructive now to see if the Richland town council could improve upon the market outcome. Let's say that the goat lobby persuades the council that the corn price of goats is too low and is hampering the goat industry. The council passes a law setting the price of goats at four bushels of corn. The goat lobby is thrilled — now their profits will soar! Stephen, who was only willing to sell one goat at the previous price of three bushels, now is willing to sell two for four bushels. Kyle, who was only willing to sell two goats at the previous price, now is willing to sell three.
But if we consider Emma's and Rachel's demand for goats, we see that the goat herders will be sorely disappointed, because at the new, higher price, they will only want one goat! Rachel, who in an unhampered market would have bought two goats, only values the first goat more than four bushels of corn. Emma, who would have bought one goat in the unhampered market, now will not buy any. Kyle and Stephen bring five goats to market, planning on "cleaning up," but instead go back home with four. There is now a glut of goats and a shortage of corn: gluts and shortages are the result of price-fixing.
In the regulated market, we can't even be sure whether Stephen or Kyle will get the corn. Although Kyle demands corn more urgently than does Stephen, the new regulation prevents him from outbidding Stephen. What's more, in the unhampered market there would be three exchanges, each of which both sides consider to be beneficial. In the regulated market only one exchange will take place. Although there is no way to calculate how much worse off the market participants are in our regulated market than they would have been in the unhampered market, we can use understanding to surmise that they are worse off.
Winners, Losers, and the Market ProcessPeople often use words from the arenas of games and war to describe the market. We hear that international competition will result in some nations being "winners" and others "losers." We read a headline that some company has "crushed" its competition, or that the U.S. is at "economic war" with Japan or OPEC.
Employed as loose metaphors, such terms are useful. But the analogy does not extend very far. The key difference between a game and the market process is that, in the market, all participants gain from voluntary exchange. Kyle, Stephen, Rachel, and Emma were all better off after completing their trades than they had been beforehand.
Imagine that you and I open competing software companies. Over time, it becomes apparent that consumers prefer your product. I close my business down, and you wind up hiring me as your lead programmer. Now, in one sense, I lost and you won. But in a much more important sense, everyone won. I now have a role in fulfilling the needs of the consumers to which I am better suited than previously, you have a new lead programmer, and the consumers have a better software company. This stands in sharp contrast to sports, where the winner gets a "1" in the standings, the loser a "0," and everyone goes home. It is also very different from war, where the winners may do what they want with the losers, including annihilate them.
To take the metaphors of games and war too literally in describing the market process is a misapprehension of its nature. Market competition is different than sports and war in crucial ways. It doesn't exist to pick "winners" and "losers": it exists to allow everyone to find a place in the scheme of production in which they can best satisfy the wishes of consumers.
It is just as mistaken to view international markets as pitting one nation against another as it is to view the domestic market as pitting employees against employers, or producers against consumers. In a market economy, whether it is domestic or international in scope, everyone's standard of living can rise at once. America has not lost if Japan or China should become wealthier than the U.S. An increase in the standard of living anywhere benefits all people who are economically integrated with the area in question.
The discovery of the law of association was a great achievement of the classical economists. It points the way toward social harmony, showing that the powerful and the weak have a better way to relate to each other than through exploitation. The nature of the market as a network of voluntary exchanges means that each participant must feel he is benefiting from a trade, or he would not enter into it.
This article is excerpted from chapter 4 of Economics for Real People. Rich, whom we meet in the introduction, is the book's equivalent of Robinson Crusoe; Helena Bonham-Carter is his Friday.
With much fanfare, the company formerly known as Kentucky Fried Chicken — now just "KFC" — has introduced a new line of grilled-chicken products. To the consternation of some local commentators, Fowler Foods (the company that owns the KFC restaurants in Memphis) has decided not to offer grilled chicken because the special grills they would need to install are too expensive.
As one can imagine, this has been controversial. Memphis has one of the highest obesity rates in the country, and in its discussion of the local KFC franchisee's decision not to offer grilled products because the special grills would be too expensive, the local newspaper editorialized on May 6 that "it seems reasonable to invest money now for customers who might still be around to buy the product several years later." Predictably, this has created some controversy. A few minutes with Google reveals comment threads suggesting boycotts, denunciations of the company, and defenses of their rights to sell what they want. So what are we to make of this?
In an important contribution, F.A. Hayek argued that competition is "a discovery procedure." Fortunately, the Memphis food market is extremely competitive. If the critics are right, then Fowler Foods has missed an opportunity to turn a tidy profit by selling grilled chicken. This means that there is an opportunity for the KFC's critics: they can earn these overlooked profits by offering their own grilled chicken. The critics' inaction suggests that Fowler Foods made the right decision.
Competition means that unexploited profit opportunities do not stay unexploited for very long. If Fowler Foods is overlooking a robust market for grilled chicken in Memphis, then I encourage the company's critics to stop squawking, enter the market, and show them the error of their ways by earning profits in the market for grilled chicken.
What we know about entrepreneurship aside, Fowler's critics also fail the symmetry test. In Fair Play: What Your Child Can Teach You About Economics, Values, and the Meaning of Life, Steven Landsburg devotes a chapter to the symmetry principle, which holds that any concept of justice has to apply equally to all parties to a transaction. As Landsburg puts it, the symmetry principle is "the most fundamental requirement of fairness — that people should be treated equally, in the sense that their rights and responsibilities should not change because of irrelevant external circumstances" (p. 88).
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Fowler's critics violate the symmetry principle by rushing to question and criticize the company's decision to stick to fried chicken while not questioning the decision of so many others — myself, for example — who are not selling grilled chicken to anyone at any price. Fowler is (supposedly) failing to exercise their responsibility to provide healthy eating options for Memphians, but the company's critics and other Memphians aren't filling this void for healthy eating options either. I'm working on a few economics articles. I suspect that the editorial writers for the local newspaper are thinking about things to editorialize about. None of us are grilling chicken. Are we not at least as morally culpable as Fowler Foods, if not more so? If we are going to condemn Fowler Foods for its refusal to serve grilled chicken, should we not also condemn the company's critics — like the owners of the Memphis Commercial Appeal — for their apparent unwillingness to serve grilled chicken?[note]
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NotesI'll go ahead and head off the accusation that I'm being paid by Fowler Foods, KFC, or whoever to write an apologetic for their decision. My fast-food-chicken restaurants of choice are Chick-fil-A and when I'm in Alabama, Guthrie's. Zaxby's is also good. They serve fried chicken in the cafeteria at Rhodes every Friday, and it's absolutely fantastic. I think the last time I had KFC was about two years ago. I'm intrigued, though, and may try to find a KFC where I can get grilled chicken sometime this weekend.
[This article is excerpted from The Privatization of Roads and Highways.]
Although I shall be criticizing you, even severely, please do not take this amiss. I mean your organization no harm. Quite the contrary. My two children, in their early twenties, are both new drivers. I would suffer more than I can tell you if anything were to happen to them as a result of drunken driving. I am thus a supporter of yours. I am on your side. Please take what I say as no more than friendly amendments to your plans and proposals. Some of the following critiques may sound harsh, but friends do not mince words with each other in life-and-death situations, and I would like you to consider me a friend of yours. We may disagree on means but certainly not on ends.
ExpansionFirst, you must expand your scope of operations. While drunk driving is of course a major calamity on our nation's roads, it is far from the only one. There are quite a few others, even besides the "big three" of speed, weather conditions, and driver error.[1] What difference does it really make if our children and loved ones die in a traffic fatality emanating from drunkenness or any of these other conditions? Happily there is no need to change even the MADD name if you adopt this suggestion. Only instead of the first "D" standing for "drunk" it could refer to "death," as in Mothers Against Death Drivers. All of these things — alcohol, drugs, speeding, malfunctioning vehicles, badly engineered roads, weather conditions, whatever — are threats to our families' lives. Why single out any one of them?
A possible defense of the status quo is to borrow a leaf from the economists and defend the present, limited, status of MADD on grounds of specialization and division of labor.[2] True, no one organization can do everything. Better to take on a limited agenda and do it well than to take on too much and accomplish little or nothing.
But this insight applies only when to take on additional tasks is to dilute the focus of an enterprise. If you truly oppose fatalities only from the single cause of alcoholism, well and good. MADD as presently constituted then needs no broadening of vision. But if your goal is decrease the senseless roadway slaughter of innocents which stems from any cause, which I strongly suspect is the case, then to include the contributions from other sources does not weaken the mission; on the contrary, it fortifies it.
PrivatizationMy second suggestion is far more radical. Please hear me out. There are very important matters at stake. True, the highway fatality rates have been declining in recent years.[3] But 41,480, the number of people who perished as a result of improper automobile use in 1998, for example, is still far too high. Desperate circumstances require radical solutions.
The radical suggestion I offer is that MADD adopt as one of its major policy planks the proposal that our nation's roadways be privatized. And this includes not only the federal interstate highway system but every byway, country road, city street, and even sidewalk — wherever vehicle-related deaths have occurred. Why? There are several reasons.
First, it is not at all true that speed, alcohol, drugs, etc., are ultimately responsible for vehicular death. Rather, they are only the proximate causes. The underlying explanation is that the managers of the roads, those in charge of them, have failed to deal with these problems. The reason Chrysler went broke is only indirectly related to car size, changing styles, competition, imports, the price of oil and gas, etc. This company was bankrupted because its managers failed to meet these challenges. When a restaurant shuts down, it is not due to such proximate causes as poorly cooked food, poor service, bad location, unclean premises, etc. Rather, this circumstance is due to the fact that the owners, operators, managers of the restaurant failed to address these problems.
Second, with a system of private highways and streets, the various owners would compete with one another to provide service for their customers (including, preeminently, safety). Those who failed (e.g., pursued policies detrimental to the "health of children and other living things") would be forced either to change the error of their ways or go belly up. Those who saved lives by better dealing with drunkards, speeders, etc., would earn profits and thus be enabled to expand the base of their operations.
Third, this is precisely the system — privatization — that vastly outstripped that of the U.S.S.R. in providing computers, cars, clothes, and a plethora of other products and services. Yet, instead of borrowing a leaf from our own success and applying it to highways, we have instead copied the discredited Soviet economic system and applied it to our network of roadways. That is, our highway network is governmentally owned and managed. This is why people die like flies on these roads and suffer from traffic congestion serious enough to try the patience of a saint (which also exacerbates casualties through road rage).
Fourth, the rules of the road that would minimize automobile accidents (this goes for most other valuable economic recipes) do not come to us from on high, imprinted on stone tablets. Rather, they have to be learned, ofttimes by hard and difficult experience. The time-honored and traditional capitalist way of learning is by allowing all entrepreneurs, willing to risk their own money, free rein to do exactly as they please. The ones who hit upon the best way of proceeding earn profits; those who do not either have to copy the successful or fall by the wayside. It is precisely this, the magic of the marketplace, that has brought us our world-class standard of living. But this learning process cannot possibly take place when politicians, bureaucrats, and other members of the nomenklatura class determine the rules of the road, and do not lose an iota of their personal fortunes when they err in this way, or, indeed, are guilty of any other sort of highway mismanagement.
We all deplore highway casualties. But at least when they occur, let us have a system wherein someone in authority loses money thereby. There is nothing that concentrates the managerial mind more. At present, when deaths take place, there is no one in a position to ameliorate matters who suffers financially. Surely we may expect better results from a system that monetarily rewards the successful and punishes those who fail than from one that does neither.
Take a case in point. It is perhaps a truism that "speed kills." Yet the rate of fatalities has decreased after the elimination of the 55 mph speed limit. Some analysts have suggested that it is not the average rate of travel that is determinative but rather the variance in speed. That is, we might all be safer with a slow-lane speed requirement (both minimum and maximum) of 60 mph, a middle lane of 70 mph, and a fast lane of 80 mph than with the present minimum of 40 mph and maximum of 70, typical of many highways. I don't know the answer to this question. But I do know the best way to answer it: unleash a new breed of road entrepreneurs on it. Allow each of them to address this issue as they wish. Then, using the same system we as a society have utilized to improve the quality of cars, computers, and clothes, among other things, we shall find the answer.
Take another example, closer to the concerns of MADD. How best to stop drunk driving? Heavier penalties? More emphasis on driver education? More police monitoring? Rewards for exemplary driving? Payment for joining Alcoholics Anonymous? Again, the same principles apply. Privatize the avenues of vehicular transportation, and rely upon the new owners — under the tutelage of the free-enterprise, profit-and-loss system — to find solutions.
One of this new breed of highway proprietors, of course, would be MADD. Under such a system, a revitalized and reinvigorated MADD, as an organization, would be able to implement its own policies on drinking while driving, speeding, whatever. It would have to take its chances in competition with all other entrants into this industry, but that is the way of the market system.
At present, in contrast, under a road system that would bring a smile to the face of a Russian commissar, there is simply no managerial role for MADD to play. Compare your situation with that of Ducks Unlimited, Western Wilderness Society, or any other environmental group. They are not relegated to the sidelines in their analogous field, limited to offering advice, and, in a word, begging the powers that be. They can of course do these things. But they can also buy up vast tracts of land (they would have been unable to do this in the U.S.S.R.) and manage them as they please.[4] Why should MADD accept its present inferior status, vis à vis these other groups?
ConclusionTwo final points. There are those who will dismiss these suggestions as the ravings of a lunatic. They will throw up all sorts of obstacles and objections: the specter of having to place a coin in a toll box of every home you pass by in the street; of having your house surrounded by private road owners who deny access and egress; of crazy road owners who would demand weird behavior, such as forcing everyone to travel in reverse gear. However, there is a wealth of published material refuting these and all other criticisms of private highway ownership and management.[5] Before giving in to the "nattering nabobs of negativism," you owe it to yourself to at least familiarize yourself with this literature.
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Last but not least, why have I written an open letter to you, MADD, and not taken up my case with the authorities? For one thing, private organizations such as MADD are what have made this country great; government bureaucrats, operating way past their capacities, have always brought us down. For another, those presently in charge of our roadways are not just part of the problem; they pretty much are the problem. When and if a Nuremberg-type trial is ever held for those responsible for thousands upon thousands of unnecessary traffic fatalities, these are the very people who will be prime candidates for occupancy in the dock.
MADD has a passion for saving lives. This, indeed, is what MADD is all about. That puts this organization head and shoulders above all others concerned with preserving life on our highways. But more needs to be done. Far more. It is time for a radical departure from previous activity, in order, paradoxically, to build on previous good work. It is time for highway privatization, with MADD taking a lead role in this initiative.
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This article is excerpted from Walter Block's astounding new book The Privatization of Roads and Highways (Mises Institute, 2009). The chapter first appeared as Walter Block, "Roads, Bridges, Sunlight and Private Property: Reply to Gordon Tullock," Journal des Economistes et des Etudes Humaines 8, no. 2/3 (June–September 1998): 315–26.
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Notes[1] Sam Peltzman, "The Effects of Automobile Safety Regulation," Journal of Political Economy 83, no. 4 (1975): 677–725, lists the following:
Vehicle speed … alcohol consumption … the number of young drivers … changes in drivers incomes … the money costs of accidents … the average age of cars … the ratio of new cars to all cars (because it has been suggested that while drivers familiarize themselves with their new cars, accident risk may increase) … traffic density … expenditures on traffic-law enforcement by state highway patrols expenditures on roads … the ratio of imports to total car (because there is evidence that small cars are more lethal than large cars if an accident occurs) … education of the population … and the availability of hospital care (which might reduce deaths if injury occurs).
The list put together by the National Highway Traffic and Safety Administration is much larger. See also Traffic Safety Facts 2001 from the National Highway Traffic Safety Administration and the Fatality Analysis Reporting System (FARS) database.
[2] See on this Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (New York: Modern Library, [1776] 1965).
[3] According to the Fatality Analysis Reporting System (FARS) of the National Highway Traffic and Safety Administration (NHTSA), for 1999, highway deaths for 1998 were 41,480; for 1997, 42,103; for 1994, 40,676; for 1993, 40,115; and for 1979, 51,093. Since the number of passenger miles was increasing during this time period, the actual safety improvement given by these statistics on a mile-traveled basis is understated.
[4] Terry Anderson and Donald R. Leal, Free Market Environmentalism (San Francisco: Pacific Institute, 1991), pp. 64, 90, mention the case of the National Audubon Society's Rainey Wildlife Sanctuary in Louisiana. When natural gas was discovered on their property, this organization chose to develop it, something of a departure from their typical reaction to such circumstances.
[5] See on this Block, "Roads, Bridges, Sunlight and Private Property: Reply to Gordon Tullock;" idem, "Compromising the Uncompromisable: Speed, Parades, Cigarettes," Asian Economic Review 40, no. 1 (April 1998): 15–29; idem, "Private Roads, Competition, Automobile Insurance and Price Controls," Competitiveness Review 8, no. 1: 55–64; "Road Socialism," International Journal of Value-Based Management 9 (1996): 195–207; Walter Block and Matthew Block, "Roads, Bridges, Sunlight and Private Property Rights," Journal des Economistes et des Etudes Humaines 7, no. 2/3 (June — September 1996): 351–62; Block, "Theories of Highway Safety," Transportation Research Record #912 (1983): 7–10; idem, "Public Goods and Externalities: The Case of Roads," Journal of Libertarian Studies 7, no. 1 (Spring 1983): 1–34; idem, "Congestion and Road Pricing," Journal of Libertarian Studies 4, no. 3 (Summer 1980): 299–330; idem, "Free Market Transportation: Denationalizing the Roads," Journal of Libertarian Studies 3, no. 2 (Summer, 1979): 209–38; anthologized in Tibor R. Machan, The Libertarian Reader (Totowa, N.J.: Row-man & Littlefield, 1982): 164–83; Michelle Cadin and Walter Block, "Privatize the Public Highway System," The Freeman 47, no. 2 (February 1997): 96–97; John Cobin, "Market Provisions of Highways: Lessons from Costanera Norte," Planning and Markets 2, no. 1 (1999); Gerald Gunderson, "Privatization and the 19th-Century Turnpike," Cato Journal 9, no. l (Spring/Summer 1989): 191–200; W.T. Jackman, The Development of Transportation in Modern England (Cambridge: Cambridge University Press, 1916); Dan Klein, "The Voluntary Provision of Public Goods? The Turnpike Companies of Early America," Economic Inquiry (October 1990): 788–812; Dan Klein, John Majewski, and Christopher Baer, "Economy, Community and the Law: The Turnpike Movement in New York, 1797–1845," Journal of Economic History (March 1993): 106–22; idem, "From Trunk to Branch: Toll Roads in New York, 1800–1860," Essays in Economic and Business History 11 (1993): 191–209; Dan Klein and G.J. Fielding, "Private Toll Roads: Learning From the Nineteenth Century," Transportation Quarterly (July 1992): 321–41; idem, "How to Franchise Highways," Journal of Transport Economics and Policy (May 1993): 113–30; idem, "High Occupancy/Toll Lanes: Phasing in Congestion Pricing a Lane at a Time," Policy Study 170 (November 1993); Roth (1987); Gabriel Roth, A Self-Financing Road System (London: Institute of Economic Affairs, 1966); idem, Paying for Roads: The Economics of Traffic Congestion (Middlesex, U.K.: Penguin, 1967; idem, The Private Provision of Public Services in Developing Countries (Oxford: Oxford University Press, 1987); Murray N. Rothbard, For a New Liberty (New York: Macmillan); William C. Woolridge, Uncle Sam, The Monopoly Man (New Rochelle, N.Y.: Arlington House, 1970).
Dr. Block is interviewed by Ron Smith, WBAL AM1090, Baltimore, 14 November 2008. [26:21]
The Pricing ProcessValuation and AppraisementThe Prices of the Goods of Higher OrdersCost AccountingLogical Catallactics Versus Mathematical Catallactics[This article is excerpted from chapter 16 of Human Action. Robert Murphy has written a study guide for this chapter, available in HTML and PDF.This article follows "Chapter XV. The Market, Part 2."]
- The Pricing ProcessIn an occasional act of barter in which men who ordinarily do not resort to trading with other people exchange goods ordinarily not negotiated, the ratio of exchange is determined only within broad margins. Catallactics, the theory of exchange ratios and prices, cannot determine at what point within these margins the concrete ratio will be established. All that it can assert with regard to such exchanges is that they can be effected only if each party values what he receives more highly than what he gives away.
The recurrence of individual acts of exchange generates the market step by step with the evolution of the division of labor within a society based on private property. As it becomes a rule to produce for other people's consumption, the members of society must sell and buy. The multiplication of the acts of exchange and the increase in the number of people offering or asking for the same commodities narrow the margins between the valuations of the parties. Indirect exchange and its perfection through the use of money divide the transactions into two different parts: sale and purchase. What in the eyes of one party is a sale, is for the other party a purchase. The divisibility of money, unlimited for all practical purposes, makes it possible to determine the exchange ratios with nicety. The exchange ratios are now as a rule money prices. They are determined between extremely narrow margins: the valuations on the one hand of the marginal buyer and those of the marginal offerer who abstains from selling, and the valuations on the other hand of the marginal seller and those of the marginal potential buyer who abstains from buying.
The concatenation of the market is an outcome of the activities of entrepreneurs, promoters, speculators, and dealers in futures and in arbitrage. It has been asserted that catallactics is based on the assumption — contrary to reality — that all parties are provided with perfect knowledge concerning the market data and are therefore in a position to take best advantage of the most favorable opportunities for buying and selling. It is true that some economists really believed that such an assumption is implied in the theory of prices. These authors not only failed to realize in what respects a world peopled with men perfectly equal in knowledge and foresight would differ from the real world which all economists wanted to interpret in developing their theories; they also erred in being unaware of the fact that they themselves did not resort to such an assumption in their own treatment of prices.
In an economic system in which every actor is in a position to recognize correctly the market situation with the same degree of insight, the adjustment of prices to every change in the data would be achieved at one stroke. It is impossible to imagine such uniformity in the correct cognition and appraisal of changes in data except by the intercession of superhuman agencies. We would have to assume that every man is approached by an angel informing him of the change in data which has occurred and advising him how to adjust his own conduct in the most adequate way to this change. Certainly the market that catallactics deals with is filled with people who are to different degrees aware of the changes in data and who, even if they have the same information, appraise it differently. The operation of the market reflects the fact that changes in the data are first perceived only by a few people and that different men draw different conclusions in appraising their effects. The more enterprising and brighter individuals take the lead; others follow later. The shrewder individuals appreciate conditions more correctly than the less intelligent and therefore succeed better in their actions. Economists must never disregard in their reasoning the fact that the innate and acquired inequality of men differentiates their adjustment to the conditions of their environment.
The driving force of the market process is provided neither by the consumers nor by the owners of the means of production — land, capital goods, and labor — but by the promoting and speculating entrepreneurs. These are people intent upon profiting by taking advantage of differences in prices. Quicker of apprehension and farther-sighted than other men, they look around for sources of profit. They buy where and when they deem prices too low, and they sell where and when they deem prices too high. They approach the owners of the factors of production, and their competition sends the prices of these factors up to the limit corresponding to their anticipation of the future prices of the products. They approach the consumers, and their competition forces prices of consumers' goods down to the point at which the whole supply can be sold. Profit-seeking speculation is the driving force of the market as it is the driving force of production.
On the market, agitation never stops. The imaginary construction of an evenly rotating economy has no counterpart in reality. There can never emerge a state of affairs in which the sum of the prices of the complementary factors of production, due allowance being made for time preference, equals the prices of the products and no further changes are to be expected. There are always profits to be earned by somebody. The speculators are always enticed by the expectation of profit.
The imaginary construction of the evenly rotating economy is a mental tool for comprehension of entrepreneurial profit and loss. It is, to be sure, not a design for comprehension of the pricing process. The final prices corresponding to this imaginary conception are by no means identical with the market prices. The activities of the entrepreneurs or of any other actors on the economic scene are not guided by consideration of any such things as equilibrium prices and the evenly rotating economy. The entrepreneurs take into account anticipated future prices, not final prices or equilibrium prices. They discover discrepancies between the height of the prices of the complementary factors of production and the anticipated future prices of the products, and they are intent upon taking advantage of such discrepancies. These endeavors of the entrepreneurs would finally result in the emergence of the evenly rotating economy if no further changes in the data were to appear.
The operation of the entrepreneurs brings about a tendency toward an equalization of prices for the same goods in all subdivisions of the market, due allowance being made for the cost of transportation and the time absorbed by it. Differences in prices which are not merely transitory and bound to be wiped out by entrepreneurial action are always the outcome of particular obstacles obstructing the inherent tendency toward equalization. Some check prevents profit-seeking business from interfering. An observer not sufficiently familiar with actual commercial conditions is often at a loss to recognize the institutional barrier hindering such equalization. But the merchants concerned always know what makes it impossible for them to take advantage of such differences.
Statisticians treat this problem too lightly. When they have discovered differences in the wholesale price of a commodity between two cities or countries, not entirely accounted for by the cost of transportation, tariffs, and excise duties, they acquiesce in asserting that the purchasing power of money and the "level" of prices are different.Sometimes the difference in price as established by price statistics is apparent only. The price quotations may refer to various qualities of the article concerned. Or they may, complying with the local usages of commerce, mean different things. They may, for instance, include or not include packing charges; they may refer to cash payment or to payment at a later date; and so on. On the basis of such statements people draft programs to remove these differences by monetary measures. However, the root cause of these differences cannot lie in monetary conditions. If prices in both countries are quoted in terms of the same kind of money, it is necessary to answer the question as to what prevents businessmen from embarking upon dealings which are bound to make price differences disappear. Things are essentially the same if the prices are expressed in terms of different kinds of money. For the mutual exchange ratio between various kinds of money tends toward a point at which there is no further margin left to profitable exploitation of differences in commodity prices. Whenever differences in commodity prices between various places persist, it is a task for economic history and descriptive economics to establish what institutional barriers hinder the execution of transactions which must result in the equalization of prices.
All the prices we know are past prices. They are facts of economic history. In speaking of present prices we imply that the prices of the immediate future will not differ from those of the immediate past. However, all that is asserted with regard to future prices is merely an outcome of the understanding of future events.
The experience of economic history never tells us more than that at a definite date and definite place two parties A and B traded a definite quantity of the commodity a against a definite number of units of the money p. In speaking of such acts of buying and selling as the market price of a, we are guided by a theoretical insight, deduced from an aprioristic starting point. This is the insight that, in the absence of particular factors making for price differences, the prices paid at the same time and the same place for equal quantities of the same commodity tend toward equalization, viz., a final price. But the actual market prices never reach this final state. The various market prices about which we can get information were determined under different conditions. It is impermissible to confuse averages computed from them with the final prices.
Only with regard to fungible commodities negotiated on organized stock or commodity exchanges is it permissible, in comparing prices, to assume that they refer to the same quality. Apart from such prices negotiated in exchanges and from prices of commodities the homogeneity of which can be precisely established by technological analysis, it is a serious blunder to disregard differences in the quality of the commodity in question. Even in the wholesale trade of raw textiles the diversity of the articles plays the main role. A comparison of prices of consumers' goods in mainly misleading on account of the difference in quality. The quantity traded in one transaction too is relevant in the determination of the price paid per unit. Shares of a corporation sold in one large lot bring a different price than those sold in several small lots.
It is necessary to emphasize these facts again and again because it is customary nowadays to play off the statistical elaboration of price data against the theory of prices. However, the statistics of prices is altogether questionable. Its foundations are precarious because circumstances for the most part do not permit the comparison of the various data, their linking together in series, and the computation of averages. Full of zeal to embark upon mathematical operations, the statisticians yield to the temptation of disregarding the incomparability of the data available. The information that a certain firm sold at a definite date a definite type of shoes for six dollars a pair relates a fact of economic history. A study of the behavior of shoe prices from 1923 to 1939 is conjectural, however sophisticated the methods applied may be.
Catallactics shows that entrepreneurial activities tend toward an abolition of price differences not caused by the costs of transportation and trade barriers. No experience has ever contradicted this theorem. The results obtained by an arbitrary identification of unequal things are irrelevant.
- Valuation and AppraisementThe ultimate source of the determination of prices is the value judgments of the consumers. Prices are the outcome of the valuation preferring a to b. They are social phenomena as they are brought about by the interplay of the valuations of all individuals participating in the operation of the market. Each individual, in buying or not buying and in selling or not selling, contributes his share to the formation of the market prices. But the larger the market is, the smaller is the weight of each individual's contribution. Thus the structure of market prices appears to the individual as a datum to which he must adjust his own conduct.
The valuations which result in determination of definite prices are different. Each party attaches a higher value to the good he receives than to the good he gives away. The exchange ratio, the price, is not the product of an equality of valuation, but, on the contrary, the product of a discrepancy in valuation.
Appraisement must be clearly distinguished from valuation. Appraisement in no way depends upon the subjective valuation of the man who appraises. He is not intent upon establishing the subjective use-value of the good concerned, but upon anticipating the prices which the market will determine. Valuation is a value judgment expressive of a difference in value. Appraisement is the anticipation of an expected fact. It aims at establishing what prices will be paid on the market for a particular commodity or what amount of money will be required for the purchase of a definite commodity.
Valuation and appraisement are, however, closely connected. The valuations of an autarkic husbandman directly compare the weight he attaches to different means for the removal of uneasiness. The valuations of a man buying and selling on the market must not disregard the structure of market prices; they depend upon appraisement. In order to know the meaning of a price one must know the purchasing power of the amount of money concerned. It is necessary by and large to be familiar with the prices of those goods which one would like to acquire and to form on the ground of such knowledge an opinion about their future prices. If an individual speaks of the costs incurred by the purchase of some goods already acquired or to be incurred by the purchase of goods he plans to acquire, he expresses these costs in terms of money. But this amount of money represents in his eyes the degree of satisfaction he could obtain by employing it for the acquisition of other goods. The valuation makes a detour: it goes via the appraisement of the structure of market prices; but it always aims finally at the comparison of alternative modes for the removal of felt uneasiness.
It is ultimately always the subjective value judgments of individuals that determine the formation of prices. Catallactics in conceiving the pricing process necessarily reverts to the fundamental category of action, the preference given to a over b. In view of popular errors it is expedient to emphasize that catallactics deals with the real prices as they are paid in definite transactions and not with imaginary prices. The concept of final prices is merely a mental tool for the grasp of a particular problem, the emergence of entrepreneurial profit and loss. The concept of a "just" or "fair" price is devoid of any scientific meaning; it is a disguise for wishes, a striving for a state of affairs different from reality. Market prices are entirely determined by the value judgments of men as they really act.
If one says that prices tend toward a point at which total demand is equal to total supply, one resorts to another mode of expressing the same concatenation of phenomena. Demand and supply are the outcome of the conduct of those buying and selling. If, other things being equal, supply increases, prices must drop. At the previous price all those ready to pay this price could buy the quantity they wanted to buy. If the supply increases, they must buy larger quantities or other people who did not buy before must become interested in buying. This can only be attained at a lower price.
It is possible to visualize this interaction by drawing two curves, the demand curve and the supply curve, whose intersection shows the price. It is no less possible to express it in mathematical symbols. But it is necessary to comprehend that such pictorial or mathematical modes of representation do not affect the essence of our interpretation and that they do not add a whit to our insight. Furthermore it is important to realize that we do not have any knowledge or experience concerning the shape of such curves. Always, what we know is only market prices — that is, not the curves but only a point which we interpret as the intersection of two hypothetical curves. The drawing of such curves may prove expedient in visualizing the problems for undergraduates. For the real tasks of catallactics they are mere byplay.
- The Prices of the Goods of Higher OrdersThe market process is coherent and indivisible. It is an indissoluble intertwinement of actions and reactions, of moves and countermoves. But the insufficiency of our mental abilities enjoins upon us the necessity of dividing it into parts and analyzing each of these parts separately. In resorting to such artificial cleavages we must never forget that the seemingly autonomous existence of these parts is an imaginary makeshift of our minds. They are only parts, that is, they cannot even be thought of as existing outside the structure of which they are parts.
The prices of the goods of higher orders are ultimately determined by the prices of the goods of the first or lowest order, that is, the consumers' goods. As a consequence of this dependence they are ultimately determined by the subjective valuations of all members of the market society. It is, however, important to realize that we are faced with a connection of prices, not with a connection of valuations. The prices of the complementary factors of production are conditioned by the prices of the consumers' goods. The factors of production are appraised with regard to the prices of the products, and from this appraisement their prices emerge. Not the valuations but the appraisement are transferred from the goods of the first order to those of higher orders. The prices of the consumers' goods engender the actions resulting in the determination of the prices of the factors of production. These prices are primarily connected only with the prices of the consumers' goods. With the valuations of the individuals they are only indirectly connected, viz., through the intermediary of the prices of the consumers' goods, the products of their joint employment.
The tasks incumbent upon the theory of the prices of factors of production are to be solved by the same methods which are employed for treatment of the prices of consumers' goods. We conceive the operation of the market of consumer's goods in a twofold way. We think on the one hand of a state of affairs which leads to acts of exchange; the situation is such that the uneasiness of various individuals can be removed to some extent because various people value the same goods in a different way. On the other hand, we think of a situation in which no further acts of exchange can happen because no actor expects any further improvement of his satisfaction by further acts of exchange. We proceed in the same way in comprehending the formation of the prices of factors of production. The operation of this market is actuated and kept in motion by the exertion of the promoting entrepreneurs, eager to profit from differences in the market prices of the factors of production and the expected prices of the products. The operation of this market would stop if a situation were ever to emerge in which the sum of the prices of the complementary factors of production — but for interest — equaled the prices of the products and nobody believed that further price changes were to be expected. Thus we have described the process adequately and completely by pointing out, positively, what actuates it and, negatively, what would suspend its motion. The main importance is to be attached to the positive description. The negative description resulting in the imaginary constructions of the final price and the evenly rotating economy is merely auxiliary. For the task is not the treatment of imaginary concepts, which never appear in life and action, but the treatment of the market prices at which the goods of higher orders are really bought and sold.
This method we owe to Gossen, Carl Menger, and Böhm-Bawerk. Its main merit is that it implies the cognition that we are faced with a phenomenon of price determination inextricably linked with the market process. It distinguishes between two things: (a) the direct valuation of the factors of production which attaches the value of the product to the total complex of the complementary factors of production, and (b) the prices of the single factors of production which are formed on the market as the resultant of the concurring actions of competing highest bidders. Valuation as it can be practiced by an isolated actor (Robinson Crusoe or a socialist board of production management) can never result in a determination of such a thing as quotas of value. Valuation can only arrange goods in scales of preference. It can never attach to a good something that could be called a quantity or magnitude of value. It would be absurd to speak of a sum of valuations or values. It is permissible to declare that, due allowance being made for time preference, the value attached to a product is equal to the value of the total complex of complementary factors of production. But it would be nonsensical to assert that the value attached to a product is equal to the "sum" of the values attached to the various complementary factors of production. One cannot add up values or valuations. One can add up prices expressed in terms of money, but not scales of preference. One cannot divide values or single out quotas of them. A value judgment never consists in anything other than preferring a to b.
The process of value imputation does not result in derivation of the value of the single productive agents from the value of their joint product. It does not bring about results which could serve as elements of economic calculation. It is only the market that, in establishing prices for each factor of production, creates the conditions required for economic calculation. Economic calculation always deals with prices, never with values.
The market determines prices of factors of production in the same way in which it determines prices of consumers' goods. The market process is an interaction of men deliberately striving after the best possible removal of dissatisfaction. It is impossible to think away or to eliminate from the market process the men actuating its operation. One cannot deal with the market of consumers' goods and disregard the actions of the consumers. One cannot deal with the market of the goods of higher orders while disregarding the actions of the entrepreneurs and the fact that the use of money is essential in their transactions. There is nothing automatic or mechanical in the operation of the market. The entrepreneurs, eager to earn profits, appear as bidders at an auction, as it were, in which the owners of the factors of production put up for sale land, capital goods, and labor. The entrepreneurs are eager to outdo one another by bidding higher prices than their rivals. Their offers are limited on the one hand by their anticipation of future prices of the products and on the other hand by the necessity to snatch the factors of production away from the hands of other entrepreneurs competing with them.
The entrepreneur is the agency that prevents the persistence of a state of production unsuitable to fill the most urgent wants of the consumers in the cheapest way. All people are anxious for the best possible satisfaction of their wants and are in this sense striving after the highest profit they can reap. The mentality of the promoters, speculators, and entrepreneurs is not different from that of their fellow men. They are merely superior to the masses in mental power and energy. They are the leaders on the way toward material progress. They are the first to understand that there is a discrepancy between what is done and what could be done. They guess what the consumers would like to have and are intent upon providing them with these things. In the pursuit of such plans they bid higher prices for some factors of production and lower the prices of other factors of production by restricting their demand for them. In supplying the market with those consumers' goods in the sale of which the highest profits can be earned, they create a tendency toward a fall in their prices. In restricting the output of those consumers' goods the production of which does not offer chances for reaping profit, they bring about a tendency toward a rise in their prices. All these transformations go on ceaselessly and could stop only if the unrealizable conditions of the evenly rotating economy and of static equilibrium were to be attained.
In drafting their plans, the entrepreneurs look first at the prices of the immediate past, which are mistakenly called present prices. Of course, the entrepreneurs never make these prices enter into their calculations without paying regard to anticipated changes. The prices of the immediate past are for them only the starting point of deliberations leading to forecasts of future prices. The prices of the past do not influence the determination of future prices. It is, on the contrary, the anticipation of future prices of the products that determines the state of prices of the complementary factors of production. The determination of prices has, as far as the mutual exchange ratios between various commodities are concerned,It is different with regard to the mutual exchange ratios between money and the vendible commodities and services. Cf. below, pp. 410–411. no direct causal relation whatever with the prices of the past. The allocation of the nonconvertible factors of production among the various branches of productionThe problem of the nonconvertible capital goods is dealt with below, pp. 503–509. and the amount of capital goods available for future production are historical magnitudes; in this regard the past is instrumental in shaping the course of future production and in affecting the prices of the future. But directly the prices of the factors of production are determined exclusively by the anticipation of future prices of the products. The fact that yesterday people valued and appraised commodities in a different way is irrelevant. The consumers do not care about the investments made with regard to past market conditions and do not bother about the vested interests of entrepreneurs, capitalists, landowners, and workers, who may be hurt by changes in the structure of prices. Such sentiments play no role in the formation of prices. (It is precisely the fact that the market does not respect vested interests that makes the people concerned ask for government interference.) The prices of the past are for the entrepreneur, the shaper of future production, merely a mental tool. The entrepreneurs do not construct afresh every day a radically new structure of prices or allocate anew the factors of production to the various branches of industry. They merely transform what the past has transmitted in better adapting it to the altered conditions. How much of the previous conditions they preserve and how much they change depends on the extent to which the data have changed.
The economic process is a continuous interplay of production and consumption. Today's activities are linked with those of the past through the technological knowledge at hand, the amount and the quality of the capital goods available, and the distribution of the ownership of these goods among various individuals. They are linked with the future through the very essence of human action; action is always directed toward the improvement of future conditions. In order to see his way in the unknown and uncertain future man has within his reach only two aids: experience of past events and his faculty of understanding. Knowledge about past prices is a part of this experience and at the same time the starting point of understanding the future.
If the memory of all prices of the past were to fade away, the pricing process would become more troublesome, but not impossible as far as the mutual exchange ratios between various commodities are concerned. It would be harder for the entrepreneurs to adjust production to the demand of the public, but it could be done nonetheless. It would be necessary for them to assemble anew all the data they need as the basis of their operations. They would not avoid mistakes which they now evade on account of experience at their disposal. Price fluctuations would be more violent at the beginning; factors of production would be wasted; want satisfaction would be impaired. But finally, having paid dearly, people would again have acquired the experience needed for a smooth working of the market process.
The essential fact is that it is the competition of profit-seeking entrepreneurs that does not tolerate the preservation of false prices of the factors of production. The activities of the entrepreneurs are the element that would bring about the unrealizable state of the evenly rotating economy if no further changes were to occur. In the world-embracing public sale called the market, they are the bidders for the factors of production. In bidding, they are the mandataries of the consumers, as it were. Each entrepreneur represents a different aspect of the consumers' wants, either a different commodity or another way of producing the same commodity. The competition among the entrepreneurs is ultimately a competition among the various possibilities open to men to remove their uneasiness as far as possible by the acquisition of consumers' goods. The decisions of the consumers to buy one commodity and to postpone buying another determine the prices of factors of production required for manufacturing these commodities. The competition between the entrepreneurs reflects the prices of consumers' goods in the formation of the prices of the factors of production. It reflects in the external world the conflict which the inexorable scarcity of the factors of production brings about in the soul of each individual. It makes effective the subsumed decisions of the consumers as to what purpose the nonspecific factors should be used for and to what extent the specific factors of production should be used.
The pricing process is a social process. It is consummated by an interaction of all members of the society. All collaborate and cooperate, each in the particular role he has chosen for himself in the framework of the division of labor. Competing in cooperation and cooperating in competition, all people are instrumental in bringing about the result, viz., the price structure of the market, the allocation of the factors of production to the various lines of want satisfaction, and the determination of the share of each individual. These three events are not three different matters. They are only different aspects of one indivisible phenomenon which our analytical scrutiny separates into three parts. In the market process they are accomplished uno actu. Only people prepossessed by socialist leanings who cannot free themselves from longing glances at socialist methods speak of three different processes in dealing with the market phenomena: the determination of prices, the direction of productive efforts, and distribution.
A Limitation on the Pricing of Factors of ProductionThe process which makes the prices of the factors of production spring from the prices of products can achieve its results only if, of the complementary factors not replaceable by substitutes, not more than one is of absolutely specific character, that is, is not suitable for any other employment. If the production of a product requires two or more absolutely specific factors, only a cumulative price can be assigned to them. If all factors of production were absolutely specific, the pricing process would not achieve more than such cumulative prices. It would accomplish nothing more than statements like this: as combining 3 a and 5 b produces one unit of p, 3a and 5b together are equal to 1p and the final price of 3a+5b is — due allowance being made for time preference — equal to the final price of 1p. As entrepreneurs who want to use a and b for purposes other than the production of p do not bid for them, a more detailed price determination is impossible. Only if a demand emerges for a (or for b) on the part of entrepreneurs who want to employ a (or b) for other purposes, does competition between them and the entrepreneurs planning the production of p arise and a price for a (or for b) comes into existence, the height of which determines also the price of b (or a).
"In drafting their plans, the entrepreneurs look first at the prices of the immediate past, which are mistakenly called present prices."A world in which all the factors of production are absolutely specific could manage its affairs with such cumulative prices. In such a world there would not exist the problem of how to allocate the means of production to various branches of want satisfaction. In our real world, things are different. There are many scarce means of production which can be employed for various tasks. There the economic problem is to employ these factors in such a way that no unit of them should be used for the satisfaction of a less urgent need if this employment prevents the satisfaction of a more urgent need. It is this that the market solves in determining the prices of the factors of production. The social service rendered by this solution is not in the least impaired by the fact that, for factors which can be employed only cumulatively, no other than cumulative prices are determined.
Factors of production which can be used in the same ratio of combination for the production of various commodities but do not allow of any other use, are to be considered as absolutely specific factors. They are absolutely specific with regard to the production of an intermediary product which can be utilized for various purposes. The price of this intermediary product can be assigned to them cumulatively only. Whether this intermediary product can be directly apperceived by the senses or whether it is merely the invisible and intangible outcome of their joint employment makes no difference.
- Cost AccountingIn the calculation of the entrepreneur, costs are the amount of money required for the procurement of the factors of production.
The entrepreneur is intent upon embarking upon those business projects from which he expects the highest surplus of proceeds over costs and upon shunning projects from which he expects a lower amount of profit or even a loss. In doing this, he adjusts his effort to the best possible satisfaction of the needs of the consumers. The fact that a project is not profitable because costs are higher than proceeds is the outcome of the fact that there is a more useful employment available for the factors of production required. There are other products in the purchase of which the consumers are prepared to allow for the prices of these factors of production. But the consumers are not prepared to pay these prices in buying the commodity the production of which is not profitable.
Cost accounting is affected by the fact that the two following conditions are not always present:
First, every increase in the quantity of factors expended for the production of a consumers' good increases its power to remove uneasiness.
Second, every increase in the quantity of a consumers' good requires a proportional increase in the expenditure of factors of production or even a more-than-proportional increase in their expenditure.
If both these conditions were always and without any exception fulfilled, every increment z expended for increasing the quantity m of a commodity g would be employed for the satisfaction of a need viewed as less urgent than the least-urgent need already satisfied by the quantity m available previously. At the same time, the increment z would require the employment of factors of production to be withdrawn from the satisfaction of other needs considered as more pressing than those needs whose satisfaction was foregone in order to produce the marginal unit of m. On the one hand, the marginal value of the satisfaction derived from the increase in the quantity available of g would drop. On the other hand, the costs required for the production of additional quantities of g would increase in marginal disutility: factors of production would be withheld from employments in which they could satisfy more urgent needs. Production must stop at the point at which the marginal utility of the increment no longer compensates for the marginal increase in the disutility of costs.
"It is precisely the fact that the market does not respect vested interests that makes the people concerned ask for government interference."Now these two conditions are present very often, but not generally without exception. There exist many commodities of all orders of goods whose physical structure is not homogeneous and which are therefore not perfectly divisible.
It would, of course, be possible to conjure away the deviation from the first condition mentioned above by a sophisticated play on words. One could say, half a motorcar is not a motorcar. If one adds to half a motorcar a quarter of a motorcar, one does not increase the "quantity" available; only the perfection of the process of production which turns out a complete car produces a unit and an increase in the "quantity" available. However, such an interpretation misses the point. The problem we must face is that not every increase in expenditure increases proportionately the objective use-value, the physical power of a thing to render a definite service. The various increments in expenditure bring about different results. There are increments the expenditure of which remains useless if no further increments of a definite quantity are added.
On the other hand — and this is the deviation from the second condition — an increase in physical output does not always require a proportionate increase in expenditure or even any additional expenditure. It may happen that costs do not rise at all or that their rise increases output more than proportionately. For many means of production are not homogeneous either and not perfectly divisible. This is the phenomenon known to business as the superiority of big-scale production. The economists speak of the law of increasing returns or decreasing costs.
We consider — as case A — a state of affairs in which all factors of production are not perfectly divisible and in which full utilization of the productive services rendered by every further indivisible element of each factor requires full utilization of the further indivisible elements of every other of the complementary factors. Then in every aggregate of productive agents, each of the assembled elements — every machine, every worker, every piece of raw material — can be fully utilized only if all the productive services of the other elements are fully employed too. Within these limits the production of a part of the maximum output attainable does not require a higher expenditure than the production of the highest possible output. We may also say that the minimum-size aggregate always produces the same quantity of products; it is impossible to produce a smaller quantity of products even if there is no use for a part of it.
We consider — as case B — a state of affairs in which one group of the productive agents (p) is for all practical purposes perfectly divisible. On the other hand, the imperfectly divisible agents can be divided in such a way that full utilization of the services rendered by each further indivisible part of one agent requires full utilization of the further indivisible parts of the other imperfectly divisible complementary factors. Then increasing production of an aggregate of further indivisible factors from a partial to a more complete utilization of their productive capacity requires merely an increase in the quantity of p, the perfectly divisible factors. However, one must guard oneself against the fallacy that this necessarily implies a decrease in the average cost of production. It is true that within the aggregate of imperfectly divisible factors each of them is now better utilized, that therefore costs of production as far as they are caused by the cooperation of these factors remain unchanged, and that the quotas falling to a unit of output are decreasing. But on the other hand, an increase in the employment of the perfectly divisible factors of production can be attained only by withdrawing them from other employments. The value of these other employments increases, other things being equal, with their shrinking; the price of these perfectly divisible factors tends to rise as more of them are used for the better utilization of the productive capacity of the aggregate of the not-further-divisible factors in question. One must not limit the consideration of our problem to the case in which the additional quantity of p is withdrawn from other enterprises producing the same product in a less efficient way and forces these enterprises to restrict their output. It is obvious that in this case — competition between a more and a less efficient enterprise producing the same article out of the same raw materials — the average cost of production is decreasing in the expanding plant. A more general scrutiny of the problem leads to a different result. If the units of p are withdrawn from other employments in which they would have been utilized for the production of other articles, there emerges a tendency toward an increase in the price of these units. This tendency may be compensated by accidental tendencies operating in the opposite direction; it may sometimes by so feeble that its effects are negligible. But it is always present and potentially influences the configuration of costs.
Finally we consider — as case C — a state of affairs in which various imperfectly divisible factors of production can be divided only in such a way that, given the conditions of the market, any size which can be chosen for their assemblage in a production aggregate does not allow for a combination in which full utilization of the productive capacity of one factor makes possible full utilization of the productive capacity of the other imperfectly divisible factors. This case c alone is of practical significance, while the cases A and B hardly play any role in real business. The characteristic feature of case C is that the configuration of production costs varies unevenly. If all imperfectly divisible factors are utilized to less than full capacity, an expansion of production results in a decrease of average costs of production unless a rise in the prices to be paid for the perfectly divisible factors counterbalances this outcome. But as soon as full utilization of the capacity of one of the imperfectly divisible factors is attained, further expansion of production causes a sudden sharp rise in costs. Then again a tendency toward a decrease in average production costs sets in and goes on working until full utilization of one of the imperfectly divisible factors is attained anew.
Other things being equal, the more production of a certain article increases, the more factors of production must be withdrawn from other employments in which they would have been used for the production of other articles. Hence — other things being equal — average production costs increase with the increase in the quantity produced. But this general law is by sections superseded by the phenomenon that not all factors of production are perfectly divisible and that, as far as they can be divided, they are not divisible in such a way that full utilization of one of them results in full utilization of the other imperfectly divisible factors.
The planning entrepreneur is always faced with the question: to what extent will the anticipated prices of the products exceed the anticipated costs? If the entrepreneur is still free with regard to the project in question, because he has not yet made any inconvertible investments for its realization, it is average costs that count for him. But if he has already a vested interest in the line of business concerned, he sees things from the angle of additional costs to be expended. He who already owns a not fully utilized production aggregate does not take into account average cost of production but marginal cost. Without regard to the amount already expended for inconvertible investments he is merely interested in the question whether or not the proceeds from the sale of an additional quantity of products will exceed the additional cost incurred by their production. Even if the whole amount invested in the inconvertible production facilities must be wiped off as a loss, he goes on producing provided he expects a reasonableReasonable means in this connection that the anticipated returns on the convertible capital used for the continuation of production are at least not lower than the anticipated returns on its use for other projects. surplus of proceeds over current costs.
With regard to popular errors, it is necessary to emphasize that if the conditions required for the appearance of monopoly prices are not present, an entrepreneur is not in a position to increase his net returns by restricting production beyond the amount conforming with consumers' demand. But this problem will be dealt with later in section 6.
That a factor of production is not perfectly divisible does not always mean that it can be constructed and employed in one size only. This, of course, may occur in some cases. But as a rule it is possible to vary the dimensions of these factors. If out of the various dimensions which are possible for such a factor — e.g., a machine — one dimension is distinguished by the fact that the costs incurred by its production and operation are rendered lower per unit of the productive services than those for other dimensions, things are essentially identical. Then the superiority of the bigger plant does not consist in the fact that it utilizes a machine to full capacity while the smaller plant utilizes only a part of the capacity of a machine of the same size. It consists rather in the fact that the bigger plant employs a machine which operates with a better utilization of the factors of production required for its construction and operation than does the smaller machine employed by the smaller plant.
The role played in all branches of production by the fact that many factors of production are not perfectly divisible is very great. It is of paramount importance in the course of industrial affairs. But one must guard oneself against many misinterpretations of its significance.
One of these errors was the doctrine according to which in the processing industries there prevails a law of increasing returns, while in agriculture and mining a law of decreasing returns prevails. The fallacies implied have been exploded above.Cf. Above, p. 130. As far as there is a difference in this regard between conditions in agriculture and those in the processing industries, differences in the data bring them about. The immobility of the soil and the fact that the performance of the various agricultural operations depends on the seasons make it impossible for farmers to take advantage of the capacity of many movable factors of production to the degree which conditions in manufacturing for the most part allow. The optimum size of a production outfit in agricultural production is, as a rule, much smaller than in the processing industries. It is obvious and does not need any further explanation why the concentration of farming cannot be pushed to anything near the degree obtaining in the processing industries.
However, the inequality in the distribution of natural resources over the earth's surface, which is one of the two factors making for the higher productivity of the division of labor, puts a limit to the progress of concentration in the processing industries also. The tendency toward a progressive specialization and the concentration of integrated industrial processes in only a few plants is counteracted by the geographical dispersion of natural resources. The fact that the production of raw materials and foodstuffs cannot be centralized and forces people to disperse over the various parts of the earth's surface enjoins also upon the processing industries a certain degree of decentralization. It makes it necessary to consider the problems of transportation as a particular factor of production costs. The costs of transportation must be weighed against the economies to be expected from more thoroughgoing specialization. While in some branches of the processing industries the utmost concentration is the most adequate method or reducing costs, in other branches a certain degree of decentralization is more advantageous. In the servicing trades, the disadvantages of concentration become so great that they almost entirely overweigh the advantages derived.
Then a historical factor comes into play. In the past, capital goods were immobilized on sites on which our contemporaries would not have set them. It is immaterial whether or not this immobilization was the most economical procedure to which the generations that brought it about could resort. In any event the present generation is faced with a fait accompli. It must adjust its operations to the fact and it must take it into account in dealing with problems of the location of the processing industries.For a thoroughgoing treatment of the conservatism enjoined upon men by the limited convertibility of many capital goods, the historically determined element in production, see below, pp. 503–514.
Finally there are institutional factors. There are trade and migration barriers. There are differences in political organization and methods of government between various countries. Vast areas are administered in such a way that it is practically out of the question to choose them as a seat for any capital investment no matter how favorable their physical conditions may be.
Entrepreneurial cost accounting must deal with all these geographical, historical, and institutional factors. But even apart from them there are purely technical factors limiting the optimum size of plants and firms. The greater plant or firm may require provisions and procedures which the smaller plant or firm can avoid. In many instances the outlays caused by such provisions and procedures may be overcompensated by the reduction in costs derived from better utilization of the capacity of some of the not-perfectly-divisible factors employed. In other instances, this may not be the case.
Under capitalism, the arithmetical operations required for cost accounting and the confrontation of costs and proceeds can easily be effected as there are methods of economic calculation available. However, cost accounting and calculation of the economic significance of business projects under consideration is not merely a mathematical problem, which can be solved satisfactorily by all those familiar with the elementary rules of arithmetic. The main question is the determination of the money equivalents of the items which are to enter into the calculation. It is a mistake to assume, as many economists do, that these equivalents are given magnitudes, uniquely determined by the state of economic conditions. They are speculative anticipations of uncertain future conditions and, as such, depend on the entrepreneur's understanding of the future state of the market. The term fixed costs is also in this regard somewhat misleading.
Every action aims at the best possible supplying of future needs. To achieve these ends it must make the best possible use of the available factors of production. However, the historical process which brought about the present state of factors available is beside the point. What counts and influences the decisions concerning future action is solely the outcome of this historical process, the quantity and the quality of the factors available today. These factors are appraised only with regard to their ability to render productive services for the removal of future uneasiness. The amount of money spent in the past for their production and acquisition is immaterial.
It has already been pointed out that an entrepreneur who, by the time he has to make a new decision, has expended money for the realization of a definite project, is in a different position from that of a man who starts afresh. The former owns a complex of inconvertible factors of production which he can employ for certain purposes. His decisions concerning further action will be influenced by this fact. But he appraises this complex not according to what he expended in the past for its acquisition. He appraises it exclusively from the point of view of its usefulness for future action. The fact that he has spent more or less for its acquisition is insignificant. This fact is only a factor in determining the amount of the entrepreneur's past losses or profits and the present state of his fortune. It is an element in the historical process that brought about the present state of the supply of factors of production and, as such, it is of importance for future action. But it does not count for the planning of future action and the calculation regarding such action. It is irrelevant that the entries in the firm's books differ from the actual price of such inconvertible factors of production.
Of course, such consummated losses or profits may motivate a firm to operate in a different way from which it would if it were not affected by them. Past losses may render a firm's financial position precarious, especially if they bring about indebtedness and burden it with payments of interest and installments on the principal. However, it is not correct to refer to such payments as a part of fixed costs. They have no relation whatever to the current operations. They are not caused by the process of production, but by the methods employed by the entrepreneur in the past for the procurement of the capital and capital goods needed. They are only accidental with reference to the going concern. But they may enforce upon the firm in question a conduct of affairs which it would not adopt if it were financially stronger. The urgent need for cash in order to meet payments due does not affect its cost accounting, but its appraisal of ready cash as compared with cash that can only be received at a later day. It may impel the firm to sell inventories at an inappropriate moment and to use its durable production equipment in a way that unduly neglects its conservation for later use.
It is immaterial for the problems of cost accounting whether a firm owns the capital invested in its enterprise or whether it has borrowed a greater or smaller part of it and is bound to comply with the terms of a loan contract rigidly fixing the rate of interest and the dates of maturity for interest and principal. The costs of production include only the interest on the capital which is still existent and working in the enterprise. It does not include interest on capital squandered in the past by bad investment or by inefficiency in the conduct of current business operations. The task incumbent upon the businessman is always to use the supply of capital goods now available in the best possible way for the satisfaction of future needs. In the pursuit of this aim he must not be misled by past errors and failures the consequences of which cannot be brushed away. A plant may have been constructed in the past which would not have been built if one had better forecast the present situation. It is vain to lament this historical fact. The main thing is to find out whether or not the plant can still render any service and, if this question is answered in the affirmative, how it can be best utilized. It is certainly sad for the individual entrepreneur that he did not avoid errors. The losses incurred impair his financial situation. They do not affect the costs to be taken into account in planning further action.
It is important to stress this point because it has been distorted in the current interpretation and justification of various measures. One does not "reduce costs" by alleviating some firms' and corporations' burden of debts. A policy of wiping out debts or the interest due on them totally or in part does not reduce costs. It transfers wealth from creditors to debtors; it shifts the incidence of losses incurred in the past from one group of people to another group, e.g., from the owners of common stock to those of preferred stock and corporate bonds. This argument of cost reduction is often advanced in favor of currency devaluation. It is no less fallacious in this case than all the other arguments brought forward for this purpose.
What are commonly called fixed costs are also costs incurred by the exploitation of the already available factors of production which are either rigidly inconvertible or can be adapted for other productive purposes only at a considerable loss. These factors are of a more durable character than the other factors of production required. But they are not permanent. They are used up in the process of production. With each unit of product turned out, a part of the machine's power to produce is exhausted. The extant of this attrition can be precisely ascertained by technology and can be appraised accordingly in terms of money.
However, it is not only this money equivalent of the machine's wearing out which the entrepreneurial calculation has to consider. The businessman is not merely concerned with the duration of the machine's technological life. He must take into account the future state of the market. Although a machine may still be technologically perfectly utilizable, market conditions may render it obsolete and worthless. If the demand for its products drops considerably or disappears altogether, or if more efficient methods for supplying the consumers with these products appear, the machine is economically merely scrap iron. In planning the conduct of his business, the entrepreneur must pay full regard to the anticipated future state of the market. The amount of "fixed" costs which enter into his calculation depends on his understanding of future events. It is not to be fixed simply by technological reasoning.
The technologist may determine the optimum for a production aggregate's utilization. But this technological optimum may differ from that which the entrepreneur, on the ground of his judgment concerning future market conditions, enters into his economic calculation. Let us assume that a factory is equipped with machines which can be utilized for a period of ten years. Every year, 10 percent of their prime costs is laid aside for depreciation. In the third year, market conditions place a dilemma before the entrepreneur. He can double his output for the year and sell it at a price which (apart from covering the increase in variable costs) exceeds the quota of depreciation for the current year and the present value of the last depreciation quota. But this doubling of production trebles the wearing out of the equipment and the surplus proceeds from the sale of the double quantity of products are not great enough to make good also for the present value of the depreciation quota of the ninth year. If the entrepreneur were to consider the annual depreciation quota as a rigid element for his calculation, he would have to deem the doubling of production as not profitable, as additional proceeds lag behind additional cost. He would abstain from expanding production beyond the technological optimum. But the entrepreneur calculates in a different way, although in his accountancy he may lay aside the same quota for depreciation every year. Whether or not the entrepreneur prefers a fraction of the present value of the ninth year's depreciation quota to the technological services which the machines could render him in the ninth year, depends on his opinion concerning the future state of the market.
Public opinion, governments and legislators, and the tax laws look upon a business outfit as a source of permanent revenue. They believe that the entrepreneur who makes due allowance for capital maintenance by annual depreciation quotas will always be in a position to reap a reasonable return from the capital invested in his durable producers' goods. Real conditions are different. A production aggregate, such as a plant and its equipment, is a factor of production whose usefulness depends on changing market conditions and the skill of the entrepreneur in employing it in accordance with the change in conditions.
There is in the field of economic calculation nothing that is certain in the sense in which this term is used with regard to technological facts. The essential elements of economic calculation are speculative anticipations of future conditions. Commercial usages and customs and commercial laws have established definite rules for accountancy and auditing. There is accuracy in the keeping of books. But they are accurate only with regard to these rules. The book values do not reflect precisely the real state of affairs. The market value of an aggregate of durable producers' goods may differ from the nominal figures the books show. The proof is that the stock exchange appraises them without any regard to these figures.
Cost accounting is therefore not an arithmetical process which can be established and examined by an indifferent umpire. It does not operate with uniquely determined magnitudes which can be found out in an objective way. Its essential items are the result of an understanding of future conditions, necessarily always colored by the entrepreneur's opinion about the future state of the market.
Attempts to establish cost accounts on an "impartial" basis are doomed to failure. Calculating costs is a mental tool of action, the purposive design to make the best of the available means for an improvement of future conditions. It is necessarily volitional, not factual. In the hands of an indifferent umpire, it changes its character entirely. The umpire does not look forward to the future. He looks backward to the dead past and to rigid rules, which are useless for real life and action. He does not anticipate changes. He is unwittingly guided by the prepossession that the evenly rotating economy is the normal and most desirable state of human affairs. Profits do not fit into his scheme. He has a confused idea about a "fair" rate of profit or a "fair" return on capital invested. However, there are no such things. In the evenly rotating economy, there are no profits. In a changing economy, profits are not determined with reference to any set of rules by which they could be classified as fair or unfair. Profits are never normal. Where there is normality, i.e., absence of change, no profits can emerge.
- Logical Catallactics Versus Mathematical CatallacticsThe problems of prices and costs have been treated also with mathematical methods. There have even been economists who held that the only appropriate method of dealing with economic problems is the mathematical method and who derided the logical economists as "literary" economists.
If this antagonism between the logical and the mathematical economists were merely a disagreement concerning the most adequate procedure to be applied in the study of economics, it would be superfluous to pay attention to it. The better method would prove its preeminence by bringing about better results. It may also be that different varieties of procedure are necessary for the solution of different problems and that for some of them one method is more useful than the other.
However, this is not a dispute about heuristic questions, but a controversy concerning the foundations of economics. The mathematical method must be rejected not only on account of its barrenness. It is an entirely vicious method, starting from false assumptions and leading to fallacious inferences. Its syllogisms are not only sterile; they divert the mind from the study of the real problems and distort the relations between the various phenomena.
The ideas and procedures of the mathematical economists are not uniform. There are three main currents of thought which must be dealt with separately.
The first variety is represented by the statisticians who aim at discovering economic laws from the study of economic experience. They aim to transform economics into a "quantitative" science. Their program is condensed in the motto of the Econometric Society: "Science is measurement."
The fundamental error implied in this reasoning has been shown above.Cf. Above, pp. 31, 55-56. Experience of economic history is always experience of complex phenomena. It can never convey knowledge of the kind the experimenter abstracts from a laboratory experiment. Statistics is a method for the presentation of historical facts concerning prices and other relevant data of human action. It is not economics and cannot produce economic theorems and theories. The statistics of prices is economic history. The insight that, ceteris paribus, an increase in demand must result in an increase in prices is not derived from experience. Nobody ever was or ever will be in a position to observe a change in one of the market data ceteris paribus. There is no such thing as quantitative economics. All economic quantities we know about are data of economic history. No reasonable man can contend that the relation between price and supply is, in general or in respect of certain commodities, constant. We know, on the contrary, that external phenomena affect different people in different ways, that the reactions of the same people to the same external events vary, and that it is not possible to assign individuals to classes of men reacting in the same way. This insight is a product of our aprioristic theory. It is true the empiricists reject this theory; they pretend that they aim to learn only from historical experience. However, they contradict their own principles as soon as they pass beyond the unadulterated recording of individual single prices and begin to construct series and to compute averages. A datum of experience and a statistical fact is only a price paid at a definite time and a definite place for a definite quantity of a certain commodity. The arrangement of various price data in groups and the computation of averages are guided by theoretical deliberations which are logically and temporally antecedent. The extent to which certain attending features and circumstantial contingencies of the price data concerned are taken or not taken into consideration depends on theoretical reasoning of the same kind. Nobody is so bold as to maintain that a rise of a percent in the supply of any commodity must always — in every country and at any time — result in a fall of b percent in its price. But as no quantitative economist ever ventured to define precisely on the ground of statistical experience the special conditions producing a definite deviation from the ratio a : b, the futility of his endeavors is manifest. Moreover, money is not a standard for the measurement of prices; it is a medium whose exchange ratio varies in the same way, although as a rule not with the same speed and to the same extent, in which the mutual exchange ratios of the vendible commodities and services vary.
There is hardly any need to dwell longer upon the exposure of the claims of quantitative economics. In spite of all the high-sounding pronouncements of its advocates, nothing has been done for the realization of its program. The late Henry Schultz devoted his research to the measurement of elasticities of demand for various commodities. Professor Paul H. Douglas has praised the outcome of Schultz's studies as "a work as necessary to help make economics a more or less exact science as was the determination of atomic weights for the development of chemistry."Cf. Paul H. Douglas in Econometrica, VII, 105. The truth is that Schultz never embarked upon a determination of the elasticity of demand for any commodity as such; the data he relied upon were limited to certain geographical areas and historical periods. His result for a definite commodity, for instance potatoes, do not refer to potatoes in general, but to potatoes in the United States in the years from 1875 to 1929.Cf. Henry Schultz, The Theory and Measurement of Demand (University of Chicago Press, 1938), pp. 405–427. They are, at best, rather questionable and unsatisfactory contributions to various chapters of economic history. They are certainly not steps toward the realization of the confused and contradictory program of quantitative economics. It must be emphasized that the two other varieties of mathematical economics are fully aware of the futility of quantitative economics. For they have never ventured to make any magnitudes as found by the econometricians enter into their formulas and equations and thus to adapt them for the solution of particular problems. There is in the field of human action no means for dealing with future events other than that provided by understanding.
The second field treated by mathematical economists is that of the relation of prices and costs. In dealing with these problems the mathematical economists disregard the operation of the market process and moreover pretend to abstract from the use of money inherent in all economic calculations. However, as they speak of prices and costs in general and confront prices and costs, they tacitly imply the existence and the use of money. Prices are always money prices, and costs cannot be taken into account in economic calculation if not expressed in terms of money. If one does not resort to terms of money, costs are expressed in complex quantities of diverse goods and services to be expended for the procurement of a product. On the other hand, prices — if this term is applicable at all to exchange ratios determined by barter — are the enumeration of quantities of various goods against which the "seller" can exchange a definite supply. The goods which are referred to in such "prices" are not the same to which the "costs" refer. A comparison of such prices in kind and costs in kind is not feasible. That the seller values the goods he gives away less than those he receives in exchange for them, that the seller and the buyer disagree with regard to the subjective valuation of the two goods exchanged, and that an entrepreneur embarks upon a project only if he expected to receive for the product goods that he values higher than those expended in their production, all this we know already on the ground of praxeological comprehension. It is this aprioristic knowledge that enables us to anticipate the conduct of an entrepreneur who is in a position to resort to economic calculation. But the mathematical economist deludes himself when he pretends to treat these problems in a more general way by omitting any reference to terms of money. It is vain to investigate instances of nonperfect divisibility of factors of production without reference to economic calculation in terms of money. Such a scrutiny can never go beyond the knowledge already available; namely that every entrepreneur is intent upon producing those articles the sale of which will bring him proceeds that he values higher than the total complex of goods expended in their production. But if there is no indirect exchange and if no medium of exchange is in common use, he can succeed, provided he has correctly anticipated the future state of the market, only if he is endowed with a superhuman intellect. He would have to take in at a glance all exchange ratios determined at the market in such a way as to assign in his deliberations precisely the place due to every good according to these ratios.
It cannot be denied that all investigations concerning the relation of prices and costs presuppose both the use of money and the market process. But the mathematical economists shut their eyes to this obvious fact. They formulate equations and draw curves which are supposed to describe reality. In fact they describe only a hypothetical and unrealizable state of affairs, in no way similar to the catallactic problems in question. They substitute algebraic symbols for the determinate terms of money as used in economic calculation and believe that this procedure renders their reasoning more scientific. They strongly impress the gullible layman. In fact they only confuse and muddle things which are satisfactorily dealt with in textbooks of commercial arithmetic and accountancy.
Some of these mathematicians have gone so far as to declare that economic calculation could be established on the basis of units of utility. They call their methods utility analysis. Their error is shared by the third variety of mathematical economics.
The characteristic mark of this third group is that they are openly and consciously intent upon solving catallactic problems without any reference to the market process. Their ideal is to construct an economic theory according to the pattern of mechanics. They again and again resort to analogies with classical mechanics which in their opinion is the unique and absolute model of scientific inquiry. There is no need to explain again why this analogy is superficial and misleading and in what respects purposive human action radically differs from motion, the subject matter of mechanics. It is enough to stress one point, viz., the practical significance of the differential equations in both fields.
The deliberations which result in the formulation of an equation are necessarily of a nonmathematical character. The formulation of the equation is the consummation of our knowledge; it does not directly enlarge our knowledge. Yet, in mechanics, the equation can render very important practical services. As there exist constant relations between various mechanical elements and as these relations can be ascertained by experiments, it becomes possible to use equations for the solution of definite technological problems. Our modern industrial civilization is mainly an accomplishment of this utilization of the differential equations of physics. No such constant relations exist, however, between economic elements. The equations formulated by mathematical economics remain a useless piece of mental gymnastics and would remain so even it they were to express much more than they really do.
A sound economic deliberation must never forget these two fundamental principles of the theory of value: First, valuing that results in action always means preferring and setting aside; it never means equivalence or indifference. Second, there is no means of comparing the valuations of different individuals or the valuations of the same individuals at different instants other than by establishing whether or not they arrange the alternatives in question in the same order of preference.
In the imaginary construction of the evenly rotating economy, all factors of production are employed in such a way that each of them renders the most valuable service. No thinkable and possible change could improve the state of satisfaction; no factor is employed for the satisfaction of a need a if this employment prevents the satisfaction of a need b that is considered more valuable than the satisfaction of a. It is, of course, possible to describe this imaginary state of the allocation of resources in differential equations and to visualize it graphically in curves. But such devices do not assert anything about the market process. They merely mark out an imaginary situation in which the market process would cease to operate. The mathematical economists disregard the whole theoretical elucidation of the market process and evasively amuse themselves with an auxiliary notion employed in its context and devoid of any sense when used outside of this context.
In physics we are faced with changes occurring in various sense phenomena. We discover a regularity in the sequence of these changes and these observations lead us to the construction of a science of physics. We know nothing about the ultimate forces actuating these changes. They are, for the searching mind, ultimately given and defy any further analysis. What we know from observation is the regular concatenation of various observable entities and attributes. It is this mutual interdependence of data that the physicist describes in differential equations.
In praxeology, the first fact we know is that men are purposively intent upon bringing about some changes. It is this knowledge that integrates the subject matter of praxeology and differentiates it from the subject matter of the natural sciences. We know the forces behind the changes, and this aprioristic knowledge leads us to a cognition of the praxeological processes. The physicist does not know what electricity "is." He knows only phenomena attributed to something called electricity. But the economist knows what actuates the market process. It is only thanks to this knowledge that he is in a position to distinguish market phenomena from other phenomena and to describe the market process.
Now, the mathematical economist does not contribute anything to the elucidation of the market process. He merely describes an auxiliary makeshift employed by the logical economists as a limiting notion, the definition of a state of affairs in which there is no longer any action and the market process has come to a standstill. That is all he can say. What the logical economist sets forth in words when defining the imaginary constructions of the final state of rest and the evenly rotating economy and what the mathematical economist himself must describe in words before he embarks upon his mathematical work, is translated into algebraic symbols. A superficial analogy is spun out too long, that is all.
Both the logical and the mathematical economists assert that human action ultimately aims at the establishment of such a state of equilibrium and would reach it if all further changes in data were to cease. But the logical economist knows much more than that. He shows how the activities of enterprising men, the promoters and speculators, eager to profit from discrepancies in the price structure, tend toward eradicating such discrepancies and thereby also toward blotting out the sources of entrepreneurial profit and loss. He shows how this process would finally result in the establishment of the evenly rotating economy. This is the task of economic theory. The mathematical description of various states of equilibrium is mere play. The problem is the analysis of the market process.
A comparison of both methods of economic analysis makes us understand the meaning of the often-raised request to enlarge the scope of economic science by the construction of a dynamic theory instead of the mere occupation with static problems. With regard to logical economics, this postulate is devoid of any sense. Logical economics is essentially a theory of processes and changes. It resorts to the imaginary constructions of changelessness merely for the elucidation of the phenomena of change. But it is different with mathematical economics. Its equations and formulas are limited to the description of states of equilibrium and nonacting. It cannot assert anything with regard to the formation of such states and their transformation into other states as long as it remains in the realm of mathematical procedures. As against mathematical economics the request for a dynamic theory is well substantiated. But there is no means for mathematical economics to comply with this request. The problems of process analysis, i.e., the only economic problems that matter, defy any mathematical approach. The introduction of time parameters into the equations is no solution. It does not even indicate the essential shortcomings of the mathematical method. The statements that every change involves time and that change is always in the temporal sequence are merely a way of expressing the fact that, as far as there is rigidity and unchangeability, there is no time. The main deficiency of mathematical economics is not the fact that it ignores the temporal sequence, but that it ignores the operation of the market process.
The mathematical method is at a loss to show how, from a state of nonequilibrium, those actions spring up which tend toward the establishment of equilibrium. It is, of course, possible to indicate the mathematical operations required for the transformation of the mathematical description of a definite state of nonequilibrium into the mathematical description of the state of equilibrium. But these mathematical operations by no means describe the market process actuated by the discrepancies in the price structure. The differential equations of mechanics are supposed to describe precisely the motions concerned at any instant of the time traveled through. The economic equations have no reference whatever to conditions as they really are in each instant of the time interval between the state of nonequilibrium and that of equilibrium. Only those entirely blinded by the prepossession that economics must be a pale replica of mechanics will underrate the weight of this objection. A very imperfect and superficial metaphor is not a substitute for the services rendered by logical economics.
In every chapter of catallactics, the devastating consequences of the mathematical treatment of economics can be tested. It is enough to refer to two instances only. One is provided by the so-called equation of exchange, the mathematical economists' futile and misleading attempt to deal with changes in the purchasing power of money.Cf. below, p. 399. The second can be best expressed in referring to Professor Schumpeter's dictum according to which consumers, in evaluating consumers' goods "ipso facto also evaluate the means of production which enter into the production of these goods."Cf. Joseph A. Schumpeter, Capitalism, Socialism and Democracy (New York, 1942), p. 175. For a critique of this statement, cf. Hayek, ?The Use of Knowledge in Society,? Individualism and the Social Order (Chicago, 1948), pp. 89 ff. It is hardly possible to construe the market process in a more erroneous way.
Economics is not about goods and services; it is about the actions of living men. Its goal is not to dwell upon imaginary constructions such as equilibrium. These constructions are only tools of reasoning. The sole task of economics is analysis of the actions of men, is the analysis of processes.
Libertarian Paternalism. It would appear to be a contradiction in terms. But Richard Thaler and Cass Sunstein argue for just such a thing in Nudge (Yale University Press, 2008). They try to combine the two by arguing that a nudge — "any aspect of the choice architecture that alters people's behavior in a predictable way without forbidding any options or significantly changing their economic incentives" — can benefit those nudged, while staying consistent with liberty because it does not force anyone to do anything.
The prototype nudge Thaler and Sunstein propose is changing default options. For instance, rather than requiring an employee to choose to participate in an employer's 401(k) retirement plan (where the default option is to not participate), they would make participation automatic. They assert that while that would change the default option, increasing retirement savings, it would not be coercive since employees could opt out if they chose.
In the same vein, the "shortage" of organ donations could be addressed by making people donors unless they choose to opt out rather than nondonors unless they choose to opt in. Paternalistic nudges could also be used in other areas, such as reducing unhealthy choices.
Given the authors' connections to Barack Obama, Nudge and earlier work by its authors have gotten more attention than they otherwise would, and several positive reviews (though, tellingly, not from libertarians). On the other hand, those who consider issues of liberty more carefully have been less kind to their arguments, notably David Gordon, "Libertarian Paternalism," Gregory Mitchell, "Libertarian Paternalism is an Oxymoron," and Richard Epstein, Skepticism and Freedom.
While those interested in liberty should read those and other careful considerations of the theory behind Nudge, there is another fatal but overlooked flaw in the book's argument. They begin by assuming that people's current choices reflect the results when they are left alone to make them (i.e., reflecting self-ownership and voluntary market choices). That is why any shortcomings must be the fault of irrational individuals, who need paternalistic nudges to improve things. However, our current savings, organ-donation, and health choices are not those of free individuals; they are the choices made in large part because current government policies — taxes, regulations, mandates, etc. — impair incentives. They are government failures presented as market failures.
Consider Americans' famously low rate of saving, the most important "market failure" a nudge is supposed to help offset. The real problem is that government policies do so much to discourage saving.
People have been led to substitute Social Security's vastly underfunded promise of retirement benefits for funds they would have saved for their retirement. And since promised benefits are far higher than current rates of taxation can sustain, they anticipate being richer in retirement than they will actually be, reducing saving even more. Those who save enough to provide well for their retirement also face paying income taxes on up to 85% of their Social Security benefits as a result.
Taxes on capital also reduce saving, by reducing the after-tax return on saving and investment. These include property taxes that, while relatively small percentages of the capital invested, are sizable fractions of the annual income generated. Then state and federal (and sometimes local) corporate taxes take further bites from that income, further reducing the after-tax return. The implicit tax imposed by regulatory burdens must also be borne before earnings can go to investors.
Personal income taxes reduce saving even more. Investment income left after other taxes is taxed again if paid out as dividends. Further, earnings from saving and investment can trigger additional tax burdens by triggering phase-outs of deductions and exemptions that are allowed. If investment earnings are retained and reinvested, increasing asset values, they are taxed as capital gains upon sale. And even increases in asset values that only reflect inflation are taxed as if they were real increases in wealth.
Other government policies also reduce saving. Medicare coverage reduces a major reason to save. Further, current earners, who must cover three quarters of its cost, are left with less to save. The fact that Medicaid covers nursing-home costs only after one's assets are virtually exhausted reduces another motive to save. Unemployment benefits, along with food stamps and other means-tested benefits, reduce the need to set aside a nest egg "just in case." Estate taxes (which will be phased out by 2010, but reinstated in full force in 2011) also reduce successful savers' ability to pass on assets as bequests, undermining another major motive to save.
Each of these government policies acts as a disincentive to save. Together, they punish saving heavily, reducing it to the point that many do not have any appreciable savings. But fixing that saving problem doesn't require ever more government programs to help us, force us, or nudge us to save more; it only requires that the government stop undermining our incentives to save in all the ways it does now.
Consider also the "shortage" of organ donations. The root cause is not a market failure, to be fixed by making donation automatic unless one opts out. The root cause is that government has already taken away potential donors' ownership of their own body parts. Unlike everyone else involved in the big business of transplants — doctors, nurses, hospitals, drug makers, etc. — all of whom are paid — organ donors (or their heirs) are not allowed to be paid. When potential donors of very valuable organs cannot be compensated, the result is like every other government price ceiling imposed on sellers — a shortage. One needs no assumption of individual irrationality to explain the problem. And the solution to problems arising because government doesn't allow donors to benefit from markets in organs is not a government nudge in the opposite direction; it is to stop hindering the market.
Health-related issues (diet, smoking, etc.) suffer from similar problems. The costs of health problems that result once one becomes eligible for Medicare coverage are not borne by the individual (as they would be with true private insurance) as presently all are charged the same premiums, regardless of weight, smoking history, or any other factor. Similar results arise from premiums that do not vary with such circumstances in employer-provided group health insurance (which exists largely because it is not subject to income taxation). The possibilities of declaring bankruptcy, of using emergency rooms without having to be able to pay, or of becoming a Medicaid recipient if medical bills become large enough are further ways government has made it possible to impose many of the health-care costs of individuals' own choices on others. When government makes the price of health problems artificially low to those individuals making the choices, it is no wonder those choices are not as good as we would like.
The problem with any logical argument is that if one starts from false premises, even airtight logic does not guarantee correct results. Nudge's argument is far from airtight. But even more devastating is its reliance on a false premise. The "market failure" examples it promises to improve are actually government failures. And the solution to government failure is to reduce the disincentives that government causes, not to intervene further, however mild its authors find the additional intervention.
Nudge's blaming of "irrational" individuals and markets for the results of government-caused distortions is not even new. For instance, it parallels the Keynesian attribution of the business climate in the Depression to the (irrational) "animal spirits of investors," when, in fact, Hoover and FDR's massive interventions (e.g., the Smoot-Hawley tariff, the National Industrial Recovery Act, tax increases, mandatory wage increases, FDR's attacks on businessmen who resisted his plans as "economic royalists", etc.) were among the irrational government causes that would deter any rational investor. Going even further back, as David Gordon observed, any claim that Nudge has to being a kinder, gentler form of paternalism that is compatible with liberty is dashed by Alexis de Tocqueville. In Democracy in America, he described the consequences of that approach:
"Above this race of men stands an immense and tutelary power, which takes upon itself alone to secure their gratifications and to watch over their fate. That power is absolute, minute, regular, provident, and mild… The will of man is not shattered, but softened, bent, and guided; men are seldom forced by it to act, but they are constantly restrained from acting. Such a power does not destroy, but it prevents existence; it does not tyrannize, but it compresses, enervates, extinguishes, and stupefies a people, till each nation is reduced to nothing better than a flock of timid and industrious animals, of which the government is the shepherd."
Thaler and Sunstein claim to be trying "to influence choices in a way that will make choosers better off, as judged by themselves." But in their reasoning, they ignore how much those choices are actually currently caused by existing government interventions — both paternalistic and predatory (to pay for the paternalism), making their prescriptions little more than distractions, directing attention away from the real source — government — and real solution: expanding liberty.
What undermines their attractive-sounding sales pitch that "if incentives and nudges replace requirements and bans, government will be both smaller and more modest," is that they are not in fact proposing less intrusive government nudges to replace more intrusive government coercion, but yet still more government on top of what we have today.
At the outset of the American "experiment," the tax burden was light. Money was gold and silver. The definition of private property was clear and seemingly immutable, and the right to self-defense was sacrosanct. No standing army existed, and a firm commitment to free trade and a noninterventionist foreign policy appeared to be in place. Two hundred years later, matters have changed dramatically, writes Hans-Hermann Hoppe.
This audio Mises Daily is narrated by Floy Lilley.
Albert Jay Nock wrote, "The only element in Judean society that was particularly worth bothering about was the Remnant. Isaiah seems finally to have got it through his head that if anything substantial were ever to be done in Judea, the Remnant would have to do it. This is a very striking and suggestive idea; but before going on to explore it, we need to be quite clear about our terms. What do we mean by the masses, and what by the Remnant?"
This audio Mises Daily is narrated by Floy Lilley.
Professor Block is interviewed on a special television report on Channel 6, WDSU; New Orleans, Louisiana [13:53]
“The Broken Window,” An essay written by Frédéric Bastiat (1801–1850), was the first of a dozen short essays compiled under the heading, What is Seen and What is Not Seen (1964). In these essays, Bastiat cautions us by saying that to accurately evaluate the full outcome of an event, we must account for all effects of that event, namely, the obvious (that which is seen), and also the not so obvious (that which is not seen). “The Broken Window” is the most famous of these instructive essays and is often cited by libertarians as a precise lesson in critical economic analysis.
Volume 21, Number 4 (2007)
Includes an interview with Walter Block, from the television program "The Journal" [10:43]
My sister was telling some friends and me that a pencil drawing of a dollar sign by Andy Warhol was in the market for about $18,000. One friend then said, "It is not like there is an inherent value in the work itself as it is a pencil drawing — Warhol needed a pencil and a piece of paper to produce it." Indeed, the value people attribute to works of art is a great example of the subjective theory of value at work.
According to the subjective theory of value, the value we place on goods and services is determined by the individual who is evaluating, and there is no intrinsic value as such in items themselves. In regard to works of art, we often hear people say they are "undervalued," "underappreciated," "hyped," or "overvalued." These are subjective evaluations and no one can measure by how much a work is "undervalued" or "hyped."
How well-known an artist is plays an important part in subjective valuation. Old works from centuries ago seem intrinsically valuable because of what they are. For instance El Greco's works from the sixteenth century are often highly regarded for his unique style of elongated figures. However they slid into obscurity for many years after his death until critics and art collectors brought his works to light again in the 19th century. Likewise, artists such as Vincent van Gogh suffered from poverty only to have their works highly regarded posthumously. It is a mistake to think that there is an intrinsic value to a van Gogh just because it is a van Gogh.
The rarity of works is another significant factor. In 2004, Young Woman Seated at the Virginals by Vermeer was sold at an auction for about $28.5 million despite a debate over the authenticity of the painting that lasted for decades. It was the first Vermeer to be auctioned in over eighty years and only 35 works by Vermeer are said to be in existence. These facts must have contributed to the collector's evaluation of the painting and he predicted he would derive satisfaction from owning that particular painting as opposed to not owning it, since he demonstrated the preference by being the highest bidder.
An individual's valuation may also depend greatly on who actually created a work. Serious collectors do not bid for a picture of a nice garden by Monet solely because they want a picture of a garden. If that was the case, a poster would be sufficient. In Leaf v International Galleries (1950) the plaintiff brought an action for rescission of a contract. The plaintiff purchased a painting called Salisbury Cathedral for £85 and the defendant, who sold the painting, honestly believed that it was a genuine Constable.
Five years after the purchase, the plaintiff realized that it was not by John Constable, and that it was a reproduction. He therefore wanted to return the painting and have his money back — the value that the plaintiff placed on the painting dropped once he realized who painted the work because the satisfaction he derived from it being a genuine Constable vanished. This case shows that a person's preference can change over time concerning the same good.
The case further demonstrates that it is wrong to think of value in terms of what labor has been put into a good. Forgers study original works of art extensively. A skillful forger would pay attention to every aspect of a painting that is to be copied. This requires a lot of time, effort, and talent, as well as materials. Yet once a work of art proves to be a copy, an individual's valuation changes. Furthermore, a simple work by a famous artist that is rather like an autograph, which takes seconds to produce, can be more valuable to some collectors than an oil paint by an unknown artist.
The medium used could also affect an individual's valuation. Printing techniques can produce vibrant and eye-catching works. Let us suppose that an artist makes a hundred editions of an identical image. I purchase one and hang it in the living room, which gives me great satisfaction. I then acquire two more of these to hang in the kitchen and the bathroom. These two additions do not give me the same sort of satisfaction as the first print because by then, I am already familiar with the image and the two I acquire later are extras.
As the principle of diminishing marginal utility tells us, the first print has satisfied the most urgent need — having the image at my place — and the further two prints are additions, which might even make me become tired of the image.
An artist does not often produce a hundred exact copies of an image using oil paint — even if they were painted, each one would be slightly different if manually done. Therefore a collector may attribute a greater value to an oil painting than to a print due to the relative abundance of prints.
It is important to note that the price paid for a work of art is not a measurement of the value attributed to it by the buyer in any way. It would be nonsensical to say that the Portrait of Adele Bloch-Bauer is eleven times more valuable than Summer Day based on prices paid for these works. Not only were they purchased by different people whose interests are divergent, but even if one person bought both paintings, one cannot say that the former gives eleven times more satisfaction than the latter.
If they satisfy their owners respectively, that is the end of the matter and no comparison can be made as to exactly how much each person appreciates the work. Beauty is in the eye of beholder and only an individual can make subjective valuation of a work of art based on the satisfaction that he derives from it. So which Mona Lisa do you prefer: Botero's, da Vinci's, or Duchamp's?
Have you noticed how the text of the "fortunes" in fortune cookies seem to be improving? In contrast to the old days when the fortune was a mere throw away, these days, the language is clearer. The thoughts are more profound. Some of them are real keepers.
Is this a consequence of China's having become more capitalistic?
While I can't comment on the "lucky numbers" printed on them — who knows? — the last four fortunes I received in my cookies just astounded me with their very erudition (even without adding any words at the end of them). Indeed they seemed to sum up the essence of core postulates of Austrian Economics!
Let's see, and keep in mind that these are real.
Now, here we have a popular summary of the subjective theory of value. Value is not embedded in the material properties of any good or service. Neither does a thing acquire value merely because labor was employed to create it. Value is not dictated by the production process or social conditioning. An economic good is valued because an individual mind values it. It is a product of the human mind.
As Menger says:
Value is therefore nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being, and in consequence carry over to economic goods as the exclusive causes of the satisfaction of our needs.
Next we come to a further condition that affects economic valuation:
Admittedly, this fortune is not quite as scientific but it makes a good point. Prices are the result of the interaction of subjective valuation and objective conditions of the relative availability of a good. They represent a historical record of trades that have already taken place. They do not and cannot dictate the future.
And yet even given a good with a certain price on the market, the desirability of a good cannot be imposed on others. It must be adopted and accepted by buyers, who assess prices based on individual usefulness.
Or as Mises says,
It is ultimately always the subjective value judgments of individuals that determine the formation of prices…. The concept of a "just" or "fair" price is devoid of any scientific meaning; it is a disguise for wishes, a striving for a state of affairs different from reality. Market prices are entirely determined by the value judgments of men as they really act.
So let us accept the fortune cookie's implied claim that past data cannot somehow dictate our actions and therefore the future. The market is always forward looking. Our actions to buy or sell or invest or save are always a speculation, a judgment call. Nowhere is this more clear than in the institution of entrepreneurship, about which the next fortune speaks:
Given the forward-looking nature of the market process, and the human desire for economic development, there must be individuals who can imagine a future that is yet to be experienced, invest real resources in seeing their judgment come to pass in the production process, and thereby enjoy the rewards to come from profitability. This person is the entrepreneur-capitalist: the dreamer who imagines a possible future and then commits real resources to making that future happen.
The market process does not stop with one entrepreneurial success. Profits call forth emulators, people attracted to a certain idea or sector because a good or service is yielding high profits. For example, if a software entrepreneur comes up with an excellent anti-spyware program and becomes rich, others will take notice and enter the market and provide competition.
The method of success becomes part of the social store of knowledge that others are free to acquire and employ for their own use. As more producers enter the market, the result will be lower prices (if nothing else changes) and reduced profits for each producer.
In short, the successful entrepreneur will attract many people who strive to be just like him. His sucess in making his dreams become reality provides a model for others who do the same. Following the text of the fortune, we can call these people "friends."
The fortune is already ahead of us here, because it also speaks the reality of losses. Let us never forget that capitalism is not only about profits, that win friends. As Rothbard says, entrepreneurs also face the prospect of losses, sometimes big losses. When this happens, people flee our adversity. We lose our friends. We are humbled, and learn from our errors. We then look to others who are making profits and follow their ways, and the process continues without end, to the continual improvement of our standard of living.
If China's path to economic development continues on an upward path, can we expect ever-increasing economic sophistication from fortune cookies? I heartily await other fortunes that discuss capital theory, interest rates, the business cycle, and perhaps even price controls. If some entrepreneur wants to take the risk and create them, and I find them in my next set of cookies, I promise to scan them and make them famous. In your prosperity, your friends will know you.
Most people feel that stereotyping is wrong and unfair.
Why should one person be affected by the actions or qualities of the rest of his or her demographic? Of course, people are individuals with their own moral values (or lack of), intelligence, and talents. Stereotyping is, however, a method that people use, consciously or subconsciously, as an efficient way of economizing on information costs.
For example, if somebody offered you $1 million to solve a complex mathematical problem and, furthermore, you could choose anybody on a university campus to help you, I doubt you would choose the Paris Hilton–type sorority girl or the Abercrombie and Fitch–wearing fraternity boy. Now consider the young man wearing glasses and a pocket protector in his short-sleeve, button-down shirt: would you not think that he is a better bet?
If you were a soccer coach and had to draft a player for your team and the only information you had was that Player A is from Brazil and Player B is from the United States, who would you choose?
Finally, assume that you are walking down the street and you have only two choices — either walk on the left side of the street or the right side of the street. Before you choose, you notice that on the left side there are ten tattooed, muscular men with shaved heads walking and talking together, while on the right side you see ten "clean-cut" men wearing dress shirts and ties carrying Bibles. Now, what would you do?
If you chose the "nerdy" student with the pocket protector in the first scenario, the Brazilian player in the second scenario, and the right side of the street in the third scenario, are you being immoral or "prejudiced"? In fact, what does the word "prejudice" really mean? One of the definitions that is normally overlooked is "a preconceived preference or idea." In other words, prejudice simply means pre-judging.
Of course you may not be correct in your judgment, and your later judgments will be affected by the success or failure of the accuracy of your forecasts. But the alternative is to use a completely random basis on which to make pre-judgments, which is very silly and probably impossible.
In his article "Non Politically Correct Thinking", my former professor and economist Dr. Walter Williams argued
"… that going to the word's Latin root, to pre-judge simply means: making decisions on the basis of incomplete information. Here's an example. Suppose leaving your workplace you see a full-grown tiger standing outside the door. Most people would endeavor to leave the area in great dispatch. That prediction isn't all that interesting but the question is why. Is your decision to run based on any detailed information about that particular tiger or is it based on tiger folklore and how you've seen other tigers behaving? It's probably the latter. You simply pre-judge that tiger; you stereotype him. If you didn't pre-judge and stereotype that tiger, you'd endeavor to obtain more information, like petting him on the head and doing other friendly things to determine whether he's dangerous. Most people quickly calculate that the likely cost of an additional unit of information about the tiger exceeded any benefit and wouldn't bother to seek additional information. In other words, all they need to know is he's a tiger."
Acquiring information is costly. Moreover, we assume that rational people economize. As beings who want to get the "biggest bang for their buck," people will apply this rational behavior to information as well. Assuming that I am that person who, when he sees a tiger running at him, gets scared and tries to run to safety, am I being unfair or prejudiced? If I hear there is a murderer in my neighborhood, am I prejudiced if I start looking around the neighborhood for a suspicious looking male rather than a female?
This topic of course has implications when it comes to social policy. After 9/11, the Transportation Security Administration agents at airports, to show that they were impartial, would pull aside old ladies and little children to make sure that they were not carrying dangerous items that could lead to terrorism.
I can recall that one time when I was traveling, a TSA agent pulled aside a young blonde girl for additional screening rather than checking the adult men that were going on that flight. Did it make me feel safer to know that politics and not security was foremost on the mind of the screeners? Not particularly.
Providing security requires the use of scarce means. In a world of imperfect knowledge, economizing on information is a tool that should not have to be defended.
In another important area, government's interventionist policies in the labor market can make the bad kind of discrimination we normally think about more prevalent. For example, European Union countries have very strict laws on firing people compared to the United States. Because of this, it is more costly for a firm to hire somebody.
Now, if I am an employer and I know that I am stuck with a worker once I hire him, don't you think I will be more likely to economize on information (i.e., discriminate) before I hire him? Conversely, in a free-market, I will be more likely to take a risk on somebody and give him a chance (and not indulge my initial "prejudices") because I know if he ends up being a poor selection, I can easily fire him. Those who advocate "fair labor laws" had better be careful what they ask for.
Economics affects our everyday lives. Economics can be viewed as the study of individual human actors making choices. Of course, people should not be rude to others based on looks, race, or gender. I also know that there are a lot of ignorant, mean-spirited people who assume things about others that are completely baseless. But in the market economy, they also pay a price for being wrong.
Let us remember that we live in a world of scarcity, that economizing on information can be efficient, and that sometimes the reason stereotypes exist is because, well, they're true.
By the way, I am half-Hispanic and half-Middle Eastern. I am not your "stereotypical" WASP — but I'm sure you didn't think that while reading my article … right?
I - IntroductionA Statement of the ConceptPositivism and the Charge of TautologyProfessor Samuelson and "Revealed Preference"Psychologizing and Behaviorism: Twin PitfallsA Note on Professor Armstrong's CriticismII - Utility TheoryOrdinal Marginal Utility and "Total Utility"Professor Robbins's ProblemThe Fallacy of IndifferenceThe Neo-Cardinalists: the von Neumann-Morgenstern ApproachIII - Welfare Economics: A CritiqueEconomics and EthicsThe Problem of the New Welfare Economics: The Unanimity RuleProfessor Robbins's Escape RouteThe Compensation PrincipleThe Social Welfare FunctionThe Economist as AdviserThe End of Welfare Economics?IV - Welfare Economics: A ReconstructionDemonstrated Preference and the Free MarketThe Free Market and the "Problem of Distribution"The Role of the StateLaissez-faire ReconsideredThe State as a Voluntary Institution: A CritiqueV - ConclusionNotesIntroductionIndividual valuation is the keystone of economic theory. For, fundamentally, economics does not deal with things or material objects. Economics analyzes the logical attributes and consequences of the existence of individual valuations. "Things" enter into the picture, of course, since there can be no valuation without things to be valued. But the essence and the driving force of human action, and therefore of the human market economy, are the valuations of individuals. Action is the result of choice among alternatives, and choice reflects values, that is, individual preferences among these alternatives.
Individual valuations are the direct subject matter of the theories of utility and of welfare. Utility theory analyzes the laws of the values and choices of an individual; welfare theory discusses the relationship between the values of many individuals, and the consequent possibilities of a scientific conclusion on the "social" desirability of various alternatives. Both theories have lately been foundering in stormy seas. Utility theory is galloping off in many different directions at once; welfare theory, after reaching the heights of popularity among economic theorists, threatens to sink, sterile and abandoned, into oblivion.
The thesis of this paper is that both related branches of economic theory can be salvaged and reconstructed, using as a guiding principle of both fields the concept of "demonstrated preference."
A Statement of the ConceptHuman action is the use of means to arrive at preferred ends. Such action contrasts to the observed behavior of stones and planets, for it implies purpose on the part of the actor. Action implies choice among alternatives. Man has means, or resources, which he uses to arrive at various ends; these resources may be time, money, labor energy, land, capital goods, and so on. He uses these resources to attain his most preferred ends. From his action, we can deduce that he has acted so as to satisfy his most highly valued desires or preferences.
The concept of demonstrated preference is simply this: that actual choice reveals, or demonstrates, a man's preferences; that is, that his preferences are deducible from what he has chosen in action. Thus, if a man chooses to spend an hour at a concert rather than a movie, we deduce that the former was preferred, or ranked higher on his value scale. Similarly, if a man spends five dollars on a shirt we deduce that he preferred purchasing the shirt to any other uses he could have found for the money. This concept of preference, rooted in real choices, forms the keystone of the logical structure of economic analysis, and particularly of utility and welfare analysis.
While a similar concept played a role in the writings of the early utility economists, it had never received a name, and it therefore remained largely undeveloped and unrecognized as a distinct concept. It was generally discarded in the 1930s, before it had even achieved recognition. This view of preference as derived from choice was present in varying degree in the writings of the early Austrian economists, as well as in the works of Jevons, Fisher, and Fetter. Fetter was the only one who clearly employed the concept in his analysis. The clearest and most thorough formulation of the concept has been the works of Professor Mises.See Alan R. Sweezy, "The Interpretation of Subjective Value Theory in the Writings of the Austrian Economists," Review of Economic Studies (June 1934): 176-85, for an historical survey. Sweezy devotes a good part of the article to a criticism of Mises as the leading exponent of the demonstrated preference approach. For Mises's views, see Human Action (New Haven, Conn.: Yale University Press, 1949), pp. 94-96, 102-3; Theory of Money and Credit (1912, 3 rd ed; New Haven: Yale University Press, 1951), pp. 46ff. Also see Frank A. Fetter, Economic Principles (New York: The Century Co., 1915), pp. 14-21.
Positivism and the Charge of TautologyBefore developing some of the applications of the demonstrated preference principle to utility and welfare theory, we must consider the methodological objections that have been leveled against it. Professor Alan Sweezy, for example, seizes on a sentence of Irving Fisher's which very succinctly expressed the concept of demonstrated preference: "Each individual acts as he desires." Sweezy is typical of the majority of present-day economists in not being able to understand how such a statement can be made with absolute validity. To Sweezy, insofar as it is not an empirically testable proposition in psychology, such a sentence must simply reduce to the meaningless tautology: "each individual acts as he acts."
This criticism is rooted in a fundamental epistemological error that pervades modern thought: the inability of modern methodologists to understand how economic science can yield substantive truths by means of logical deduction (that is, the method of "praxeology"). For they have adopted the epistemology of positivism (now dubbed "logical empiricism" or "scientific empiricism" by its practitioners), which uncritically applies the procedures appropriate in physics to the sciences of human action.See the methodological treatises of Kaufman, Hutchison, Souter, Stonier, Myrdal, Morgenstern, and so on.
In physics, simple facts can be isolated in the laboratory. These isolated facts are known directly, but the laws to explain these facts are not. The laws may only be hypothesized. Their validity can only be determined by logically deducing consequents from them which can be verified by appeal to the laboratory facts. Even if the laws explain the facts, however, and their inferences are consistent with them, the laws of physics can never be absolutely established. For some other law may prove more elegant or capable of explaining a wider range of facts. In physics, therefore, postulated explanations have to be hypothesized in such a way that they or their consequents can be empirically tested. Even then, the laws are only tentatively rather than absolutely valid.
In human action, however, the situation is reversed. There is here no laboratory where "facts" can be isolated and broken down into their simple elements. Instead, there are only historical "facts" which are complex phenomena, resultants of many causal factors. These phenomena must be explained, but they cannot be isolated or used to verify or falsify any law. On the other hand, economics, or praxeology, has full and complete knowledge of its original and basic axioms. These are the axioms implicit in the very existence of human action, and they are absolutely valid so long as human beings exist. But if the axioms of praxeology are absolutely valid for human existence, then so are the consequents which can logically be deduced from them. Hence, economics, in contrast to physics, can derive absolutely valid substantive truths about the real world by deductive logic. The axioms of physics are only hypothesized and hence subject to revision; the axioms of economics are already known and hence absolutely true.On the methodology of praxeology and physics, see Mises, Human Action, and F.A. Hayek, The Counter Revolution of Science (Glencoe, Ill.: The Free Press, 1952), pt 1. The irritation and bewilderment of positivists over the "dogmatic" pronouncements of praxeology stem, therefore, from their universal application of methods proper only to the physical sciences.It is even dubious that positivists accurately interpret the proper methodology of physics itself. On the widespread positivist misuse of the Heisenberg Uncertainty Principle in physics as well as in other disciplines, cf. Albert H. Hobbs, Social Problems and Scientism (Harrisburg, Penn.: The Stackpole Co., 1953), pp. 220-32.
The suggestion has been made that praxeology is not really scientific, because its logical procedures are verbal ("literary") rather than mathematical and symbolic.For a typical suggestion, cf. George J. Schuller, "Rejoinder," American Economic Review (March 1951): 188. For realization that mathematical logic is essentially subsidiary to basic verbal logic, cf. the remarks of Andre Lalande and Rene Poirier, on "Logique" and "Logistique," in Vocabulaire technique et critique de la philosophie, Andre Lalande, ed., 6th ed. (Paris: Presses Universitaires de France, 1951), pp. 574, 579. But mathematical logic is uniquely appropriate to physics, where the various logical steps along the way are not in themselves meaningful; for the axioms and therefore the deductions of physics are in themselves meaningless, and only take on meaning "operationally," insofar as they can explain and predict given facts. In praxeology, on the contrary, the axioms themselves are known as true and are therefore meaningful. As a result, each step-by-step deduction is meaningful and true. Meanings are far better expressed verbally than in meaningless formal symbols. Moreover, simply to translate economic analysis from words into symbols, and then to retranslate them so as to explain the conclusions, makes little sense, and violates the great scientific principle of Occam's Razor that there should be no unnecessary multiplication of entities.
The crucial concept of the positivists, and the one that forms the basis for their attack on demonstrated preference, is that of "operational meaning." Indeed, their favorite critical epithet is that such and such a formulation or law is "operationally meaningless."Paul Samuelson has added the weight of his authority to Sweezy's criticism of Mises and demonstrated preference, and has couched his endorsement in terms of "operational meaning." Samuelson explicitly rejects the idea of a true utility theory in favor of one that is merely hypothetical. See Paul A. Samuelson, "The Empirical Implications of Utility Analysis," Econometrica (1938):344ff; and Samuelson, Foundations of Economic Analysis (Cambridge, Mass.:Harvard University Press, 1947), pp. 91-92. The concept of operational meaning was originated by the physicist Percy W. Bridgman explicitly to explain the methodology of physics. Cf. Bridgman, The Logic of Modern Physics (New York: Macmillan, 1927). Many founders of modern positivism, such as Mach and Boltzmann, were also physicists. The test of "operationally meaningful" is derived strictly from the procedures of physics as outlined above. An explanatory law must be framed so that it can be tested and found empirically false. Any law which claims to be absolutely true and not empirically capable of being falsified is therefore "dogmatic" and operationally meaningless — hence, the positivist's view that if a statement or law is not capable of being falsified empirically, it must simply be a tautologous definition. And consequently, Sweezy's attempted reduction of Fisher's sentence to a meaningless identity.The heroes of positivism, Rudolf Carnap and Ludwig Wittgenstein, disparaged deductive inference as merely drawing out "tautologies" from the axioms. Yet all reasoning is deductive, and this process is peculiarly vital to arriving at truth. For a critique of Carnap and Wittgenstein, and a demonstration that inference is not merely identity to "tautology," cf. Lalande, "Tautoglie," in Vocabulaire, pp. 1103-4.
Sweezy objects that Fisher's "each man acts as he desires" is circular reasoning, because action implies desire, and yet desires are not arrived at independently, but are only discoverable through the action itself. Yet this is not circular. For desires exist by virtue of the concept of human action and of the existence of action. It is precisely the characteristic of human action that it is motivated by desires and ends, in contrast to the unmotivated bodies studied by physics. Hence, we can say validly that action is motivated by desires and yet confine ourselves to deducing the specific desires from the real actions.
Professor Samuelson and "Revealed Preference""Revealed preference" — preference revealed through choice — would have been an apt term for our concept. It has, however, been preempted by Samuelson for a seemingly similar but actually quite different concept of his own. The critical difference is this: Samuelson assumes the existence of an underlying preference scale that forms the basis of a man's actions and that remains constant in the course of his actions over time. Samuelson then uses complex mathematical procedures in an attempt to "map" the individual's preference scale on the basis of his numerous actions.
The prime error here is the assumption that the preference scale remains constant over time. There is no reason whatever for making any such assumption. All we can say is that an action, at a specific point of time, reveals part of a man's preference scale at that time. There is no warrant for assuming that it remains constant from one point of time to another.Samuelson's analysis suffers from other errors as well, such as the use of invalid "index number" procedures. On the theoretical fallacies of index numbers, cf. Mises, Theory of Money and Credit, pp. 187-94. The "revealed preference" theorists do not recognize that they are assuming constancy; they believe that their assumption is simply that of consistent behavior, which they identify with "rationality." They will admit that people are not always "rational," but uphold their theory as being a good first approximation or even as having normative value. However, as Mises has pointed out, constancy and consistency are two entirely different things. Consistency means that a person maintains a transitive order of rank on his preference scale (if A is preferred to B and B is preferred to C, then A is preferred to C). But the revealed preference procedure does not rest on this assumption so much as on an assumption of constancy — that an individual maintains the same value scale over time. While the former might be called irrational, there is certainly nothing irrational about someone's value scales changing through time. Hence, no valid theory can be built on a constancy assumption.See Mises, Human Action, pp. 102-3. Mises demonstrates that Wicksteed and Robbins committed a similar error.
One of the most absurd procedures based on a constancy assumption has been the attempt to arrive at a consumer's preference scale not through observed real action, but through quizzing him by questionnaires. In vacuo, a few consumers are questioned at length on which abstract bundle of commodities they would prefer to another abstract bundle, and so on. Not only does this suffer from the constancy error, no assurance can be attached to the mere questioning of people when they are not confronted with the choices in actual practice. Not only will a person's valuation differ when talking about them from when he is actually choosing, but there is also no guarantee that he is telling the truth.It is Samuelson's credit that he rejects the questionnaire approach. Professors Kennedy and Keckskemeti, for different reasons, defend the questionnaire method. Kennedy simply says, rather illogically, that in vacuo procedures are being used anyway, when the theorist states that more of a good is preferred to less. But this is not in vacuo; it is a conclusion based on the praxeological knowledge that since a good is any object of action, more must be preferred to less while it remains a good. Kennedy is wrong, therefore, when he asserts that this is a circular argument, for the fact that action exists is not "circular."Keckskemeti actually asserts that the questionnaire method is preferable to observing behavior in discovering preferences. The basis of his arguments is a spurious dichotomy between utility and ethical valuations. Ethical valuations may be considered either as identical with, or a subset of, utility judgments, but they can not be separated. Cf. Charles Kennedy, "The Common Sense of Indifference Curves," Oxford Economic Papers (January 1950): 123-31; Kenneth J. Arrow, "Review of Paul Keckskemeti's Meaning, Communication, and Value," Econometrica (January 1955): 103.
The bankruptcy of the revealed-preference approach has never been better portrayed than by a prominent follower, Professor Kennedy. Says Kennedy: "In what respectable science would the assumption of consistency (that is, constancy) be accepted for one moment?"Kennedy, "The Common Sense of Indifference Curves." Kennedy's article furnishes the best brief explanation of the revealed-preference approach. But he asserts it must be retained anyway, else utility theory could not serve any useful purpose. The abandonment of truth for the sake of a spurious usefulness is a hallmark of the positivist-pragmatist tradition. Except for certain auxiliary constructions, it should be clear that the false cannot be useful in constructing a true theory. This is particularly the case in economics, which is explicitly built on true axioms.This error again stems from physics, where such assumptions as absence of friction are useful as first approximations — to known facts from unknown explanatory laws! For a refreshing skepticism on the value of false axioms, cf. Martin Bronfenbrenner, "Contemporary Economics Resurveyed," Journal of Political Economy (April 1953).
Psychologizing and Behaviorism: Twin PitfallsThe revealed-preference doctrine is one example of what we may call the fallacy of "psychologizing," the treatment of preference scales as if they existed as separate entities apart from real action. Psychologizing is a common error in utility analysis. It is based on the assumption that utility analysis is a kind of "psychology," and that, therefore, economics must enter into psychological analysis in laying the foundations of its theoretical structure.
Praxeology, the basis of economic theory, differs from psychology, however. Psychology analyzes the how and the why of people forming values. It treats the concrete content of ends and values. Economics, on the other hand, rests simply on the assumption of the existence of ends, and then deduces its valid theory from such a general assumption.The axiom of the existence of ends may be considered a proposition in philosophical psychology. In that sense, praxeology is grounded in psychology, but its development then completely diverges from psychology proper. On the question of purpose, praxeology takes its stand squarely with the Leibnizian tradition of philosophical psychology as opposed to the Lockean tradition upheld by positivists, behavorists, and associationists. For an illuminating discussion of this issue, cf. Gordon W. Allport, Becoming (New Haven, Conn.: Yale University Press, 1955), pp. 6-17. It therefore has nothing to do with the content of ends or with the internal operations of the mind of the acting man.Thus, the law of diminishing marginal utility does not at all rest on some postulated psychological law of satiety of wants, but on the praxeological truth that the first units of a good will be allocated to the most valuable uses, the next units to the next-most valuable uses, and so on.
"The abandonment of truth for the sake of a spurious usefulness is a hallmark of the positivist-pragmatist tradition."If psychologizing is to be avoided, so is the opposite error of behaviorism. The behaviorist wishes to expunge "subjectivism," that is, motivated action, completely from economics, since he believes that any trace of subjectivism is unscientific. His ideal is the method of physics in treating observed movements of unmotivated, inorganic matter. In adopting this method, he throws away the subjective knowledge of action upon which economic science is founded; indeed, he is making any scientific investigation of human beings impossible. The behaviorist approach in economics began with Cassel, and its most prominent modern practitioner is Professor Little. Little rejects the demonstrated preference theory because it assumes the existence of preference. He glories in the fact that, in his analysis, the maximizing individual "at last disappears" which means, of course, that economics disappears as well.I.M.D. Little, "A Reformulation of the Theory of Consumers' Behavior," Oxford Economic Papers (January 1949): 90-99.
The errors of psychologizing and of behaviorism have in common a desire by their practitioners to endow their concepts and procedures with "operational meaning," either in the areas of observed behavior or in mental operations. Vilfredo Pareto, perhaps the founder of an explicitly positivist approach in economics, championed both errors. Discarding a demonstrated preference approach as "tautologous," Pareto, on the one hand, sought to eliminate subjective preferences from economics and, on the other, to investigate and measure preference scales apart from real action. Pareto was, in more ways than one, the spiritual ancestor of most current utility theorists.Vilfredo Pareto, "On the Economic Phenomenon," International Economic Papers 3 (1953): 188-94. For an excellent rebuttal, cf. Benedetto Croce, "On the Economic Principle, Parts I and II," ibid.: 175-76. 201. The famous Croce-Pareto debate is an illuminating example of early debate between praxeological and positivist views in economics.Vivian C. Walsh is an interesting current example of the combinations of both types of error. On the one hand, he is an extreme behaviorist, who refuses to recognize thatany preferences are relevant to, or can be demonstrated by, action. On the other hand, he also takes the extreme psychologizing view that psychological states per se can be directly observed. For this, he falls back on "common sense." But this position fails because Walsh's psychological "observations" are ideal types and not analytic categories. Thus, Walsh says that: "saying that someone is a smoker is different from saying that he is smoking now," upholding the former type of statement for economics. But such statements are historical ideal types, relevant to history and psychology, but not to economic analysis. Cf. Vivian C. Walsh, "On Descriptions of Consumers' Behavior," Economica (August 1954): 244-52. On ideal types and relation to praxeology, cf. Mises, Human Action, pp. 59-64.
A Note on Professor Armstrong's CriticismProfessor Armstrong has delivered a criticism of the revealed-preference approach which he would undoubtedly apply to demonstrated preference as well. He asserts that when more than one commodity is being ranked, individual preference scales cannot be unitary, and we cannot postulate the ranking of the commodities on one scale.Wallace E. Armstrong, "A Note on the Theory of Consumer's Behavior," Oxford Economic Papers (January 1950): 199ff. On this point, cf. Little's rebuttal, in I.M.D. Little, "The Theory of Consumer's Behavior — A Comment," ibid., 132-35. On the contrary, it is precisely the characteristic of a deduced preference scale that it is unitary. Only if a man ranks two alternatives as more and less valuable on one scale can he choose between them. Any of his means will be allocated to his more preferred use. Real choice therefore always demonstrates relevant preferences ranked on a unitary scale.
Utility TheoryUtility theory, over the last generation, has been split into two warring camps: (1) those who cling to the old concept of cardinal, measurable utility, and (2) those who have thrown over the cardinal concept, but have dispensed with the utility concept as well and have substituted an analysis based on indifference curves.
In its pristine form, the cardinalist approach has been abandoned by all but a rearguard. On demonstrated preference grounds, cardinality must be eliminated. Psychological magnitudes cannot be measured since there is no objectively extensive unit — a necessary requisite of measurement. Further, actual choice obviously cannot demonstrate any form of measurable utility; it can only demonstrate one alternative being preferred to another.Mises's priority in establishing this in establishing this conclusion is acknowledged by Professor Robbins; cf. Lionel Robbins, "Robertson on Utility and Scope," Economica (May 1953): 99-111; Mises, Theory of Money and Credit, pp. 38-47 and passim. Mises's role in forging an ordinal marginal utility theory has suffered almost total neglect.
Ordinal Marginal Utility and "Total Utility"The ordinalist rebels, led by Hicks and Allen in the early 1930s, felt it necessary to overthrow the very concept of marginal utility along with measurability. In doing so, they threw out the Utility baby together with the Cardinal bathwater. They reasoned that marginal utility itself implies measurability. Why? Their notion rested on the implicit neoclassical assumption that the "marginal" in marginal utility is equivalent to the "marginal" of the differential calculus. Since, in mathematics, a total "something" is the integral of marginal "somethings," economists early on assumed that "total utility" was the mathematical integral of a series of "marginal utilities."The error began perhaps with Jevons. Cf. W. Stanley Jevons, Theory of Political Economy (London: Macmillan, 1888), pp. 49ff. Perhaps, too, they realized that this assumption was essential to a mathematical representation of utility. As a result, they assumed, for example, that the marginal utility of a good with a supply of six units is equal to the "total utility" of six units minus the "total utility" of five units. If utilities can be subjected to the arithmetical operation of subtraction, and can be differentiated and integrated, then obviously the concept of marginal utility must imply cardinally measurable utilities.That this reasoning lay at the base of the ordinalists' rejection of marginal utility may be seen in John R. Hicks, Value and Capital, 2nd ed. (Oxford: Oxford University Press, 1946), p. 19. That many ordinalists regret the loss of marginal utility may be seen in the statement by Arrow that: "The older discussion of diminishing marginal utility as aiming for the satisfaction of more intense wants first makes more sense" than the current "indifference-curve" analysis, but that, unfortunately it is "bound up with the untenable notion of measurable utility." Quoted in D.H. Robertson, "Utility and All What?"
The mathematical representation of the calculus rests on the assumption of continuity, that is, infinitely small steps. In human action, however, there can be no infinitely small steps. Human action and the facts on which it is based must be in observable and discrete steps and not infinitely small ones. Representation of utility in the manner of the calculus is therefore illegitimate.Hicks concedes the falsity of the continuity assumption but blindly pins his faith on the hope that all will be well when individual actions are aggregated. Hicks, Value and Capital, p. 11.
There is, however, no reason why marginal utility must be conceived in calculus terms. In human action, "marginal" refers not to an infinitely small unit, but to the relevant unit. Any unit relevant to a particular action is marginal. For example, if we are dealing in a specific situation with single eggs, then each egg is the unit; if we are dealing in terms of six-egg cartons, then each six-egg carton is the unit. In either case, we can speak of a marginal utility. In the former case, we deal with the "marginal utility of an egg" with various supplies of eggs; in the latter, with the "marginal utility of cartons" whatever the supply of cartons of eggs. Both utilities are marginal. In no sense is one utility a "total" of the other.
To clarify the relationship between marginal utility and what has been misnamed "total utility" but actually refers to a marginal utility of a larger- sized unit, let us hypothetically construct a typical value scale for eggs:
Ranks in Value
5 eggs4 eggs3 eggs2 eggs1 egg2nd egg3rd egg4th egg5th eggThis is a man's ordinal value, or preference, scale for eggs. The higher the ranking, the higher the value. At the center is one egg, the first egg in his possession. By the Law of Diminishing Marginal Utility (ordinal), the second, third, fourth eggs, and so on, rank below the first egg on his value scale, and in that order. Now, since eggs are goods and therefore objects of desire, it follows that a man will value two eggs more than he will one, three more than he will two, and so on. Instead of calling this "total utility," we will say that the marginal utility of a unit of a good is always higher than the marginal utility of a unit of smaller size. A bundle of 5 eggs will be ranked higher than a bundle of 4 eggs, and so on. It should be clear that the only arithmetic or mathematical relationship between these marginal utilities is a simple ordinal one. On the one hand, given a certain sized unit, the marginal utility of that unit declines as the supply of units increases. This is the familiar Law of Diminishing Marginal Utility. On the other hand, the marginal utility of a larger-sized unit is greater than the marginal utility of a smaller-sized unit. This is the law just underlined. And there is no mathematical relationship between, say, the marginal utility of 4 eggs and the marginal utility of the 4th egg except that the former is greater than the latter.
We must conclude then that there is no such thing as total utility; all utilities are marginal. In those cases where the supply of a good totals only one unit, then the "total utility" of that whole supply is simply the marginal utility of a unit the size of which equals the whole supply. The key concept is the variable size of the marginal unit, depending on the situation.The analysis of total utility was first put forward by Mises, in Theory of Money and Credit, pp. 38-47. It was continued by Harro F. Bernardelli, especially in his "The End of the Marginal Utility Theory?" Economica (May 1938): 206. Bernardelli's treatment, however, is marred by laborious attempts to find some form of legitimate mathematical representation. On the failure of the mathematical economists to understand this treatment of marginal and total, see the criticism of Bernardelli by Paul A. Samuelson, "The End of Marginal Utility: A Note on Dr. Bernardelli's Article," Economica (February 1939): 86-87; Kelvin Lancaster, "A Refutation of Mr. Bernadelli," Economica (August 1953): 259-62. For rebuttals see Bernadelli, "A Reply to Mr. Samuelson's Note," Economica (February 1939): 88-89; and "Comment on Mr. Lancaster's Refutation," Economica (August 1954): 240-42.
A typical error on the concept of marginal utility is a recent statement by Professor Kennedy that "the word 'marginal' presupposes increments of utility" and hence measurability. But the word "marginal" presupposes not increments of utility, but the utility of increments of goods, and this need have nothing to do with measurability.See Charles Kennedy, "Concerning Utility," Economica (February 1954): 13. Kennedy's article, incidentally, is an attempt to rehabilitate a type of cardinalism by making distinctions between "quantity" and "magnitude," and uasing the Bertrand Russell concept of "relational addition." Surely, this sort of approach falls with one slash of Occam's Razor — the great scientific principle that entities not be multiplied unnecessarily. For a criticism, cf. D.H. Robertson, "Utility and All What?" pp. 668-69.
Professor Robbins's ProblemThe Fallacy of Psychologizing: the treatment of preference scales as if they existed as separate entities apart from real action.Professor Lionel Robbins, in the course of a recent defense of ordinalism, raised a problem which he left unanswered. Accepted doctrine, he declared, states that if difference between utility rankings can be judged by the individual, as well as the rankings themselves, then the utility scale can in some way be measured. Yet, Robbins says, he can judge differences. For example, among three paintings, he can say that he prefers a Rembrandt to a Holbein far less than he prefers a Holbein to a Munnings. How, then, can ordinalism be saved?Robbins, "Robertson on Utility and Scope," p. 104. Is he not conceding measurability? Yet Robbins's dilemma had already been answered twenty years earlier in a famous article by Oskar Lange.Oskar Lange, "The Determinateness of the Utility Function," Review of Economic Studies (June 1934): 224ff. Unfortunately, Lange balked at the implications of his own analysis and adopted an assumption of cardinality, solely because of his anxious desire to reach certain cherished "welfare" conclusions. Lange pointed out that in terms of what we would call demonstrated preference, only pure rankings are revealed by acts of choice. "Differences" in rank are not so revealed, and are therefore mere psychologizing, which, however interesting, are irrelevant to economics. To this, we need only add that differences of rank can be revealed through real choice, whenever the goods can be obtained by money. We need only realize that money units (which are characteristically highly divisible) can be lumped in the same value-scale as commodities. For example, suppose someone is willing to pay $10,000 for a Rembrandt, $8,000 for a Holbein and only $20 for a Munnings. Then, his value-scale will have the following descending order: Rembrandt, $10,000; Holbein, $9,000, $8,000, $7,000, $6,000 … , Munnings, $20. We may observe these ranks and no question of the measurability of utilities need arise. That money and units of various goods can be ranked on one value scale is the consequence of Mises's money-regression theorem, which makes possible the application of marginal utility analysis to money.See Mises, Theory of Money and Credit, pp. 97-123. Mises replied to critics in Human Action, pp. 405ff. The only further criticism has been that of Gilbert, who asserts that the theorem does not explain how a paper money can be introduced after the monetary system has broken down. Presumably he refers to such cases as the German Rentenmark. The answer, of course, is that such paper was not introduced de novo; gold and foreign exchange existed previously existing moneys. Cf. J.C. Gilbert, "The Demand for Money: the Development of an Economic Concept," Journal of Political Economy(April 1953): 149. It is characteristic of Professor Samuelson's approach that he scoffs at the whole problem of circularity which money-regression had solved. He falls back on Léon Walras, who developed the idea of "general equilibrium in which all magnitudes are simultaneously determined by efficacious interdependent relations," which he contrasts to the "fears of literary writers" about circular reasoning.Samuelson, Foundations of Economic Analysis, pp. 117-18. For similar attacks on earlier Austrian economists, cf. Frank H. Knight, "Introduction" in Carl Menger, Principles of Economics (Glencoe, Ill.: The Free Press, 1950), p. 23; George J. Stigler, Production and Distribution Theories (New York: Macmillan, 1946), p. 181. Stigler criticizes Bv?hm-Bawerk for spurning "mutual determination" for "the older concept of cause and effect" and explains this by saying that Bv?hm-Bawerk was untrained in mathematics. For Menger's attack on the mutual determination concept, cf. Terence W. Hutchison, A Review of Economic Doctrines, 1870-1929 (Oxford: Clarendon Press, 1953), p. 147.
This is one example of the pernicious influence of the mathematical method in economics. The idea of mutual determination is appropriate in physics, which tries to explain the unmotivated motions of physical matter. But in praxeology, the cause is known: individual purpose. In economics, therefore, the proper method is to proceed from the causing action to its consequent effects.
The Fallacy of IndifferenceThe Hicksian Revolutionaries replaced the cardinal utility concept with the concept of indifference classes, and for the last twenty years, the economic journals have been rife with a maze of two- and three-dimensional indifference curves, tangencies, "budget lines," and so on. The consequence of an adoption of the demonstrated preference approach is that the entire indifference-class concept, along with the complicated superstructure erected upon it, must fall to the ground.
Indifference can never be demonstrated by action. Quite the contrary. Every action necessarily signifies a choice, and every choice signifies a definite preference. Action specifically implies the contrary of indifference. The indifference concept is a particularly unfortunate example of the psychologizing error. Indifference classes are assumed to exist somewhere underlying and apart from action. This assumption is particularly exhibited in those discussions that try to "map" indifference curves empirically by the use of elaborate questionnaires.
If a person is really indifferent between two alternatives, then he cannot and will not choose between them.The "indifference theorists" also err in assuming infinitely small steps, essential for their geometric representation but erroneous for an analysis of human action. Indifference is therefore never relevant for action and cannot be demonstrated in action. If a man, for example, is indifferent between the use of 5.1 ounces and 5.2 ounces of butter because of the minuteness of the unit, then there will be no occasion for him to act on these alternatives. He will use butter in larger-sized units, where varying amounts are not indifferent to him. The concept of "indifference" may be important for psychology, but not for economics. In psychology, we are interested in finding out intensities of value, possible indifference, and so on. In economics, however, we are only interested in values revealed through choices. It is immaterial to economics whether a man chooses alternative A to alternative B because he strongly prefers A or because he tossed a coin. The fact of ranking is what matters for economics, not the reasons for the individual's arriving at that rank.
In recent years, the indifference concept has been subjected to severe criticism. Professor Armstrong pointed out that under Hicks's curious formulation of "indifference," it is possible for an individual to be "indifferent" between two alternatives and yet choose one over the other.Wallace E. Armstrong, "The Determinateness of Utility Function," Economic Journal (1939): 453-67. Armstrong's point that indifference is not a transitive relation (as Hicks assumed), only applies to different-sized units of one commodity. Also cf. Armstrong, "A Note on the Theory of Consumers' Behavior." Little has some good criticisms of the indifference concept, but his analysis is vitiated by his eagerness to use faulty theorems in order to arrive at welfare conclusions, and by his radically behaviorist methodology.Little, "Reformulation" and "Theory." It is another defect of Samuelson's revealed preference approach that he attempts to "reveal" indifference-curves as well. A very interesting attack on the indifference concept from the point of view of psychology has been leveled by Professor Macfie.Alec L. Macfie, "Choice in Psychology and as Economic Assumption," Economic Journal (June 1953): 352-67. The indifference theorists have two basic defenses of the role of indifference in real action. One is to cite the famous fable of Buridan's Ass. This is the "perfectly rational" ass who demonstrates indifference by standing, hungry, equidistant from two equally attractive bales of hay.Thus, cf. Joseph A. Schumpeter, History of Economic Analysis (New York: Oxford University Press, 1954), pp. 94 n. 1064.
Since the two bales are equally attractive in every way, the ass can choose neither one and starves therefore. This example is supposed to indicate how indifference can be revealed in action. It is, of course, difficult to conceive of an ass, or a person, who could be less rational. Actually, he is not confronted with two choices but with three, the third being to starve where he is. Even on the indifference theorists' own grounds, this third choice will be ranked lower than the other two on the individual's value-scale. He will not choose starvation.
If both bundles of hay are equally attractive, then the ass or man, who must choose one or the other, will allow pure chance, such as the flip of a coin, to decide on either one. But then indifference is still not revealed by this choice, for the flip of a coin has enabled him to establish a preference!Also see Croce's warning about using animal illustrations in analyses of human action. Croce, "Economic Principle I," p. 175.
The other attempt to demonstrate indifference classes rests on the consistency-constancy fallacy, which we have analyzed above. Thus, Kennedy and Walsh claim that a man can reveal indifference if, when asked to repeat his choices between A and B over time, he chooses each alternative 50 percent of the time.Kennedy, "The Common Sense of Indifference Curves" and "On Descriptions of Consumer's Behavior."
If the concept of the individual indifference curve is completely fallacious, it is quite obvious that Baumol's concept of the "community indifference curve," which he purports to build up from individual curves, deserves the shortest possible shrift.William J. Baumol, Welfare Economics and the Theory of the State (1952; Cambridge, Mass.: Harvard University Press, 1965), pp. 47ff.
The Neo-Cardinalists: the von Neumann-Morgenstern ApproachIn recent years, the world of economics has been taken by storm by a neo-cardinalist, quasi-measurement theory of utility. This approach, which has the psychological advantage of being garbed in a mathematical form more advanced than economics had yet known, was founded by von Neumann and Morgenstern in their celebrated work.John von Neumann and Oskar Morgenstern, Theory of Games and Economic Behavior, 2nd ed. (Princeton, N.J.: Princeton University Press, 1947), pp. 8, 15-32, 617-32. Their theory had the further advantage of being grounded on the most recent and fashionable (though incorrect) developments in the philosophy of measurement and the philosophy of probability. The Neumann-Morgenstern thesis was adopted by the leading mathematical economists and has gone almost unchallenged to this day. The chief consolation of the ordinalists has been the assurance by the neo-cardinalists that their doctrine applies only to utility under conditions of uncertainty, and therefore does not shake the ordinalist doctrine too drastically.Thus see the excellent expository article by Armen A. Alchian, "The Meaning of Utility Measurement," American Economic Review (May 1953):384-397. The leading adherents of the Neumann-Morgenstern approach are Marschak, Friedman, Savage, and Samuelson.Claims of the theory, even at its best, to measure utility in any way have been nicely exploded by Ellsberg, who also demolishes Marschak's attempt to make the theory normative. Ellsberg's critique suffers considerably, however, from being based on the "operational meaning" concept. D. Ellsberg, "Classic and Current Notions of Measurable Utility," Economic Journal (September 1954): 528-56. But this consolation is really quite limited, considering that some uncertainty enters into every action.
The Neumann-Morgenstern theory is briefly as follows: an individual can compare not only certain events, but also combinations of events with definite numerical probabilities for each event. Then, according to the authors, if an individual prefers alternative A to B, and B to C, he is able to decide whether he prefers B or a 50:50 probability combination of C and A. If he prefers B, then his preference of B over C is deduced as being greater than his preference of A over B. In a similar fashion, various combinations of probabilities are selected. A quasi-measurable numerical utility is assigned to his utility scale in accordance with the indifference of utilities of B as compared with various probability combinations of A or C. The result is a numerical scale given when arbitrary numbers are assigned to the utilities of two of the events.
The errors of this theory are numerous and grave:
None of the axioms can be validated on demonstrated preference grounds, since admittedly all of the axioms can be violated by the individual actors.The theory leans heavily on a constancy assumption so that utilities can be revealed by action over time.The theory relies heavily on the invalid concept of indifference of utilities in establishing the numerical scale.The theory rests fundamentally on the fallacious application of a theory of numerical probability to an area where it cannot apply. Richard von Mises has shown conclusively that numerical probability can be assigned only to situations where there is a class of entities, such that nothing is known about the members except they are members of this class, and where successive trials reveal an asymptotic tendency toward a stable proportion, or frequency of occurrence, of a certain event in that class. There can be no numerical probability applied to specific individual events.Richard von Mises, Probability, Statistics, and Truth (New York: Macmillan, 1957). Also Ludwig von Mises, Human Action, pp. 106-17. The currently fashionable probability theories of Rudolf Carnap and Hans Reichenbach have failed to shake the validity of Richard von Mises's approach. Mises refutes them in the third German Edition of his work, unfortunately unavailable in English. See Richard von Mises, Wahrscheinlichkeit, Statistik, und Wahrheit, 3rd ed. (Vienna: J. Springer, 1951). The only plausible critique of Richard von Mises has been that of W. Kneale, who pointed out that the numerical assignment of probability depends on an infinite sequence, whereas in no human action can there be an infinite sequence. This, however, weakens the application of numerical probability even to cases such as lotteries, rather than enabling it to expand into other areas. See also Little, "A Reformulation of the Theory of Consumers' Behavior."Yet, in human action, precisely the opposite is true. Here, there are no classes of homogeneous members. Each event is a unique event and is different from other unique events. These unique events are not repeatable. Therefore, there is no sense in applying numerical probability theory to such events.Compare Frank Knight's basic distinction between the narrow cases of actuarial "risk" and the more widespread nonactuarial "uncertainty." Frank H. Knight, Risk, Uncertainty, and Profit (2nd ed.; London, 1940). G.L.S. Schackle has also leveled excellent criticism at the probability approach to economics, especially that of Marschak. His own "surprise" theory, however, is open to similar objections; cf. C.F. Carter, "Expectations in Economics," Economic Journal (March 1950): 92–105; G.L.S. Schackle, Expectations in Economics (Cambridge: Cambridge University Press, 1949), pp. 109–23. It is no coincidence that, invariably, the application of the neo-cardinalists has always been to lotteries and gambling. It is precisely and only in lotteries that probability theory can be applied. The theorists beg the entire question of its applicability to general human action by confining their discussion to lottery cases. For the purchaser of a lottery ticket knows only that the individual lottery ticket is a member of a certain-sized class of tickets. The entrepreneur, in making his decisions, is on the contrary confronted with unique cases about which he has some knowledge and which have only limited parallelism to other cases.
The neo-cardinalists admit that their theory is not even applicable to gambling if the individual has either a like or a dislike for gambling itself. Since the fact that a man gambles demonstrates that he likes to gamble, it is clear that the Neumann-Morgenstern utility doctrine fails even in this tailor-made case.It is curious how economists have been tempted to discuss gambling by first assuming that the participant doesn't like to gamble. It is on this assumption that Alfred Marshall based his famous "proof" that gambling (because of each individual's diminishing utility of money) is "irrational."A curious new conception of measurement. The new philosophy of measurement discards concepts of "cardinal" and "ordinal" in favor of such labored constructions as "measurable up to a multiplicative constant" (cardinal); "measurable up to a monotomic transform" (ordinal); "measurable up to a linear transform" (the new quasi-measurement, of which the Neumann-Morgenstern proposed utility index is an example). This terminology, apart from its undue complexity (under the influence of mathematics), implies that everything, including ordinality, is somehow "measurable." The man who proposes a new definition for an important word must prove his case; the new definition of measurement has hardly done so.Measurement, on any sensible definition, implies the possibility of a unique assignment of numbers which can be meaningfully subjected to all the operations of arithmetic. To accomplish this, it is necessary to define a fixed unit. In order to define such a unit, the property to be measured must be extensive in space, so that the unit can be objectively agreed upon by all. Therefore, subjective states, being intensive rather than objectively extensive, cannot be measured and subjected to arithmetical operations. And utility refers to intensive states. Measurement becomes even more implausible when we realize that utility is a praxeological, rather than a directly psychological, concept.
A favorite rebuttal is that subjective states have been measured; thus, the old, unscientific subjective feeling of heat has given way to the objective science of thermometry.Thus, cf. von Neumann and Morgenstern, Theory of Games and Economic Behavior, pp. 16–17. But this rebuttal is erroneous; thermometry does not measure the intensive subjective feelings themselves. It assumes an approximate correlation between the intensive property and an objective extensive event — such as the physical expansion of gas or mercury. And thermometry can certainly lay no claim to precise measurement of subjective states: we all know that some people, for various reasons, feel warmer or colder at different times even if the external temperature remains the same.Cf. Morris R. Cohen, A Preface to Logic (New York: Henry Holt, 1944), p. 151. Certainly no correlation whatever can be found for demonstrated preference scales in relation to physical lengths. For preferences have no direct physical basis, as do feelings of heat.
No arithmetical operations whatever can be performed on ordinal numbers; therefore, to use the term "measurable" in any way for ordinal numbers is hopelessly to confuse the meaning of the term. Perhaps the best remedy for possible confusion is to avoid using any numbers for ordinal rank; the rank concept can just as well be expressed in letters (A, B, C …), using a convention that A, for example, expresses higher rank. As to the new type of quasi-measurability, no one has yet proved it capable of existence. The burden of proof rests on the proponents. If an object is extensive, then it is at least theoretically capable of being measured, for an objective fixed unit can, in principle, be defined. If it is intensive, then no such fixed unit can apply, and any assignment of number would have to be ordinal. There is no room for an intermediate case. The favorite example of quasi-measurability that is always offered is, again, temperature. In thermometry, centigrade and Fahrenheit scales are supposed to be convertible into each other not at a multiplicative constant (cardinality) but by multiplying and then adding a constant (a "linear transform"). More careful analysis, however, reveals that both scales are simply derivations from one scale based on an absolute zero point. All we need to demonstrate the cardinality of temperature is to transform both centigrade and Fahrenheit scales into scales where "absolute zero" is zero, and then each will be convertible into the other by a multiplicative constant. Furthermore, the actual measurement in temperature is a measurement of length (say, of the mercury column) so that temperature is really a derived measure based on the cardinally measurable magnitude of length.On measurement, see Norman Campbell, What is Science? (New York: Dover, 1952), pp. 109-34; and Campbell An Account of the Principles of Measurement and Calculation (London: Longmans, Green, 1928). Although the above view of measurement is not currently fashionable, it is backed by the weighty authority of Mr. Campbell. A description of the controversy between Campbell and S. Stevens on the issue of measurement of intensive magnitudes was included in the unpublished draft of Carl G. Hempel's Concept Formation, but was unfortunately omitted from Hempel's published Fundamentals of Concept Formation in Empirical Science (Chicago: University of Chicago, 1952). Campbell's critique can be found in A. Ferguson, et al. Interim Report (British Association for the Advancement of Science Final Report, 1940), pp. 331-49.
Jacob Marschak, one of the leading members of the Neumann-Morgenstern school, has conceded that the temperature case is inappropriate for the establishment of quasi-measurability, because it is derived from the fundamental, cardinal measurement of distance. Yet, astonishingly, he offers altitude in its place. But if "temperature readings are nothing but distance," what else is altitude, which is solely and purely distance and length?Jacob Marschak, "Rational Behavior, Uncertain Prospects, and Measureability," Econometrica (April 1950): 131.
Welfare Economics: A CritiqueEconomics and EthicsIt is now generally accepted among economists, at least pro forma, that economics per se cannot establish ethical judgments. It is not sufficiently recognized that to accept this need not imply acceptance of the Max Weber position that ethics can never be scientifically or rationally established. Whether we accept the Max Weber position, or we adhere to the older view of Plato and Aristotle that a rational ethics is possible, it should be clear that economics by itself cannot establish an ethical position. If an ethical science is possible, it must be built up out of data supplied by truths established by all of the other sciences.
Medicine can establish the fact that a certain drug can cure a certain disease, while leaving to other disciplines the problem whether the disease should be cured. Similarly, economics can establish that Policy A leads to the advancement of life, prosperity, and peace, while Policy B leads to death, poverty, and war. Both medicine and economics can establish these consequences scientifically, and without introducing ethical judgments into the analysis. It might be protested that doctors would not inquire into possible cures for a disease if they did not want a cure, or economists would not investigate causes of prosperity if they did not want the result. There are two answers to this point: (1) that this is undoubtedly true in almost all cases, but not necessarily so — some doctors or economists may care only about the discovery of truth, and (2) this only establishes the psychological motivation of the scientists; it does not establish that the discipline itself arrives at values. On the contrary, it bolsters the thesis that ethics is arrived at apart from the specific sciences of medicine or economics.
Thus, whether we hold the view that ethics is a matter of non-rational emotions or taste, or whether we believe in a rational ethic, we must agree that economic science per se cannot establish ethical statements. As political policy judgment is a branch of ethics, the same conclusion applies to politics. If prosperity vs. poverty, for example, are political alternatives, economic science cannot decide between them; it simply presents the truth about the consequences of each alternative political decision. As citizens, we take these truths into account when we make our politico-ethical decisions.
The Problem of the New Welfare Economics: The Unanimity RuleThe problem of "welfare economics" has always been to find some way to circumvent this restriction on economics, and to make ethical, and particularly political, statements directly. Since economics discusses individuals' aiming to maximize their utility or happiness or welfare, the problem may be translated into the following terms: When can economics say that "society is better off" as a result of a certain change? Or alternatively, when can we say that "social utility" has been increased or "maximized"?
Neoclassical economists, led by Professor Pigou, found a simple answer. Economics can establish that a man's marginal utility of money diminishes as his money-income increases. Therefore, they concluded, the marginal utility of a dollar is less to a rich man than to a poor man. Other things being equal, social utility is maximized by a progressive income tax which takes from the rich and gives to the poor. This was the favorite demonstration of the "old welfare economics," grounded on Benthamite utilitarian ethics, and brought to fruition by Edgeworth and Pigou. Economists continued blithely along this path until they were brought up short by Professor Robbins. Robbins showed that this demonstration rested on interpersonal comparisons of utility, and since utility is not a cardinal magnitude, such comparisons involve ethical judgments.Lionel Robbins, "Interpersonal Comparisons of Utility," Economic Journal (December 1938): 635-41; and Robbins, An Essay on the Nature and Significance of Economic Science, 2nd ed. (London: Macmillan, 1935), pp. 138-41. What Robbins actually accomplished was to reintroduce Pareto's Unanimity Rule into economics and establish it as the iron gate where welfare economics must test its credentials.Vilfredo Pareto, Manuel d'va^conomie Politique, 2nd ed. (Paris: Marcel Giard, 1927), p. 617. This Rule runs as follows: We can only say that "social welfare" (or better, "social utility") has increased due to a change, if no individual is worse off because of the change (and at least one is better off). If one individual is worse off, the fact that interpersonal utilities cannot be added or subtracted prevents economics from saying anything about social utility. Any statement about social utility would, in the absence of unanimity, imply an ethical interpersonal comparison between the gainers and the losers from a change. If X number of individuals gain, and Y number lose, from a change, any weighing to sum up in a "social" conclusion would necessarily imply an ethical judgment on the relative importance of the two groups.Kemp tries to alter the Unanimity Rule to read that social utility is only increased if everyone is better off, non being worse off or indifferent. But, as we have seen, indifference cannot be demonstrated in action, and therefore this alteration is invalid. Murray C. Kemp, "Welfare Economics: A Stocktaking," Economic Record (November 1954): 245.
The Pareto-Robbins Unanimity Rule conquered economics and liquidated the old Pigovian welfare economics almost completely. Since then, an enormous literature known as the "new welfare economics" has flourished, devoting itself to a series of attempts to square the circle: to assert certain political judgments as scientific economics, while still retaining the Unanimity Rule.
Professor Robbins's Escape RouteRobbins's own formulation of the Unanimity Rule far undervalues the scope of its restrictive power over the assertions of economists. Robbins stated that only one ethical assertion would be necessary for economists to make interpersonal comparisons: namely, that every man has an "equal capacity for satisfaction" in similar circumstances. To be sure, Robbins grants that this ethical assumption cannot be established by economics; but he implies that since all good democrats are bound to make this egalitarian assumption, we can all pretty well act as if interpersonal comparisons of utility can be made and go on to make ethical judgments.
In the first place, it is difficult, upon analysis, to make sense of the phrase "equal capacity for satisfaction." Robbins, as we have seen, admits that we cannot scientifically compare utilities or satisfactions between individuals. But since there is no unit of satisfaction by which we can make comparisons, there is no meaning to any assumption that different men's satisfactions will be "equal" to any circumstances. "Equal" in what way, and in what units? We are not at liberty to make any ethical assumption we please, because even an ethical assumption must be framed meaningfully, and its terms must be definable in a meaningful manner. Since there is no meaning to the term "equality" without some sort of definable unit, and since there is no unit of satisfaction or utility, it follows that there can be no ethical assumption of "equal capacity for satisfaction," and that this cannot provide a shortcut to permit the economists to make conclusions about public policy.
The Robbins position, moreover, embodies a highly oversimplified view of ethics and its relation to politico-economic affairs. The problem of interpersonal comparisons of utility is only one of the very many ethical problems which must at least be discussed before any policy conclusions can rationally be framed. Suppose, for example, that two social changes take place, each of which causes 99 percent of the people to gain in utility and one percent to lose. Surely no assumption about the interpersonal comparison of utility can suffice to establish an ethical judgment, divorced from the content of the change itself. If, for example, one change was the enslavement of the one percent by the 99 percent, and the other was the removal of a governmental subsidy to the one percent, there is apt to be a great deal of difference in our ethical pronouncements on the two cases, even if the assumed "social utility" in the two cases is approximately the same.
The Compensation PrincipleA particularly notable attempt to make policy conclusions within the framework of the Unanimity Rule was the Kaldor-Hicks "compensation principle," which stated that "social utility" may scientifically be said to increase, if the winners may be able to compensate the losers and still remain winners.On the compensation principle, see Nicholas Kaldor, "Welfare Propositions in Economics," Economic Journal (September 1939): 549; John R. Hicks, "The Foundations of Welfare Economics," Economic Journal (December 1939): 706. For a criticism, see William J. Baumol, "Community Indifference," Review of Economic Studies (1946-1947): 44-48; Baumol, Welfare Economics and the Theory of the State, pp. 12 ff; Kemp, "Welfare Economics: A Stocktaking," pp. 246-50. For a summary of the discussion, see D.H. Robertson, Utility and All That (London: Allen and Unwin, 1952): pp. 29-35. The weakness in Robbin's accession to the Unanimity Rule is demonstrated by his endorsement of the compensating principle. Robbins, "Robertson on Utility and Scope." There are many fatal errors in this approach. In the first place, since the compensation principle is supposed to help economists form policy judgments, it is evident that we must be able to compare, at least in principle, actual social states. We are therefore always concerned with actual, and not potential, winners and losers from any change. Whether or not the winners may compensate the losers is therefore irrelevant; the important question is whether the compensation does, in fact take place. Only if the compensation is actually carried out so that not a single person remains a loser, can we still assert a gain in social utility. But can this compensation ever be carried out? In order to do so, everybody's utility scale would have to be investigated by the compensators. But from the very nature of utility scales this is an impossibility. Who knows what has happened to anyone's utility scale? The compensation principle is necessarily divorced from demonstrated preference, and once this occurs, it is impossible to find out what has happened to anyone's utility. The reason for the divorce is that the act of compensation is, necessarily, a unilateral gift to a person rather than an act of that person, and therefore it is impossible to estimate how much his utility has increased as compared to its decrease in some other situation. Only if a person is actually confronted with a choice between two alternatives can we say that he prefers one to the other. Certainly, the compensators could not rely on questionnaires in a situation where everyone need only say that he has lost utility in order to receive compensation. And suppose someone proclaims that his sensibilities are so hurt by a certain change that no monetary reward could ever compensate him? The existence of one such person would annul any compensation attempt. But these problems necessarily occur when we leave the realm of demonstrated preference.
The Social Welfare FunctionUnder the impact of criticisms far less thoroughgoing than the above, the compensation principle has been abandoned by most economists. There have been recent attempts to substitute another device — the "Social Welfare Function." But after a flurry of activity, this concept, originated by Professors Bergson and Samuelson, quickly struck rocky waters, and virtually sank under the impact of various criticisms. It came to be regarded as an empty and therefore meaningless concept. Even its founders have given up the struggle and concede that economists must import ethical judgments from outside economics in order to make policy conclusions.See Abram Bergson, "On the Concept of Social Welfare," Quarterly Journal of Economics (May 1954): 249; Paul A. Samuelson, "Welfare Economics; Comment," in A Survey of Contemporary Economics, Vol. II, B.F. Haley, ed. (Homewood, Ill.: R.D. Irwin, 1952), 2, p. 37. Also Jerome Rothenberg, "Conditions for a Social Welfare Function," Journal of Political Economy (October 1953): 397; Sidney Schoeffler, "Note on Modern Welfare Economics," American Economic Review (December 1952): 881; I.M.D. Little, "Social Choice and Individual Values," Journal of Political Economy (October 1952): 422-32.
Professor Rothenberg has made a desperate attempt to salvage the social welfare function by radically changing its nature, that is, by identifying it with an existing "social decision-making process." To uphold this shift, Rothenberg must make the false assumption that "society" exists apart from individuals and makes "its" own valuation. Furthermore, as Bergson has pointed out, this procedure abolishes welfare economics, since the function of the economist would be to observe empirically the social decision-making process at work and to pronounce its decisions as gains in "social utility."
The Economist as AdviserFailing the establishment of policy conclusions through the compensation principle or the social welfare function, there is another very popular route to enable the economist to participate in policy formation while still remaining an ethically neutral scientist. This view holds that someone else may set the ends, while the economist is justified in telling that person (and in being hired by that person) the correct means for attaining these desired ends. Since the economist takes someone else's hierarchy of ends as given and only points out the means to attain them, he is alleged to remain ethically neutral and strictly scientific. This viewpoint, however, is a misleading and fallacious one. Let us take an example suggested by a passage in Professor Philbrook's seminal article; a monetary economist advising the Federal Reserve System.Clarence Philbrook, " 'Realism' in Policy Espousal," American Economic Review (December 1953): 846-59. The entire article is of fundamental importance in the study of economics and its relation to public policy. Can this economist simply take the ends set by the heads of this System and advise on the most efficient means to attain them? Not unless the economist affirms these ends as being positively good, that is, not unless he makes an ethical judgment. For suppose that the economist is convinced that the entire Federal Reserve System is pernicious. In that case, his best course may well be to advise that policy which would make the System highly inefficient in the pursuit of its ends. The economist employed by the System cannot, therefore, give any advice whatever without abandoning ethical neutrality. If he advises the System on the best way to achieve its ends, it must be logically inferred that he supports these ends. His advice involves no less an ethical judgment on his part if he chooses to "tacitly accept the decisions of the community as expressed through the political machinery."E.J. Mishan, "The Principle of Compensation Reconsidered," Journal of Political Economy (August 1952): 312. See especially the excellent note of I.M.D. Little, "The Scientist and the State," Review of Economic Studies (1949-50): 75-76.
The End of Welfare Economics?After twenty years of florid growth, welfare economics is once more confined to an even tighter Unanimity Rule. Its attempts to say anything about political affairs within the confines of this rule have been in vain. The death of the New Welfare Economics has begun to be reluctantly recognized by all of its supporters, and each has taken turns in pronouncing its demise.Thus, see the rather mournful discussion in the American Economic Association's second volume of the Survey of Contemporary Economics; Kenneth E. Boulding, "Welfare Economics," pp.1-34; Melvin W. Reder, "Comment," pp. 34-36; and Samuelson, The Empirical Implications of Utility Analysis. Also see the articles by Schoeffler, Bergson, and Kemp cited above. If the strictures advanced in this paper are conceded, the burial rites will be accelerated, and the corpse decently interred. Many New Welfare Economists understandably continue to grope for some way of salvaging something out of the wreckage. Thus, Reder suggests that economics make specific, piecemeal policy recommendations anyway. But surely this is only a despairing refusal to take the fundamental problems into account. Rothenberg tries to inaugurate a constancy assumption based on psychologizing about underlying basic personalities.Jerome Rothenberg, "Welfare Comparisons and changes in Tastes," American Economic Review (December 1953): 888-90. Aside from the fact that "basic" changes can take place at any time, economics deals with marginal changes, and a change is no less a change for being marginal. In fact, whether changes are marginal or basic is a problem for psychology, not praxeology. Bergson tries the mystical route of denying demonstrated preference, and claiming it to be possible that people's values "really differed" from what they chose in action. He does this by adopting the "consistency"-constancy fallacy.
Does the Unanimity Rule then spell the end of all possible welfare economics, as well as the "old" and the "new" versions? Superficially, it would seem so. For if all changes must injure nobody, that is, if no people must feel worse off as a result of a change, what changes could pass muster as socially useful within the Unanimity Rule? As Reder laments:
"Consideration of the welfare implications of envy, for example, make it impossible even to say that welfare will be increased by everyone having more of every commodity."Reder, "Comment," p. 35.
Welfare Economics: A ReconstructionDemonstrated Preference and the Free MarketIt is the contention of this paper that the wake for all welfare economics is premature, and that welfare economics can be reconstructed with the aid of the concept of demonstrated preference. This reconstruction, however, will have no resemblance to either of the "old" or "new" edifices that preceded it. In fact, if Reder's thesis is correct, our proposed resurrection of the patient may be considered by many as more unfortunate than his demise.To a considerable extent, welfare (and related) theorizing of the 1930s and 1940s was an attempt to show the variety and importance of the circumstances under which laissez- faire was inappropriate." Ibid.
Demonstrated preference, as we remember, eliminates hypothetical imaginings about individual value scales. Welfare economics has until now always considered values as hypothetical valuations of hypothetical "social states." But demonstrated preference only treats values as revealed through chosen action.
Let us now consider exchanges on the free market. Such an exchange is voluntarily undertaken by both parties. Therefore, the very fact that an exchange takes place demonstrates that both parties benefit (or more strictly, expect to benefit) from the exchange. The fact that both parties chose the exchange demonstrates that they both benefit. The free market is the name for the array of all the voluntary exchanges that take place in the world. Since every exchange demonstrates a unanimity of benefit for both parties concerned, we must conclude that the free market benefits all its participants. In other words, welfare economics can make the statement that the free market increases social utility, while still keeping to the framework of the Unanimity Rule.Havelmo criticizes the thesis that the free market maximizes social utility on the grounds that this "assumes" that the individuals "somehow get together" to make an optimal decision. But the free market is precisely the method by which the "get together" takes place! See Trygve Haavelmo, "The Notion of Involuntary Economic Decision," Econometrica (January 1950): 8.
But what about Reder's bogey: the envious man who hates the benefits of others? To the extent that he himself has participated in the market, to that extent he reveals that he likes and benefits from the market. And we are not interested in his opinions about the exchanges made by others, since his preferences are not demonstrated through action and are therefore irrelevant. How do we know that this hypothetical envious one loses in utility because of the exchanges of others? Consulting his verbal opinions does not suffice, for his proclaimed envy might be a joke or a literary game or a deliberate lie.
We are led inexorably, then, to the conclusion that the processes of the free market always lead to a gain in social utility. And we can say this with absolute validity as economists, without engaging in ethical judgments.
The Free Market and the "Problem of Distribution"Economics, in general, and welfare economics, in particular, have been plagued with the "problem of distribution." It has been maintained, for example, that assertions of increased social utility on the free market are all very well, but only within the confines of assuming a given distribution of income.It would be more correct to say given distribution of money assets. Since changes in the distribution of income seemingly injure one person and benefit another, no statements, it is alleged, can be made about social utility with respect to changes in distribution. And income distribution is always changing.
On the free market, however, there is no such thing as a separate "distribution." A man's monetary assets have been acquired precisely because his or his ancestors' services have been purchased by others on the free market. There is no distributional process apart from the production and exchange processes of the market; hence the very concept of "distribution" becomes meaningless on the free market. Since "distribution" is simply the result of the free exchange process, and since this process benefits all participants in the market and increases social utility, it follows directly that the "distributional" results of the free market also increase social utility. The strictures of the critics do apply, however, to cases of State action. When the State takes from Peter and gives to Paul it is effecting a separate distribution process. Here, there does exist a process separate from production and exchange, and hence the concept becomes meaningful. Moreover, such State action obviously and demonstrably benefits one group and injures another, thus violating the Unanimity Rule.
The Role of the StateUntil quite recently, welfare economics has never analyzed the role of the State. Indeed, economics in general has never devoted much attention to this fundamental problem. Specific problems, such as public finance, or price controls, have been investigated, but the State itself has been a shadowy figure in the economic literature. Usually, it has vaguely been considered as representing "society" or "the public" in some way. "Society," however, is not a real entity; it is only a convenient short-hand term for an array of all existing individuals.On this fallacy of methodological collectivism, and the broader fallacy of conceptual realism, see the excellent discussion in Hayek, Counter Revolution of Science, pp. 53ff.
The largely unexplored area of the State and State actions, however, can be analyzed with the powerful tools of demonstrated preference and the Unanimity Rule.
The State is distinguished from all other institutions in society in two ways:
it and it alone can interfere by the use of violence with actual or potential market exchanges of other people; andit and it alone obtains its revenues by a compulsory levy, backed by violence.No other individual or group can legally act in these ways.Criminals also act in these ways, but they cannot do so legally. For the purpose of praxeological rather than legal analysis, the same conclusions apply to both groups.
Now what happens when the State, or a criminal, uses violence to interfere with exchanges on the market? Suppose that the government prohibits A and B from making an exchange they are willing to make. It is clear that the utilities of both A and B have been lowered, for they are prevented by threat of violence from making an exchange that they otherwise would have made. On the other hand, there has been a gain in utility (or at least an anticipated gain) for the government officials imposing this restriction, otherwise they would not have done so. As economists, we can therefore say nothing about social utility in this case, since some individuals have demonstrably gained and some demonstrably lost in utility from the governmental action.
The same conclusion follows in those cases where the government forces C and D to make an exchange which they otherwise would not have made. Once again, the utilities of the government officials gain. And at least one of the two participants (C or D) lose in utility, because at least one would not have wanted to make the exchange in the absence of governmental coercion. Again, economics can say nothing about social utility in this case.We cannot discuss here the praxeological analysis of general economics which shows that, in the long run, for many acts of coercive interference, the coercer himself loses in utility.
We conclude therefore that no government interference with exchanges can ever increase social utility. But we can say more than that. It is the essence of government that it alone obtains its revenue by the compulsory levy of taxation. All of its subsequent acts and expenditures, whatever their nature, rest on this taxing power. We have just seen that whenever government forces anyone to make an exchange which he would not have made, this person loses in utility as a result of the coercion. But taxation is just such a coerced exchange. If everyone would have paid just as much to the government under a system of voluntary payment, then there would be no need for the compulsion of taxes. Given the fact that coercion is used for taxes, therefore, and since all government actions rest on its taxing power, we deduce that: no act of government whatever can increase social utility.
Economics, therefore, without engaging in any ethical judgment whatever, and following the scientific principles of the Unanimity Rule and demonstrated preference, concludes:
that the free market always increases social utility; andthat no act of government can ever increase social utility.These two propositions are the pillars of the reconstructed welfare economics.
Exchanges between persons can take place either voluntarily or under the coercion of violence. There is no third way. If, therefore, free market exchanges always increase social utility, while no coerced exchange or interference can increase social utility, we may conclude that the maintenance of a free and voluntary market "maximizes" social utility (provided we do not interpret "maximize" in a cardinal sense). Generally, even the most rigorously Wertfrei economists have been willing to allow themselves one ethical judgment: they feel free to recommend any change or process that increases social utility under the Unanimity Rule. Any economist who pursues this method would have to
uphold the free market as always beneficial, andrefrain from advocating any governmental action.In other words, he would have to become an advocate of "ultra" laissez-faire.
Laissez-faire ReconsideredIt has been quite common to scoff at the French "optimist" laissez-faire school of the nineteenth century. Usually, their "welfare economic" analysis has been dismissed as naive prejudice. Actually, however, their writings reveal that their laissez-faire conclusions were post-judices — were judgments based on their analysis, rather than preconceptions of their analysis.Lionel Robbin's The Theory of Economic Policy in English Classical Political Economy (London: MacMillan, 1952) is devoted to the thesis that the English classical economists were really "scientific" because they did not uphold laissez-faire, while the French optimists were dogmatic and "metaphysical" because they did. To uphold this, Robbins abandons his praxeological approach of twenty years before, and adopts positivism: "The final test whether a statement is metaphysical (sic) or scientific is … whether it argues dogmatically a priori or by way of appeal to experience." Naturally, Robbins cites examples from the physical sciences to bolster this fallacious dichotomy. Ibid., pp. 23-24. It was the discovery of the general social benefit from free exchange that led to the rhapsodies over the free exchange process in the works of such men as Frédéric Bastiat, Edmond About, Gustave de Molinari, and the American, Arthur Latham Perry. Their analyses of State action were far more rudimentary (except in the case of Molinari), but their analyses generally needed only the ethical presumption in favor of social utility to lead them to a pure laissez-faire position.Bastiat's writings are well known, but his "welfare" analysis was generally inferior to that of About or Molinari. For a brilliant analysis of State action, see Gustave de Molinari, The Society of Tomorrow (New York: G.P. Putnam and Sons, 1904), pp. 65-96. Their treatment of exchange may be seen in this passage from the completely neglected Edmond About:
Now what is admirable in exchange is that it benefits the two contracting parties…. Each of the two, by giving what he has for that which he has not, makes a good bargain…. This occurs at every free and straightforward exchange…. In fact, whether you sell, whether you buy, you perform an act of preference. No one constrains you to give over any of your things for the things of another.Edmond About, Handbook of Social Economy (London: Straham, 1872), p. 104. Also, ibid., pp. 101-12; and Arthur Latham Perry, Political Economy, 21st ed. (New York: Charles Scribners' Sons, 1892), p. 180.
The analysis of free exchange underlying the laissez-faire position has suffered general neglect in economics. When it is considered, it is usually dismissed as "simple." Thus, Hutchison calls the idea of exchange as mutual benefit "simple"; Samuelson calls it "unsophisticated." Simple is perhaps it, but simplicity per se is hardly a liability in science. The important consideration is whether the doctrine is correct; if it is correct, then Occam's Razor tells us that the simpler it is, the better.Terence W. Hutchison, A Review of Economic Doctrines, 1870-1929, p. 282; Samuelson, Foundations of Economic Analysis, p. 204.
The rejection of the simple seems to have its root in the positivist methodology. In physics (the model of positivism), the task of science is to go beyond common-sense observation, building a complex structure of explanation of the common-sense facts. Praxeology, however, begins with the common-sense truths as its axioms. The laws of physics need complicated empirical testing; the axioms of praxeology are known as obvious to all upon reflection. As a result, positivists are uncomfortable in the presence of universal truth. Instead of rejoicing in the ability to ground knowledge on universally accepted truth, the positivist rejects it as simple, vague, or "naive."For an example of this attitude, see the critique of Hayek's Counter Revolution of Science by May Brodbeck, in "On the Philosophy of the Social Sciences," Philosophy of Science (April 1954). Brodbeck complains that the praxeological axioms are not "surprising"; if she pursued the analysis, however, she might find the conclusions surprising enough.
Samuelson's only attempt to refute the laissez-fare position was to refer briefly to the allegedly classic refutation by Wicksell.Knut Wicksell, Lectures on Political Economy (London: Routledge and Kegan Paul, 1934), 1, pp. 72ff. Wicksell, however, also dismissed the approach of the French "harmony economists" without argument, and went on to criticize at length the far weaker formulation of Léon Walras. Walras tried to prove "maximum utility" from free trade in the sense of an interpersonally cardinal utility and thus left himself wide open to refutation.
Furthermore, it should be stressed that the theorem of maximum social utility applies not to any type of "perfect" or "pure" competition, or even to "competition" as against "monopoly." It applies simply to any voluntary exchange. It might be objected that a voluntary cartel's action in raising prices makes many consumers worse off, and therefore that assertion of the benefits of voluntary exchange would have to exclude cartels. It is not possible, however, for an observer scientifically to compare the social utilities of results on the free market from one period of time to the next. As we have seen above, we cannot determine a man's value-scales over a period of time. How much more impossible for all individuals! Since we cannot discover people's utilities over time, we must conclude that whatever the institutional conditions of exchange, however large or small the number of participants on the market, the free market at any time will maximize social utility. For all the exchanges are exchanges effected voluntarily by all parties. Then, suppose some producers voluntarily form a cartel in an industry. This cartel makes its exchanges in Period 2. Social utility is again maximized, for again no one's exchanges are being altered by coercion. If, in Period 2, the government should intervene to prohibit the cartel, it could not increase social utility since the prohibition demonstrably injures the producers.It is also possible to argue, on general economic, rather than welfare-economic, grounds, that a voluntary cartel action, if profitable, will benefit consumers. In that case, consumers as well as producers would be injured by governmental outlawry of the cartel. As we have indicated above, welfare economics demonstrates that no governmental action can increase social utility. General economics demonstrates that, in many instances of government actions, even those who immediately benefit lose in the long run.
The State as a Voluntary Institution: A CritiqueIn the development of economic thought, far more attention has been paid to analysis of free exchange than to State action. Generally, as we have indicated, the State has simply been assumed to be a voluntary institution. The most common assumption is that the State is voluntary because all government must rest on majority consent. If we adhere to the Unanimity Rule, however, it is obvious that a majority is not unanimity, and that therefore economics cannot consider the State as voluntary on this ground. The same comment applies to the majority voting procedures of democracy. The man who votes for the losing candidate, and even more the man who abstains from voting, can hardly be said voluntarily to approve of the action of the government.Schumpeter is properly scornful when he says: "The theory which construes taxes on the analogy of club dues or of purchase of services of, say, a doctor only proves how far removed this part of the social sciences is from scientific habits of mind." Joseph A. Schumpeter, Capitalism, Socialism, and Democracy (New York: Harper and Brothers, 1942), p. 198. For a realistic analysis see Molinari, The Society of Tomorrow, pp. 87-95.
In the last few years, a few economists have begun to realize that the nature of the State needs careful analysis. In particular, they have realized that welfare economics must prove the State to be in some sense voluntary before it can advocate any State action whatever. The most ambitious attempt to designate the State as a "voluntary" institution is the work of Professor Baumol.See William J. Baumol, "Economic Theory and the Political Scientist," World Politics (January 1954): 275-77; and Baumol, Welfare Economics and the Theory of the State. Baumol's "external economy" thesis may be put succinctly as follows: certain wants are by their nature "collective" rather than "individual." In these cases, every individual will rank the following alternatives on his value scale: In (A) he would most prefer that everyone but himself be coerced to pay for the satisfaction of the group want (for example, military protection, public parks, dams, and so on). But since this is not practicable, he must choose between alternatives B and C. In (B) no one is forced to pay for the service, in which case the service will probably not be provided since each man will tend to shirk his share; in (C) everyone, including the particular individual himself, is forced to pay for the service. Baumol concludes that people will pick C; hence the State's activities in providing these services are "really voluntary." Everyone cheerfully chooses that he be coerced.
This subtle argument can be considered on many levels. In the first place, it is absurd to hold that "voluntary coercion" can be a demonstrated preference. If the decision were truly voluntary, no tax coercion would be necessary — people would voluntarily and publicly agree to pay their share of contributions to the common project. Since they are all supposed to prefer getting the project to not paying for it and not getting it, they are then really willing to pay the tax-price to obtain the project. Therefore, the tax coercion apparatus is not necessary, and all people would bravely, if a bit reluctantly, pay what they are "supposed to" without any coercive tax system. Second, Baumol's thesis undoubtedly is true for the majority, since the majority, passively or eagerly, must support a government if it is to survive any length of time. But even if the majority are willing to coerce themselves in order to coerce others (and perhaps tip the balance of coercion against the others), this proves nothing for welfare economics, which must rest its conclusions on unanimity, not majority, rule. Will Baumol contend that everyone has this value ordering? Isn't there one person in the society who prefers freedom for all to coercion over all? If one such person exists, Baumol can no longer call the State a voluntary institution. On what grounds, a priori or empirical, can anyone contend that no such individual exists?Galbraith, in effect, does make such an assumption, but obviously without adequate basis. See John K. Galbraith, Economics and the Art of Controversy (New Brunswick, N.J.: Rutgers University Press, 1955), pp. 77-78.
But Baumol's thesis deserves more detailed consideration. For even though he cannot establish the existence of voluntary coercion, if it is really true that certain services simply cannot be obtained on the free market, then this would reveal a serious weakness in the free-market "mechanism." Do cases exist where only coercion can yield desired services? At first glance, Baumol's "external economy" grounds for an affirmative answer seem plausible. Such services as military protection, dams, highways, and so on, are important. People desire that they be supplied. Yet wouldn't each person tend to slacken his payment, hoping that the others would pay? But to employ this as a rationale for State provision of such services is a question-begging example of circular reasoning. For this peculiar condition holds only and precisely because the State, not the market, provides these services! The fact that the State provides a service means that, unlike the market, its provision of the service is completely separated from its collection of payment. Since the service is generally provided free and more or less indiscriminately to the citizens, it naturally follows that every individual — assured of the service — will try to shirk his taxes. For, unlike the market, his individual tax payment brings him nothing directly. And this condition cannot be a justification for State action; for it is only the consequence of the existence of the State action itself.
But perhaps the State must satisfy some wants because these wants are "collective" rather than "individual"? This is Baumol's second line of attack. In the first place, Molinari has shown that the existence of collective wants does not necessarily imply State action. But, furthermore, the very concept of "collective" wants is a dubious one. For this concept must imply the existence of some existent collective entity who does the wanting! Baumol struggles against conceding this, but he struggles in vain. The necessity for assuming such an entity is made clear in Haavelmo's discussion of "collective action," cited favorably by Baumol. Thus, Haavelmo grants that deciding on collective action "requires a way of thinking and a power to act which are outside the functional sphere of any individual group as such."Haavelmo, "The Notion of Involuntary Economic Decision." Yves Simon, cited favorably by Rothenberg, is even more explicit, postulating a "public reason" and a "public will" as contrasted to individual reasonings and wills. See Yves Simon, Philosophy of Democratic Government (Chicago: University of Chicago, 1951); Rothenberg, "Conditions," pp. 402-3.
Baumol attempts to deny the necessity for assuming a collective entity by stating that some services can be financed only "jointly," and will serve many people jointly. Therefore, he argues that individuals on the market cannot provide these services. This is a curious position indeed. For all large-scale businesses are "jointly" financed with huge aggregations of capital, and they also serve many consumers, often jointly. No one maintains that private enterprise cannot supply steel or automobiles or insurance because they are "jointly" financed. As for joint consumption, in one sense no consumption can be joint, for only individuals exist and can satisfy their wants, and therefore everyone must consume separately. In another sense, almost all consumption is "joint." Baumol, for example, asserts that parks are an example of "collective wants" jointly consumed, since many individuals must consume them. Therefore, the government must supply this service. But going to a theater is even more joint, for all must go at the same time. Must all theaters therefore be nationalized and run by the government? Furthermore, in a broad view, all modern consumption depends on mass production methods for a wide market. There are no grounds by which Baumol can separate certain services and dub them "examples of interdependence" or "external economies." What individuals could buy steel or automobiles or frozen foods, or almost anything else, if enough other individuals did not exist to demand them and make their mass-production methods worthwhile? Baumollian interdependencies are all around us, and there is no rational way to isolate a few services and call them "collective."
A common argument related to, though more plausible than, Baumol's thesis is that certain services are so vital to the very existence of the market that they must be supplied collectively outside the market. These services (protection, transportation, and so on) are so basic, it is alleged, that they permeate market affairs and are a prior necessary condition for its existence. But this argument proves far too much. It was the fallacy of the classical economists that they considered goods in terms of large classes, rather than in terms of marginal units. All actions on the market are marginal, and this is precisely the reason that valuation and imputation of value-productivity to factors can be effected. If we start dealing with whole classes rather than marginal units, we can discover all sorts of activities which are necessary prerequisites of, and vital to, all market activity; land, room, food, clothing, shelter, power, and so on — and even paper! Must all of these be supplied by the State and the State only?
Stripped of its many fallacies, the whole "collective wants" thesis boils down to this: certain people on the market will receive benefits from the action of others without paying for them.See the critique of a similar position of Spencer's by "S.R.," "Spencer As His Own Critic," Liberty (June 1904). This is the long and short of the criticism of the market, and this is the only relevant "external economy" problem.The famous "external diseconomy" problems (noise, smoke nuisance, fishing, and so on) are really in an entirely different category, as Mises has shown. These "problems" are due to insufficient defense of private property against invasion. Rather than a defect of the free market, therefore, they are the results of invasions, of property, invasions which are ruled out of the free market by definition. See Mises, Human Action, pp. 650-56. A and B decide to pay for the building of a dam for their uses; C benefits though he did not pay. A and B educate themselves at their expense and C benefits by being able to deal with educated people, and so on. This is the problem of the Free Rider. Yet it is difficult to understand what the hullabaloo is all about. Am I to be specially taxed because I enjoy the sight of my neighbor's garden without paying for it? A's and B's purchase of a good reveals that they are willing to pay for it; if it indirectly benefits C as well, no one is the loser. If C feels that he would be deprived of the benefit if only A and B paid, then he is free to contribute too. In any case, all the individuals consult their own preferences in the matter.
In fact, we are all free riders on the investment, and the technological development, of our ancestors. Must we wear sackcloth and ashes, or submit ourselves to State dictation, because of this happy fact? Baumol and others who agree with him are highly inconsistent. On the one hand, action cannot be left up to voluntary individual choice because the wicked free rider might shirk and obtain benefits without payment. On the other hand, individuals are often denounced because people will not do enough to benefit free riders. Thus, Baumol criticizes investors for not violating their own time-preferences and investing more generously. Surely, the sensible course is neither to penalize the free rider nor to grant him special privilege. This would also be the only solution consistent with the Unanimity Rule and demonstrated preference.In a good, though limited, criticism of Baumol, Reder points out that Baumol completely neglects voluntary social organizations formed by individuals, for he assumes the State to be the only social organization. This error may stem partly from Baumol's peculiar definition of "individualistic" as meaning a situation where no one considers the effects of his actions on anyone else. See Melvin W. Reder, "Review of Baumol's Welfare Economics and the Theory of the State," Journal of Political Economy (December 1953): 539.
Insofar as the "collective want" thesis is not the problem of the free rider, it is simply an ethical attack on individual valuations, and a desire by the economist (stepping into the role of an ethicist) to substitute his valuations for those of other individuals in deciding the latter's actions. This becomes clear in the assertion by Suranyi-Unger: "he (an individual) may be led by a niggardly or thoughtless or frivolous evaluation of utility and disutility and by a corresponding low degree or complete absence of group responsibility."Theo Suranyi-Unger, "Individual and Collective Wants," Journal of Political Economy (February 1948): 1-22. Suranyi-Unger also employs such meaningless concepts as the "aggregate utility" of the "collectivized want satisfaction."
Tibor Scitovsky, while engaging in an analysis similar to Baumol's, also advances another objection to the free market based on what he calls "pecuniary external economies."Tibor Scitovsky, "Two Concepts of External Economies," Journal of Political Economy (April 1954): 144-51. Briefly, this conception suffers from the common error confusing the general (and unattainable!) equilibrium of the evenly rotating economy with an ethical "ideal" and therefore belaboring such ever-present phenomena as the existence of profits as departures from such an ideal.
Finally, we must mention the very recent attempts of Professor Buchanan to designate the State as a voluntary institution.See James M. Buchanan, "Social Choice, Democracy, and Free Markets," Journal of Political Economy (April 1954): 114-23; and Buchanan, "Individual Choice in Voting and the Market," Journal of Political Economy (August 1954): 334-43. In many other respects, Buchanan's articles are quite good.
Buchanan's thesis is based on the curious dialectic that majority rule in a democracy is really unanimity because majorities can and do always shift! The resulting pulling and hauling of the political process, because obviously not irreversible, are therefore supposed to yield a social unanimity. The doctrine that endless political conflict and stalemate really amount to a mysterious social unanimity must be set down as a lapse into a type of Hegelian mysticism.How flimsy this "unanimity" is, even for Buchanan, is illustrated by the following very sensible passage: "a dollar vote is never overruled; the individual is never placed in the position of being a member of dissenting minority" — as he is in the voting process (Buchanan, "Individual Choice in Voting and the Market," p. 339). Buchanan's approach leads him so far as to make a positive virtue out of inconsistency and indecision in political choices.
ConclusionIn his brilliant survey of contemporary economics, Professor Bronfenbrenner described the present state of economic science in the gloomiest possible terms.Bronfenbrenner, "Contemporary Economics Resurveyed." "Wilderness" and "hash" were typical epithets, and Bronfenbrenner ended his article in despair by quoting the famous poem Ozymandias. Applied to currently fashionable theory, his attitude is justified. The 1930s was a period of eager activity and seemingly pathbreaking advances in economic thought. Yet one by one, reaction and attenuation have set in, and in the mid-1950s the high hopes of twenty years ago are either dying or fighting desperate rearguard action. None of the formerly new approaches any longer inspires fresh theoretical contributions. Bronfenbrenner specifically mentions in this connection the imperfect competition and the Keynesian theories, and justly so. He could also have mentioned utility and welfare theory. For the mid-1930s saw the development of the Hicks-Allen indifference curve analysis and the New Welfare Economics. Both of these theoretical revolutions have been enormously popular in the upper reaches of economic theory; and both are now crumbling.
The contention of this paper is that while the formerly revolutionary and later orthodox theories of utility and welfare deserve an even speedier burial than they have been receiving, they need not be followed by a theoretical vacuum. The tool of demonstrated preference, in which economics deals only with preference as demonstrated by real action, combined with a strict Unanimity Rule for assertions of social utility, can serve to effect a thoroughgoing reconstruction of utility and welfare economics. Utility theory can finally be established as a theory of ordinal marginal utility. And welfare economics can become a vital corpus again, even though its new personality might not attract its previous creators. It must not be thought that we have, in our discussion of welfare economics, been attempting to set any ethical or political program. On the contrary, the proposed welfare economics has been put forward without inserting ethical judgments. Economics by itself and standing alone cannot establish an ethical system, and we must grant this regardless of what philosophy of ethics we hold. The fact that the free market maximizes social utility, or that State action cannot be considered voluntary, or that the laissez-faire economists were better welfare analysts than they are given credit for, in itself implies no plea for laissez-faire or for any other social system. What welfare economics does is to present these conclusions to the framer of ethical judgments as part of the data for his ethical system. To the person who scorns social utility or admires coercion, our analysis might furnish powerful arguments for a policy of thoroughgoing Statism.
The sub-discipline of international relations in the twentieth century has been dominated by the realist idea that cooperation between state actors is extremely unlikely due to the anarchic nature of the international system. According to the traditional realist logic, the international system lacks an independent enforcing agency capable of coercing states should they attempt to defect on their cooperative agreements with other international actors, and as a consequence, states are hesitant if not completely unwilling to cooperate with other states.
The realist expectation that cooperation is extremely unlikely in situations lacking an independent enforcement agency has been forcefully challenged by Robert Axelrod in his The Evolution of Cooperation.[1] Utilizing the formal theoretical modeling of the rational choice school, Axelrod offers a strong empirical case for the possibility of cooperation between actors — even in situations lacking an independent enforcement agency.
While Axelrod rightly concludes that cooperation is possible and even probable in situations lacking an independent enforcement agency, his method is not suitable for defending this conclusion.
Axelrod's defense of the possibility of cooperation between two actors in the absence of an independent enforcement agency is based upon several computer tournaments he sponsored at the University of Michigan to investigate the best possible solution to the iterated Prisoner's Dilemma. Contestants were asked to submit strategies that would result in the best overall performance when paired against one another in a round-robin tournament of the Prisoner's Dilemma.
The strategy that emerged victorious from these round-robin tournaments was the simple "tit-for-tat" strategy in which the player opens with cooperation in the first round, then responds in kind to every move of his opponent in subsequent rounds. Interestingly, the strategies based primarily on taking advantage of one's opponent, (what Axelrod calls "mean" strategies), fared the worst in the tournaments. In contrast, the strategies that fared best were the ones that were most forgiving of the defections of the opponent, and were the most open to cooperation (that is, they were what Axelrod calls "nice" strategies). Both of these characteristics are embodied best in the "tit-for-tat" strategy.
The results of the tournaments are interpreted by Axelrod to have broad theoretical implications and applications. In the first place, and contrary to the expectations of most of the program designers, the fact that strategies that sought to cooperate with the opponent fared much better than those that sought to take advantage of the opponent is interpreted by Axelrod to indicate that the traditional understanding of the operation of the Prisoner's Dilemma is mistaken. For the Prisoner's Dilemma has traditionally been understood as a game that will almost always leads to defections on the part of both players.
The empirical results of Axelrod's tournament, however, indicate that cooperation is not only possible between two players in a Prisoner's Dilemma, it is the best possible strategy for both players to adopt if they wish to maximize their absolute gains over multiple iterations of the game.
Additionally, Axelrod argues that cooperative strategies like tit-for-tat can "invade" areas that are dominated by "mean" strategies, because just a few players employing a cooperative strategy can benefit from each other enough to allow the strategy to spread throughout the "mean" area over time. This is precisely the evolutionary aspect of Axelrod's argument; cooperative strategies, (because they are more profitable to both players than strategies based upon defection), come to be adopted by more people over time as a result of the gains they offer to the players who adopt them.
The problem with Axelrod's argument is the oft-discussed problem of interpersonal utility comparison. Axelrod's argument, (and all game theoretic modeling, welfare economics, and utilitarian moral philosophy, in fact), would require that it be possible for one to measure and compare the utilities of different people on the same scale of measurement.
The problem with this assumption is that it is quite impossible to construct a scale of measurement for human preferences — both for individuals and especially for groups of individuals.[2] In order for this to be possible it would be necessary for there to exist a constant unit of utility for each individual — the impossibility of which can be demonstrated simply by asking ourselves the following question: What is the constant unit of "utility" that separates my preference for chewing tobacco over movie popcorn?
There is no doubt that Axelrod is aware of this problem, and he addresses it specifically: "The payoffs of a player do not have to be measured on an absolute scale. They need only be measured relative to each other."[3] But, how would it be possible to measure the utilities of two different people relative to each other without a constant unit of measurement for each individual, i.e., an absolute scale for each individual? Indeed, without a constant unit of measurement for each individual, the two utility scales are completely incommensurable.
You cannot, for example, compare my idea of beauty with President Lincoln's idea of beauty, when there exist no known (or even potentially knowable) intervals (units) of beauty for me as an individual. Axelrod's disclaimer notwithstanding, he reveals in the footnote to the above statement that he is indeed assuming an absolute scale of utility measurement. He states, in fact, that:
[T]he utilities need only be measured as an interval scale. Using an interval scale means that the representation of the payoffs may be altered with any positive linear transformation and still be the same, just as temperature is equivalent whether measured in Fahrenheit or Centigrade.[4]
What I am claiming is that is quite impossible to achieve a linear transformation of two "variables" to which it is impossible to assign numerical values. You can do this with temperatures measured in millimeters of mercury solely because we assume that we can assign a constant unit of measurement — but we cannot do this with "utilities." You can, of course, put arbitrary numbers on anything, but the very idea of using an interval scale assumes that there exist known (or at least potentially knowable) intervals between each unit of measurement — an assumption that is simply untenable in the realm of what is infelicitously known as man's "utilities."
If we cannot construct an interval or continuous measure of utility for individuals or groups, then (and this is vital) it is equally impossible to know when a Prisoner's Dilemma situation exists in the world. We might be able to hypothesize, in a purely formal manner, that it might be possible for two men's preferences to approximate the Prisoner's Dilemma at a specific point in time. But, in the light of the impossibility of ever measuring or comparing utilities, we would never be able to say with any certainty that any given situation was a Prisoner's Dilemma — and, in fact, we cannot say with any certainty that a Prisoner's Dilemma has ever existed.
Since this is the case, it is surely presumptuous of Axelrod to prescribe for the reader all sorts of ways to mitigate the cooperative problems associated with the Prisoner's Dilemma — when neither he, nor anyone else, knows whether there are such dilemmas.
The foregoing discussion might give the impression that it is impossible to determine anything at all about man's preferences and utilities. In actuality, however, we can determine man's preferences with absolute certainty. Following Rothbard, we can analyze man's preferences through his actions (or, to use Rothbard's phrase, his "demonstrated preferences").[5]
If a man voluntarily acts in a certain way, we can say with absolute certainty that he preferred that course of action to any other option. Another way of saying this is to say that all voluntary human action is an attempt to make the actor subjectively, and ex ante, better off than he otherwise would have been.
We do not have to hypothesize about man's preferences, or attempt to place numerical values on them — all we have to do is observe how he voluntarily does act. It is high time that we exorcise the unjustifiable comparison of "utilities" from political science and economics.
Bibliography
Axelrod, Robert, The Evolution of Cooperation. New York: Basic Books, 1984.
Croce, Bendetto, "On the Economic Principle, Parts I and 2." International Economic Papers 3 (1953): 175-76.
Rothbard, Murray Newton, "Toward a Reconstruction of Utility and Welfare Economics." In The Logic of Action One: Method, Money, and the Austrian School, 211-55. London: Edward Elgar, 1997.
Notes
[1] New York: Basic Books, 1984.
[2] For the most compelling statement of this argument, see Murray Newton Rothbard, "Toward a Reconstruction of Utility and Welfare Economics," in The Logic of Action One: Method, Money, and the Austrian School (London: Edward Elgar, 1997). See also, Bendetto Croce, "On the Economic Principle, Parts I and 2," International Economic Papers 3 (1953).
[3] Axelrod, p. 17.
[4] Ibid., p. 216n. Emphasis mine.
[5] Rothbard, op. cit.
IntroductionObjective ValueValue SubjectivismPositive EthicsThe Goal of HappinessRights and Utility[This lecture was given at Mises University 2005.]
When I was given the title "Ethical Assumptions of Economics," my first thought was to say, "economics has no ethical assumptions." But then I thought this might not be the best way to earn my keep here. So I'm going to talk about some senses in which economics might have implications for ethics.
There are these two terms that we often hear as characterizing Austrian economics. One is "value-freedom," or Wertfreiheit. Wertfreiheit does not mean free in a valuable way; it just means a description that doesn't involve evaluation. To be value-free is simply to describe things, to tell how things are, without advocating any particular point of view.
And closely related is this notion of "value-subjectivism," the notion that Austrian economics in some sense recognizes only subjective values, only the values to the participants whose actions are being described or explained, and doesn't evaluate their actions.
Well, if Austrian economics is value-free and value-subjectivist, then it might seem as though it couldn't have much in the way of implications for ethics. But there are several respects in which ethics and economics nevertheless interestingly interact.
First, it's worth pointing out that economics is often presented in ways that are perhaps not completely value-free. For example, words like "welfare" and "property" and so forth tend to have value connotations. Now you can try to interpret them value-neutrally, but ordinarily when we say that such-and-such promotes social welfare, it sounds like we're in favor of it — since we are part of society, and we do care about our own welfare. And when we say that something is someone's property, that often implies that it's their legitimate property, and so calling something someone's property might imply that they ought to have it, not just that they happen to possess it.
You might think this can be used to bias the discussion, but medicine's a value-free science too; strictly speaking, in purely descriptive terms, medicine is indifferent between health and sickness — it just wants to describe what causes what — but since as a matter of fact practitioners of medicine are practicing it in order to promote health, naturally they're going to describe it in such a way, where it's understood that all the participants in the discussion agree that they're trying to promote health rather than promoting sickness.
Objective ValueThere's perhaps a deeper worry that's raised by the Greek philosopher Socrates in a couple of Socratic dialogues that are attributed to Plato (but it's not clear whether they're really by Plato or not), the Hipparchus and the Eryxias, where he explores the meanings of certain economic concepts like "wealth" and "profit," and gives something like an argument that these can't really be value-neutral terms.
Socrates asks the person he's talking with, "how would you define profit?" And the person answers, "getting more in exchange for less." You put in a smaller amount, and you get back a greater return than you put in. That's profit. (Now this doesn't really distinguish between profit and interest, risk premium, and all that, but never mind.)
Socrates says — translating his example into our money — "if I gave you one $10 bill, and you gave me three $1 bills back, I wouldn't think I'd made a profit, even though I'd gotten more in exchange for less — I'd given only one bill and I got three back." So what matters is the value of the bills, and the fact that a $10 bill is more valuable than a $1 bill. You can't just describe the exchange in terms of empirical mass quantities; you have to describe it in terms of value. You don't really profit unless you're getting something of greater value.
And of course Socrates wants to spin this into, ultimately, a moral argument that you don't really benefit from what you get unless what you get really is of greater real value. So if I get a lot of money by cheating you, then since cheating you is a great harm to my soul and is not outweighed by the benefit of the money I get, I haven't really profited.
"To be value-free is simply to describe things, to tell how things are, without advocating any particular point of view."It's clear enough what someone like Mises would say to this. He'd say: well, it's certainly true that you can't define profit in terms of just getting more physical things in exchange for fewer physical things; but you don't have to interpret it in terms of objective value — you can interpret it in terms of subjective value. You get a profit, not if you get things that are genuinely objectively better in return, but if you get things you value more instead of what you value less.
Part of the reason Socrates and Mises disagree here is that Socrates thinks that valuing something more involves judging that it's better, and these judgments can be true or false. And what you really want is not to get what you think is better; what you really want is to get whatever is better. And that whole way of thinking is something that Mises opposes, so they're not really going to see eye to eye here.
Value SubjectivismIs Austrian economics committed to rejecting any kind of objective morality?
We can distinguish between two kinds of value-subjectivism. You can have explanatory value-subjectivism, which simply means that in explaining someone's actions, you appeal to their evaluations, not yours — just as in explaining someone's actions you appeal to their beliefs and not yours. If you see someone walking out on a bridge, and you know the bridge is unsafe and is likely to collapse, but they don't know that, then in interpreting why they're doing what they're doing you shouldn't attribute to them your belief that the bridge is unsafe if they don't have that belief. If you try to explain their action by appealing to your belief that the bridge is unsafe, your explanation isn't going to be any good.
So likewise, if you're explaining their actions you also have to appeal to their values. Suppose that you hate vanilla ice cream, and you see someone trying to get some. What they're doing would make no sense if you assumed that they share your value. Instead, your evaluation of their taste in ice cream doesn't make any difference to explaining — whether they're right or wrong to like vanilla ice cream, nevertheless the fact that they like it is what explains their going after it.
So explanatory value-subjectivism doesn't say anything one way or the other about whether there is such a thing as objective value; it just says that if you're going to explain people's actions, you explain them in terms of their desires, not yours.
Normative value-subjectivism, on the other hand, means that there are no objective values, that there is nothing to value over and above just whatever any person happens to want. There's no right or wrong way to want things; you can't be right or wrong about your ultimate desires.
So these are two different things, and you can see that at least it's not obvious that explanatory value-subjectivism entails normative value-subjectivism.
Now Mises seems to have thought it did, and I think his reason for thinking this is not just that he somehow confused two kinds of subjectivism; I think there's a deeper reason he thought this. The fact that Mises thinks that these two go together, and that both explanatory value-subjectivism and normative value-subjectivism are true, helps to explain why a lot of people interpret Austrian economics as being against any kind of objective value.
Rothbard, on the other hand, accepted explanatory value-subjectivism. He thought that in explaining people's actions, or in trying to understand and describe economic behavior, you appeal to their beliefs and desires, not yours — but he thought normative value-subjectivism was false. He thought that there was, on the basis of philosophical arguments — the kinds of arguments he gives for example in his book The Ethics of Liberty, where he tries to develop a libertarian theory of rights — he thought you could give arguments to establish that certain values were objectively valid. But he thought those arguments didn't make any difference to how you interpreted people's economic behavior.
If economics is value-free in the sense that it doesn't presuppose any particular values, as Mises and Rothbard both seem to agree about economics, you might wonder how economics can serve as a basis for advice. Economists are often called upon to give advice; how can they do that? Well, there are several different possibilities.
Mises's view is that it's impossible to give advice about ultimate goals — except in terms of just saying, "well, I like this goal, you should pursue that," but you can't really give any reasons, Mises thinks, for ultimate goals. But given a certain ultimate goal, you can give reasons for adopting certain means to it. And economics is useful for that. Economics can tell us what sorts of actions tend to have what sorts of consequences. So if you happen to want to have, or want to avoid, certain consequences, then the economist can tell you what things to do that are likely to get you the consequences you want and to avoid the consequences you don't want.
Although you might be in the field of medicine working on germ warfare, in which case you're interested in causing sickness, most doctors, most of the time, are interested in curing disease, we hope, and so if you go to a doctor for advice, the doctor can just assume that what you want is what will promote health.
But of course it's not part of the medical expertise to tell you whether health is a good thing. Nowhere in medical school can you learn any reason for thinking health is a good thing. That's not a medical question. Mises would say it's not an answerable question at all; others might say, well yes, maybe it is an answerable question, but at any rate it's not a medical question — maybe it's a philosophical question or a theological question or something like that.
Socrates used to say that the doctor can tell you what's likely to make you live or die, but the doctor can't tell you whether you'd be better off alive or dead. That goes outside of the doctor's area of expertise. The philosopher tells you whether your life is worth living or not: "the unexamined life is not worth living," so if you're not examining your life, you're better off dead. That's what Dr. Socrates would say.
Mises thinks economics can tell us how to pursue the ends we happen to have, and given that most people prefer prosperity to poverty and cooperation to chaos, Mises thought that there's some general, all-purpose advice that economists can give.
Mises thought economics could tell us how to pursue the ends we happen to have. Rothbard went further.Rothbard went further. In the last chapter of Power and Market, Rothbard says that although economics per se can't give us positive ethical advice — it can't tell us what goals to aim at — it can criticize certain goals as being incoherent. And although I say that Rothbard here is going beyond Mises, in a sense Rothbard would think of himself as continuing what Mises was doing, even if Mises didn't call it this. So for example Mises argues that socialist calculation is impossible: you cannot rationally allocate resources in a socialist economy. Well, suppose that was your goal — to rationally allocate resources in a socialist economy. It certainly seems relevant to find out that the goal is impossible. If the goal is impossible, then it seems like you don't have any good reason to pursue it.
This is a way of criticizing ends: not criticizing ends on the grounds that they're bad, that it would be a bad thing to achieve this goal, but rather to argue that the goal can't be achieved at all. So in the last chapter of Power and Market, Rothbard runs through what he calls various positions of "anti-market ethics," and tries to refute various positions on the grounds that they posit goals that are somehow economically impossible, or logically incoherent, or in one way or another can be shown not to be possible. But he doesn't think that economics can per se give us positive goals to aim at, or show us what is really worthwhile; he thinks you have to do philosophy for that. That's why he only does this criticism of ethical theories in Power and Market, and you have to go to The Ethics of Liberty to get his positive ethical arguments.
Positive EthicsThe question is: can economics or praxeology give us anything more than that? Can it give us any implications for positive ethical theorising? What more can it tell us about ethics? I'm going to explore some various possibilities. If you're hoping that I'm going to derive an ethical system from the axioms of praxeology for you today, well — we don't have time for that! So I'm just going to give various suggestions about various issues.
First of all there's this big dispute between Mises on the one hand and Carl Menger, the founder of the Austrian School, on the other. Menger had a category of what he called "imaginary goods." He said that in order for something to be a good, it has to meet a certain number of criteria, one of which is that it has to be suitable for achieving certain goals or satisfying certain human needs. But, he says, there are some things that don't really satisfy any human need, while you think they do — like fake cures, things that are supposed to cure you but they don't really work; he seems for some reason to have included cosmetics in this category; you might wonder about that. But anyway, he thinks various things that don't really meet any human need are not real goods, they're imaginary goods, because although they may be suitable means to certain goals, those goals are not in fact genuine human needs.
Mises thought this was a horrible mistake. Mises said the economist has no business pontificating about whether these are genuine needs or not; if you want to explain human behavior, what we think of the person's desires is irrelevant. If you want to understand the market for horoscopes, or if you want to understand the market for something genuinely valid, it doesn't make any difference. As long as people think horoscopes are valuable, then they'll be willing to pay for them, and if they don't think they're valuable, then they won't, regardless of whether they really are valuable or not. Mises thought this category was irrelevant for economics.
Mises thought the only mistakes you can make are about the means to your ends, not about the ends themselves.But he didn't just think it was irrelevant for economics, he thought it was irrelevant, period. It wasn't just that classifying something as an imaginary good was a job for the philosopher rather than for the economist; Mises thought that it wasn't a job for anybody — because he thought the only way we can make mistakes is about means. We can't evaluate ends as right or wrong. Our ends are just whatever we want. If you want to justify what you're doing, you have to appeal to some further end you have. Why am I walking over here? In order to get to the chair. Why do I want to get to the chair? In order to sit down. Why do I want to sit down? Well, at some point you just have to end with "because I want to, and that's that," Mises thought.
Mises thought the ultimate goal is not capable of being rationally assessed. The only things you can criticize are people's means. The only mistakes you can make are about the means to your ends, not about the ends themselves.
However, there's a distinction which Mises doesn't consider which might complicate this. It's the distinction between instrumental means and constitutive means. And here's a way of thinking about this. Suppose that I want to play the Moonlight Sonata; and so I save money to buy a piano, and to buy sheet music, and to take piano lessons and so forth, so that I'll be able to play the Moonlight Sonata. These are all means to the end of playing the Moonlight Sonata; if you ask me why am I saving this money, why am I buying a piano, etc., I would say these are all means to my ultimate goal, which is to play the Moonlight Sonata.
But now suppose you come upon me in the middle of playing the Moonlight Sonata, and I'm hitting a particular note. And you ask me: "Why are you hitting that particular note? Is it just that you find that note valuable in and of itself?" And I would answer: "No, I'm playing that note because I want to play the Moonlight Sonata, and I can't play the Moonlight Sonata without playing that note at that point." Well, in a sense, then, playing that note is a means to playing the Moonlight Sonata; but it's not a means in the other way. It's not a means that's external to the end; it's a means that's part of the end.
When a means is external to or merely instrumental to an end, then it would make sense to say, "I wish I could have the end without having to go through all these means." I wish I could be at the top of the mountain without having to climb all this way up, or I wish I could play the Moonlight Sonata without having to save all this money to buy a piano. But it doesn't make any sense to say, "I wish I could play the Moonlight Sonata without having to play all these notes" — because the Moonlight Sonata just is those notes in that order.
So there are cases where a means can be a constitutive part of the end rather than being an external means to it. And a lot of things that Mises considers ultimate ends you might think are really means, but they're constitutive means rather than instrumental means. So then the question is: well, can we deliberate about constitutive means? How do we determine whether something is a constitutive means to an end? It seems it's not a matter of cause and effect any more; it's more a matter of logical or conceptual analysis.
"Ethical internalism is the view that you can't have any moral duties that you don't have any motivation to pursue."Why does Mises think that if you're an explanatory value-subjectivist, you have to be a normative value-subjectivist? I think that his reason comes in his two-step argument for why he thinks explanatory value-subjectivism implies utilitarianism. (Both these steps, I think, are denied by Rothbard.) So first he thinks that explanatory value-subjectivism implies normative value-subjectivism: if you can only explain things in terms of people's subjective values, then you have to give up the idea of there being any objective standard of value. I'll say in a minute why I think he thinks that. Second, he thinks that that position in turn implies utilitarianism.
And you might think that's very odd; because you might think that if someone says economics implies utilitarianism, it sounds like they think that economics implies a positive ethical theory — because we usually think of utilitarianism as a particular ethical theory, a theory that says that certain things are objectively good. The standard versions of utilitarianism, like John Stuart Mill's version, assert that a certain goal — human welfare, happiness, pleasure, satisfaction — is intrinsically valuable and worth pursuing, objectively so. And then our job is to pursue it.
Clearly Mises can't mean that. Since Mises thinks that there are no objective values, when Mises embraces utilitarianism he can't be embracing the view that human welfare is an objective value. What Mises means by "utilitarianism" is a little bit different from the kind of utilitarianism that people like John Stuart Mill advocate. By "utilitarianism" Mises means something like simply giving people advice about how to achieve the goals they already have. So you're not necessarily endorsing their goals, but utilitarianism says that really the only real role for any kind of evaluation is simply to talk about means to ends, because you can't evaluate the ends.
And I think we can see both why he thinks explanatory value-subjectivism implies normative value-subjectivism, and why he thinks that in turn implies utilitarianism of his sort, in this quote from Theory and History:
All nonutilitarian systems of ethics look upon the moral law as something outside the nexus of means and ends. The moral code has no reference to human well-being and happiness, to expediency, and to the mundane striving after ends. It is heteronomous, i.e., enjoined upon man by an agency that does not depend on human ideas and does not bother about human concerns.So that's the position that Mises thinks he's attacking. He's attacking the view that the proper moral code is completely independent of what actually makes people happy or what they actually happen to want.
And in a sort of slap at Kant, he calls this sort of thing "heteronomous." Now the term "heteronomous," which is supposed to be the opposite of "autonomous" — "autonomous" means somehow governed by a law you give to yourself, and "heteronomous" means governed by a law imposed on you from something else — Kant had used the term "heteronomous" to mean following your inclinations, which are external to and distinct from your rational will, and therefore you're acting heteronomously when you obey your inclinations. Now Mises is sort of turning Kant's terminology upside-down here.
But Mises thinks it's presumptuous to tell people that they ought to be pursuing something completely unrelated to anything they actually happen to want, desire, or have any motivation or personal reason to pursue. Now I think the reason he thinks that is that if you think that all action, as praxeology teaches, is a matter of pursuing ends, and the ends you pursue are your own — you can't pursue someone else's end unless it also happens to be your own end — then it just doesn't even make sense to demand of people that they pursue some end that they have no motivation for, no interest in, no personal reason to pursue.
So you might say that he's relying on something like the "ought implies can" principle — that it doesn't make sense to demand that you morally ought to do something unless you can do it. If I said, "you are morally obligated all to fly up to the ceiling right now," that wouldn't make any sense, to say that you ought to do it or that you should feel guilty for not doing it, because you don't have the choice, you don't have any control over whether you do that or not. I think that Mises thinks that because our actions can only be actions aiming at ends that we have — we can't perform an action without aiming at some end, and the end has to be an end we've got — it just doesn't make any sense to demand of us that we act in accordance with some objective code of ethics.
"It's not terribly controversial: most people are pro-happiness."However, I think that what he's really arguing for here is better understood as a kind of ethical internalism rather than genuine normative value-subjectivism. Ethical internalism is the view that you can't have any moral duties that you don't have any motivation to pursue. Now that's a broad family of theories, because according to some theories the moral duty just gives you a motivation, whereas for other theories, no, you've already got your motivations, and the moral duty can't get its foot in the door unless you've already got one. Those are very different kinds of internalism. But still the internalists all agree that there are no moral duties without some corresponding motivation on your part. And I think that Mises is really arguing for that. But it's important to see that that's not the same thing as normative value-subjectivism, because it might be that, given your motive, and given some appropriate story, the moral duty really is an objective one.
And likewise, the reason he thinks that this has to be purely utilitarian, that there can't be any actions that are right or wrong in themselves, but only as part of promoting some further goal, is that he thinks all action has to have a means-end structure. But again, you can have a means that is constitutive rather than instrumental. If I'm playing this particular note because I want to play the Moonlight Sonata, then that note is a means to playing the entire sonata, but it's not an external one. Likewise, people who say a certain action is morally right in and of itself might mean that it isn't an external or instrumental means to some further goal, but is just part of, say, the good life.
The Goal of HappinessNow something like Mises's view was recently defended by Leland Yeager in a book called Ethics As Social Science, where he accepts Mises's view that ultimate goals cannot be rationally assessed. He says: therefore, ultimate goals are rationally arbitrary, but the means to those goals aren't, and therefore the advantage of utilitarianism of Mises's sort, which simply says, "promote whatever satisfies human desires," is that it's the best theory because it minimises the amount of ethical arbitrariness. All that's arbitrary is just this ultimate goal, happiness; but although it's arbitrary, it's not terribly controversial: most people are pro-happiness. Whereas if you add more intrinsic values in addition to happiness, things like moral duties and so forth, then you're increasing the number of ultimate ends. And since ultimate ends are rationally arbitrary, your theory is getting more arbitrary the more of those you add.
I'm not so sure about that; if you really think the whole thing rests on an ultimate thing that's arbitrary, I'm not sure that whether it's one or many makes that much difference. But at any rate, the assumption that you can't rationally assess ends is something that I'm not convinced of. There's something called reflective equilibration, which is the idea that you weigh various beliefs and values and judgments against each other and see whether they conflict with each other. If they conflict with each other then you revise them to make them not conflict. And so if you've got some ultimate end, you can't assess it as a means to some further end, perhaps, but you can assess it by whether it fits in consistently with everything else. Now that's a kind of assessment. You might think it's a kind of wimpy assessment, but it's an assessment.
We started off with Socrates, and Socrates has to come in again. There's this tradition I call the eudaimonic tradition, from the Greek word for happiness or well-being, eudaimonia. And this is a tradition that runs through Socrates, Plato, Aristotle, the Stoics, and it runs on through the medieval philosophers and the Scholastics, Aquinas and so forth; in fact it's the dominant ethical tradition of the first 2,000 years of Western philosophy. It's not until after the end of the Middle Ages that it begins to be whittled away by new theories. And this is the view according to which there is an ultimate good, which usually gets called "happiness" — but that can be somewhat misleading, because it's not a pleasant feeling of satisfaction, although it may involve that — but it's a state of your life objectively going well, your life being an objective success, something like your being successful at living a good human life: that's what eudaimonia is. That's the ultimate good.
And morality is not just an instrumental means to that good; it's actually part of it. Morality stands to the ultimate human good as playing one note stands to playing the whole sonata — or actually, probably as playing two-thirds of the sonata stands to the whole sonata (or if you're a Stoic, as playing the entire sonata stands to playing the entire sonata).
And there are some interesting connections between this tradition and Austrian economics, simply because Austrian economics in a way indirectly grows out of this tradition. The earliest forerunners of Austrian economics are the late Scholastics, who developed a subjective theory of value in the explanatory sense of "subjective," and they developed many of the early theories and early parts of what would later go on, running through the French School, finally to become the Austrian School. And if you look at Rothbard's History of Economic Thought, there's a long section on how cool the Scholastics were. So from the fact that the Scholastics are forerunners of Austrian economics, and the Scholastics are coming at the tail end of this tradition that runs back to Socrates and Aristotle and so forth, I think it's not that surprising that there are some commonalities.
For this tradition means-end analysis is central: we evaluate things in terms of their being means to ends. But each person has an ultimate end. And this ultimate end isn't just feeling satisfied or something like that; it's an objective state of human flourishing. And we can talk about wrong ends as well as wrong means, because those wrong ends are really misidentified constitutive means. So in other words, if you wrongly value something as an end, what's really going on is that you are taking it to be a constitutive part of your ultimate good when it isn't.
Now according to this tradition, why do they say that we have just one ultimate end? Why not say that we have lots, that there are lots of things we want: ice cream, fame, not being killed? We've got all these different things, but why suppose that they're all constituents of some big super-end? Well, I think part of the reason they think this is: what happens when you make trade-offs? Suppose there are two ultimate ends you have: ice cream and fame. Those are two ultimate ends you have, and they come in degrees. (That's why I didn't use not being killed, because that's less a matter of degree.) So you want more ice cream, and you want more fame. And sometimes those go together, like winning an ice-cream-eating contest. But still there are lots of cases where these goals might conflict, and so you have to do trade-offs, and decide between them.
If you're deciding between them, that's an action. Actions have to have a means-end structure, right? So if you're trying to decide how to trade off between ice cream and fame, then doing that must be a means to some end. Well, what is the end? It can't be the end of maximizing the ice cream, because you haven't decided whether that's what you're going to do. It can't be the end of maximizing fame, because you haven't decided that. It can't be the end of getting the maximization of both, because it's a trade-off — that's impossible. Instead, you're trying to maximize something of which these two are parts, some general, overall satisfaction — that's what you're trying to maximize. You might wonder whether "maximize" is even the right word, but anyway you're trying to promote some good that includes both of these intrinsic good; these are intrinsic parts of your overall good. And it's that sort of thing that leads the eudaimonists to think that whenever you're acting, you're always promoting some ultimate good of yours, some ultimate end or aim.
Why not just say that the ultimate aim you're pursuing is some psychological state, like pleasure? We know how John Stuart Mill would have analyses this; he'd say, well, you like ice cream because ice cream isn't really your final end, ice cream promotes pleasure. And you like fame because it also gives you pleasure. And so it's really pleasure that's the ultimate goal, and ice cream and fame are simply means to that. And then your trade-off is just to determine which one will give you the most pleasure.
Or as Mises puts it, Mises talks about getting rid of uneasiness. And sometimes he seems to mean this in a purely formal sense: simply getting something that satisfies you more instead of something that satisfies you less, getting something you prefer over something you "dis-prefer," to use a Stoic term. (Actually to misuse it, in this context.) But sometimes Mises talks as though there's this feeling you get of uneasiness: which of the various things I can choose will make this feeling go away? Getting rid of that horrible feeling of uneasiness is the goal. Sometimes Mises sounds like that, sometimes he doesn't.
At any rate, you might say: why not take that view? Why not say that our ultimate goal is some psychological feeling like pleasure, or decreasing felt uneasiness, or something like that, and that everything else we do is a means to that?
Morality is not just an instrumental means to living a good human life: it's actually part of it. It stands to the ultimate human good as playing one note stands to playing the whole sonata.Well, here's the problem with that view. Suppose I buy life insurance. And you ask me, why am I doing that? And I say: so that my loved ones will do well after my death. So it looks like I'm treating buying life insurance as a means to my loved ones' doing well after my death. Now this is either an ultimate goal of mine, or it's a means to some further goal. Well, whichever one it is, this is not a feeling. And it's also not the cause of a feeling. Unless you're assuming that you're looking down from heaven after you're dead — or up, if things go worse — but anyway you're hanging around after death and seeing your loved ones doing well, and you're getting a charge out of that. But it seems like you don't have to assume that you're actually going to experience your loved ones' doing well in order to buy life insurance. People who don't believe in an afterlife, or people who believe in an afterlife where they're off somewhere not being involved with human concerns, still buy life insurance. So it seems that this is something we do that is not a means to pleasure.
Now obviously someone could say: well, wait a second, you get pleasure out of the thought that your loved ones will do well after your death, right? Yeah, that's true. So here's something, the belief that my loved ones will do well. And that causes pleasure. And maybe that's part of my reason for buying life insurance. But is it really plausible to say it's really that belief rather than their actually doing well? Because one isn't a means to the other. Your loved ones' doing well in the future can't be a cause of your belief that they'll do well now, unless you believe in backward causation. So even if you believe that the belief is part of your goal, there's still the goal of their actually doing well too — unless you think you don't really have that goal at all, you really just have the belief as your goal.
Suppose I offer you a magic pill that costs half the cost of the life insurance. And this magic pill will make you believe that your loved ones will do well after you're dead. And so you can either have the life insurance for $100, or this pill for $50. If all you care about is the belief that your loved ones will do well, then you'd take the pill over the life insurance. Well, from the fact that presumably at least a lot of people would buy the life insurance rather than the pill, that suggests that they care about their loved ones' actually doing well.
And likewise Aristotle thinks that this is naturally the way we think. He raises the question: can people's welfare be affected after they're dead? And he didn't believe in an afterlife, at least not a personal afterlife — he thought there was some aspect of you that lived on, but it wasn't your personal identity — so he wasn't talking about an afterlife. He thought that if there's something you cared about, a loved one or some project, and right after you die the project either succeeded or failed, he thought that would make some difference to how we evaluate the success of your whole life.
So our ultimate good, according to this tradition, is not pleasure — although pleasure's part of it, pleasure's one of the things we care about, relief from felt uneasiness is great, but it's not the only thing that we actually pursue.
Aristotle would say that your life's being an objective success includes the well-being of your friends. It's not that the well-being of your friends causes you some jollies — it does, sure, but that's not all there is to it. In fact, he would say that the welfare of your friends causes you pleasure because it's part of your good, not vice versa — that pleasure is a byproduct of getting what you think is good rather than the opposite.
Rights and UtilityOkay, let me finish up with a largely unrelated question — though it's not completely unrelated, because these all interconnect. The question is about the relation between rights and utility.
The question is whether rights derive from utility — in other words, is the reason that we have rights the fact that rights are a strategy that's most likely to promote either our personal self-interest or social welfare (you can take either an egoistic or a universalistic version of utilitarianism) — is that the ultimate foundation of rights? Or are our rights completely independent of utility? There are those who think that our rights are completely based on utility, that the only grounding for rights is that they somehow are strategies for promoting human welfare, either one's own or everybody's. And in some sense Mises seems to think something like that. On the other hand, you might think rights are completely independent of utility, that rights just are what they are, regardless of their results. Maybe Walter Block thinks that, I'm not sure. Rothbard is often said to have thought that, but if you read The Ethics of Liberty it's not so clear; there is some sort of eudaimonic thing going on in the background there, with the Aristotelian stuff in the early chapters.
I want to end by giving some quick reasons why I think that it's a mistake to think either that rights depend wholly on utility or that rights are wholly independent of utility.
Here's why I think rights can't depend wholly on utility: because whatever we choose, we choose either as an ultimate end or as a means — in economic terms, either as a producer's good or a consumer's good. Either you choose it as some ultimate thing you want for its own sake, or you choose it as a means to producing some further thing. So if any sort of utilitarianism is true, then morality is a producer's good, not a consumer's good. And it's solely a producer's good; I mean, everyone agrees that it's partly a producer's good. Everyone agrees that one of the things about morality that's good is that it has good results. But if you're a utilitarian, you have to think that morality is not a constitutive means to the good, it's simply a purely instrumental means.
Why is that problematic? Well, nearly all sophisticated utilitarians — and this definitely includes Mises — think that it's not a good strategy to promote human welfare to constantly be deciding everything on a case-by-case basis. Most sophisticated utilitarians are some kind of rule-utilitarians, or indirect utilitarians. They think that you have to commit yourself to some general set of principles or values. You can't just decide everything that comes up on a case-by-case basis. The best way to achieve long-term results of the kind you want is to commit yourself to acting in a principled fashion.
"I think that it's a mistake to think either that rights depend wholly on utility or that rights are wholly independent of utility."Here's an example that John Hospers, a former Libertarian Party candidate for President, gives in one of his books. He says: suppose you're an umpire in a game, or a referee, and you're making decisions, making calls — "he's safe," "he's out," — and you suddenly begin to reflect philosophically while you're standing out there, and you think, "What's the purpose? What's my purpose here as a referee? Well, my purpose is to facilitate the game going well. What's the purpose of the game?" And suppose that you conclude that the purpose of the game is to give pleasure to the spectators. I don't know whether that's the right story about the purpose of the game, but suppose that's what you conclude. Then you might conclude: "Well, then, when I give my calls and decide who's safe and who's out, I should make whatever call will be most pleasing to the spectators. And so I won't pay any attention to the actual rules of the game; I'll just consider: is it a home game or an away game? How happy are the people in the stands going to be with my ruling?"
Now this might maximize spectator pleasure in the short run, but soon it'll become obvious that winning or losing in this game no longer depends at all on the skill and abilities of the players. The players can just do any darn thing, and you'll automatically rule in favor of team A if there are more people in the stands favoring team A. Once it turns out that you're ruling in this manner, all the fun's going to go out of the game for the spectators. If you're constantly ruling with an attempt to please the spectators, that's going to end up in the long run making the spectators very unhappy. You're much more likely to please the spectators in the long run if you just stick to the rules of the game.
Likewise, most utilitarians think that you're more likely to promote human welfare in the long run if you stick to definite rules. And libertarian utilitarians think these definite rules include rules of property rights and non-aggression and so forth, that sticking to those in the long run causes more happiness, because people can count on having their rights respected, they're not constantly worried that suddenly their rights are going to be overridden for social utility, and so forth. So they're going to be better off.
So what most utilitarians say is that you should behave as if you valued these rules for their own sake, even though you really value them just for the sake of utility. But my worry is: what does it mean to say that you should value something as if it were valuable for its own sake? I mean, either you value it for its own sake or you don't. If you value it for its own sake, then you'll choose it if it competes with some other value; if you don't value it for its own sake, then you'll give it up if you find some other way of promoting the same goal. If your only reason for respecting rights is to promote social utility, then you'd be irrational not to give up rights in any particular case when you could promote social utility otherwise. So my worry is that this rule-utilitarianism or indirect consequentialism or whatever you want to call it is praxeologically unstable.
However, I also think there are good praxeological reasons not to think that rights are completely independent of utility. And that's because given precisely the view I discussed earlier, according to which whenever you're doing trade-offs between different things, where you've got different ends, you have to regard them as different parts of an overarching end. Well, unless rights are the only thing you care about, the only value you have — and I've sometimes told Walter that that's his view (although it isn't really, but it's fun to say that) — unless rights are the only values you have, then you have to say: here are a bunch of values, there's the content of justice or rights, but there are also these other values, and they all have to fit together. And if all your values have to fit together, then it doesn't really make sense to think that you can sort of separate one off and completely decide it without paying attention to any of the rest of them. I think each part of your value system has to have its content at least responsive to the other parts.
And this is what the Greeks called "unity of virtue." Now people often say that the unity of virtue just means that if you have one virtue, you have to have them all; but I think the real core of the view is that the content of any one virtue is partly determined by, or responsive to, the content of the other virtues. Your account of what justice requires can't be completely independent of your account of what courage requires, or your account of what generosity requires, or your account of any other virtue.
Any insurance involves the pooling of individual risks. Under this arrangement, there are winners and losers. Some of the insured will receive more than they paid in premiums and some will pay more into the system than they ever get back. This is a form of income redistribution from the healthy to the sick, but the characteristic mark of insurance is that no one knows in advance who the winners and losers will be. They are distributed randomly or unpredictably, and the resulting income redistribution within a pool of insured people is unsystematic.
If this were not the case — if it were possible to predict the net winners and losers — the insurance losers would not want to pool their risk with the insurance winners; they would seek to pool their risk with other "losers" at lower premiums.
For example, let's say my insurance provider wanted to pool the injury risk of someone like me, who sits behind a desk all day, with the risk of a professional football player. In that case, we can easily predict that I will end up being a constant loser: hardly anything happens to me, but plenty of accidents will happen to the professional football player, and my premiums would have to cover his significantly higher risk of injury.
Now even if the insured themselves do not recognize that there are systematically predictable winners and losers, free competition in the insurance market would eliminate all systematic redistribution among the insured.Unless of course there is the motive on the part of the insured to subsidize other groups. If I am a fan of football players and do not mind paying a higher premium for their risk, then such a systematic income redistribution can take place. In a free market, any insurance company that engaged in any systematic income redistribution (mixing people with objectively different types of risks into one single group) would be outcompeted by any company that did not engage in this type of practice. Another insurance company might realize that there are people who sit behind desks and rarely fall off their chair and injure themselves. They would recognize that they could profitably offer a lower premium to desk jockeys and insure them in a separate pool from the professional athletes. And by offering lower premiums, they would of course lure away those people who had previously been misinsured. As a result, the various companies that had misgrouped people (by mixing their low-risk clients in the same pool with their high-risk clients) would have to raise the premiums for their higher-risk clients to their naturally higher level.
Competition in the insurance market would lead to ever more-refined subgroupings of people into groups that are internally homogeneous. The discrimination of groups and subgroups would occur according to actual group risks and the premiums for all groups would then reflect the genuine insurance risks for that group, and prices on the average would tend to fall due to competition.
To put an individual client into the right group, the insurer has to discriminate according to various criteria. In the case of flood, hurricane, earthquake, or fire insurance, they would use regional or geographical criteria. They might use biological or genetic characteristics in the case of health insurance. They might use certain behavioral criteria or lifestyles: smokers and non-smokers, people who are occupied in certain occupations that cause greater or smaller risks, and so forth.
The Limitations of InsurabilityAre there certain risks against which we simply cannot insure ourselves? Mises defines events that can be insured against as "risky events" and he uses a definition of what he calls "class probability" to define these risky events:
We know or assume to know, with regard to the problem concerned, everything about the behavior of a whole class of events or phenomena; but about the actual singular events or phenomena we know nothing but that they are elements of this class.Mises, Human Action, Chapter 6, Section 3.
And then he gives some examples. For instance:
We have a complete table of mortality for a definite period of the past in a definite area. If we assume that with regard to mortality no changes will occur, we may say that we know everything about the mortality of the whole population in question. But with regard to the life expectancy of the individuals we do not know anything but that they are members of this class of people.
Another example:
Let us assume that ten tickets, each bearing the name of a different man, are put into a box. One ticket will be drawn, and the man whose name it bears will be liable to pay 100 dollars. Then an insurer can promise to the loser full indemnification if he is in a position to insure each of the ten for a premium of ten dollars. He will collect 100 dollars and will have to pay the same amount to one of the ten. But if he were to insure one only of them at a rate fixed by the calculus, he would embark not upon an insurance business, but upon gambling.
And then he says, concluding:
The characteristic mark of insurance is that it deals with the whole class of events. As we pretend to know everything about the behavior of the whole class, there seems to be no specific risk involved in the conduct of the business.
Neither is there any specific risk in the business of the keeper of a gambling bank or in the enterprise of a lottery. From the point of view of the lottery enterprise the outcome is predictable, provided that all tickets have been sold. If some tickets remain unsold, the enterpriser is in the same position with regard to them as every buyer of a ticket is with regard to the tickets he bought.
Now note again that this definition of what he calls "class probability" implies the absence of any systematic redistribution of income: If I know nothing about any particular person's individual risk except that he is the member of some group with a known group risk, then all redistribution must be random. It implies also that the individual cases that are grouped into one risk pool are homogeneous. Within the group, we cannot tell the difference between one individual and another. This implies also that the actual event comes in the form of an accident — and unpredictable event for the individual.
Now by exclusion we can also approach the complementary questions: What sorts of events are uninsurable? When is the pooling of risks impossible?
An uninsurable risk is one where the following condition holds: If I know with regard to a particular risk some or all of the factors that determine its outcome, then such a thing is no longer accidental; its likelihood can be individually affected, and therefore cannot possibly be insured. Or, to formulate it somewhat differently, everything that is within either full or partial control of an individual actor cannot be insured — cannot be risk-pooled — but falls within the realm of personal or individual responsibility.
Every risk that may be influenced by one's actions is therefore uninsurable; only what is not controllable through individual actions is insurable, and only if there are long-run frequency distributions. And it also holds that if something that was initially not controllable becomes controllable then it would lose its insurability status. With respect to the risk of a natural disaster — floods, hurricanes, earthquakes, fires — insurance is obviously possible. These events are out of an individual's control, and I know nothing about my individual risk except whether or not I am a member of a group that is, as a group, exposed to a certain flood or earthquake or fire risk.
In contrast, take for example the risk of committing suicide. Would it be possible to insure oneself (to pool one's risk with others) against suicide? The answer should be quite obvious: such a thing is not a viable venture for an insurance company. After all, I have full control over whether or not I deliberately kill myself. An insurance company that offered suicide insurance would of course attract potential suicide candidates. I could go there because I want to do my wife a big favor, pay the premium, shoot myself dead, and then my wife will be a millionaire. Insurance companies that would insure such a thing would likely disappear from the market very quickly.
Or take another example. Would it be possible to insure oneself against committing arson — that is against the risk that I will burn down my own house? Again, the answer seems to be clear that any event that I can bring about deliberately (or the likelihood of which I can affect) is, strictly speaking, an uninsurable event. The risk that my house will be set on fire by lightening can be insured against; the risk that I set my house on fire is not an insurable event.
Now take the example of unemployment. As you know, there is something called "unemployment insurance." In the modern world we have invented the art of misnaming things, of applying terms that are completely inappropriate and then trying to fool people into believing that by changing the words, we have changed the nature of things.
Unemployment is an uninsurable risk. I have full control over being employed or not being employed. All I have to do is tell my boss what I really think of him and I will soon be unemployed. On the other hand, I can almost always make sure that I will be employed if I am willing to take drastic wage cuts, for instance. If I were to work for free, I would be employed. So obviously this is not a risk that is insurable. It falls into the realm of individual responsibility.
Here is an example that begins to take us in the direction of the health insurance question: the risk of not feeling good in the morning and not getting out of bed. No insurer could ever cover such a "risk," because people do have at least some control over how they feel in the morning. If I were insured against this risk — paid whenever I don't feel so good — you can be pretty sure I would spend far more time in bed than I currently do.
With respect to all these risks then, I cannot say, "I know nothing about the particular risk except that I am a person and all persons are afflicted by these risks with a certain frequency." In fact I know considerably more about my individual risk, just as you know considerably more about your individual risk.
Take an example where we have at least partial control. Can I insure myself against the risk of making business losses? Obviously not. While I have no direct control over the actions of the buyers and non-buyers of my products (those who do directly determine my profits and losses) I do have some control over my business's success or failure. I have control over my production costs, as well as the kind and quality and price of the product I produce. In fact, I can make losses deliberately if I want to. It would be impossible for me to pool my risk with other business people, as if losses were something like being struck by lightening.
Now with this distinction between accidental events, which are insurable, and events that are uninsurable because individual action can affect their likelihood, what then can we say about the possibility of health insurance?
The first thing we can say is that sickness is insurable only insofar as the health risk for a particular group is purely accidental. Such is the case with certain forms of accident insurance, or even for events such as cancer. But for most health risks, we would have to say that they fall into the province of individual control, and very little in this field is actually insurable. Such risks must be assumed individually and must be paid for out of individual savings.
Now in all recent debate about health insurance and healthcare reform, the fact that certain things are completely uninsurable is rarely if ever mentioned. Mises was the exception. In 1922, well before the current healthcare craze, Mises addressed these issues in his book Socialism. Here is a quote that is highly revealing:
To the intellectual champions of social insurance, and to the politicians and statesmen who enacted it, illness and health appeared as two conditions of the human body sharply separated from each other and always recognizable without difficulty or doubt. Any doctor could diagnose the characteristics of "health." "Illness" was a bodily phenomenon which showed itself independently of human will, and was not susceptible to influence by will.
And then he comments on this by saying:
Now every statement in this theory is false. There is no clearly defined frontier between health and illness. Being ill is not a phenomenon independent of conscious will and of psychic forces working in the subconscious. A man's efficiency is not merely the result of his physical condition; it depends largely on his mind and will. Thus the whole idea of being able to separate, by medical examination, the unfit from the fit and from the malingerers, and those able to work from those unable to work, proves to be untenable. Those who believed that accident and health insurance could be based on completely effective means of ascertaining illnesses and injuries and their consequences were very much mistaken. The destructionist aspect of accident and health insurance lies above all in the fact that such institutions promote accidents and illness, hinder recovery, and very often create, or at any rate intensify and lengthen, the functional disorders which follow illness or accident.
Back to the example I gave before: Assume that we could insure ourselves against not feeling well enough to get out of bed in the morning. You can easily see that this would create a class of malingerers and would discourage people from getting up, regardless of what their physical condition might be.
Now in light of all of this, when we look at the question of health insurance, we would expect that most risks would have to be assumed individually. Insurance (the pooling of risks into groups) would have to be limited to the strictly accidental variety of risks, and even there, individuals can fraudulently bring about apparent "accidents," as is quite frequently the case with workers compensation.
And, of course, insurance companies would have to offer strictly limited coverage: There would be no coverage of newly discovered risks, for instance. There also would be no such thing as "cost plus" — where, for example, my house burns down and I can force the insurance company to build me a bigger house. The insurer would only insure the value of the house up to the value I insured. Under the current system, we see cost-plus all the time in the form of Medicare and Medicaid, where whatever the doctors deem necessary is automatically covered.
Generally, insurance would be in the form of indemnity or cash payments. Some insurers might offer in-kind services at specified, restricted providers or providing facilities, but this option would be less attractive to most customers and to most insurance providers as well.
Any further expansion of insurance in health matters, if it takes place at all, would be severely restricted to cases of very small groups of individuals who, as buyers of individual health maintenance services from a specified provider, are extremely homogeneous. We can imagine, for instance, that people would engage in mutual insurance services if their group can exercise extreme social control. To make sure there are no malingerers included, the members of such a group would have to have very similar outlooks on life.
Now if we look at the present reality of health insurance, we recognize immediately that the current situation has very little if anything to do with what we would expect from a free insurance market. What characterizes the present situation is, first of all, that manifestly different risk groups are grouped together in a joint pool. Furthermore, the current healthcare insurance system covers risks that are, strictly speaking, uninsurable.
To a large extent health insurance has become a form of welfare, the machinery of income redistribution. How has this happened? Insurance regulation.
State Regulation of InsuranceLet me give you some examples of the perversions that have been introduced into the insurance market due to state regulations. Insurance companies in the United States are regulated at both the state and federal level. The number of state regulations alone have risen from a total of 8 mandates in 1965 to close to 1,000 in the early 1990s. I have not looked into the numbers more recently, but I'm sure they go up day by day.
In 49 states, insurance companies are forced to cover treatment against alcoholism, which is obviously something that can be individually affected (or even if we say it cannot be individually effected, we would have to say it does not affect all people in the same way). Nonetheless all insurance companies must offer insurance against alcoholism.In 27 states, they must cover treatment against drug addiction. In other words, people who know that they will never use any addictive drugs nonetheless have to pay through their premiums for people who do make use of and are affected by this particular risk.The coverage of chiropractors is mandatory in 45 states.Podiatrists (foot doctors) in 37 states.Psychologists are covered by mandate in 36 of the states. Again, it should be perfectly clear that the desire to go or not to go to a shrink can be individually affected. I know people who go to shrinks all the time. I myself would never ever enter a shrink's office. Nonetheless, through my health insurance premium I have to pay for the risk of a group that is clearly different from my own risk.In 22 states, the services of social workers have to be included in the coverage and of course are reflected then in the premium.Georgia requires coverage for heart transplants. Now again, heart transplants might certainly be a risk that can be insured against, but it should be perfectly clear that this risk is different for different groups. Some people have a genetic predisposition to heart disease and others don't. You cannot opt out of this type of coverage. You get it whether you are affected by it or not and you have to pay whether you are affected or not.In Illinois, liver transplants have to be included. In Minnesota, hairpieces have to be included. Again it should be pretty clear that different families have different risks of hair loss.Marriage counseling has to be included in California. Pastoral counseling in Vermont,And (very nice) sperm banking in Massachusetts. (If you were to have predicted a state where that had to be covered, Massachusetts would of course have come up pretty soon, I'm sure about that.)In more than a dozen states, insurance may not ask any AIDS related questions. And in Washington DC (again a place where you would expect this) any HIV testing is prohibited for all insurers. That is almost the same as if you could burn your house down first and then retroactively insure yourself against it.In California (again, a not-so-surprising candidate for these sorts of insanities) there can be no discrimination between any genetic traits that distinguish people. For instance, sickle-cell anemia affects mostly black men. Nobody is allowed to investigate this from the outset. Tay-Sachs disease affects mostly Jews, but that cannot be considered when insuring against the risk of the disease. With the advances we make in genetic research, these types of differentiations would become finer and finer as scientific progress is made, but insurance companies are barred from recognizing this type of progress.Now all of these mandates are at best a mixed blessing for the insurance companies. On the one hand, as insurance companies have to cover more and more uninsurable risks, they are continually forced to raise premiums. State regulation lets them get away with these higher prices, because competition from more discriminating insurance providers has been disallowed.
But as prices go up, more and more people drop out of the insurance market altogether. They recognize that most of the risks don't apply to them and they make a rational decision between being "overinsured" at extraordinarily high premiums or uninsured. Keep in mind that in the current discussion about all of these things, there is this constant whining about all the people who are uninsured, without of course emphasizing that to a large extent, this is precisely the effect of the previous interventionist policies.
It is increasingly rational for people to be uninsured.
Of course, dropping out of the insurance market is a risky thing to do, but young healthy people are almost crazy to pay the high premiums that come about from subsidizing all these unhealthy lifestyles and covering risk that they know don't apply to them.
This is a lesson in the logic of interventionism."Interventionism cannot be considered as an economic system destined to stay. It is a method for the transformation of capitalism into socialism by a series of successive steps." Ludwig von Mises, "Middle of the Road Policy Leads to Socialism." The first interventionist act brought about a big mess — insurance premiums always go up because insurers are no longer allowed to discriminate correctly and are even forced to include uninsurable risks. So now the problem arises of more and more people dropping out. For those who remain insured, premiums have to be raised to adjust for the fact that so many are dropping out.
The next step, which we in the United States are on the verge of taking, is to make health insurance compulsory. No More Dropping Out! If this step is taken — compulsory health insurance, with all the other mandates remaining in place — then of course premiums will skyrocket even more than they have in the past.
What then will be the next step? This too can easily be predicted: there must be cost controls imposed. There will be a rebellion on the part of the public, who will say, "The price is out of control! The government has to do something!" But all the government can do is engage in price controls. What happens with price controls? We get tremendous shortages of certain services, as in places like Canada where you can't get certain treatments and there are one- or two-year waits for others.
All healthcare provision will become increasingly politicized: the government will design lists of good diseases for which you do get treatment (such as AIDS, I'm sure) and bad diseases, such as those you get from smoking too much. Those with the bad diseases the government will let die.
Where does all this lead then? Intervention in the insurance market creates an ever-increasing loss of individual responsibility, creates shortsightedness, and creates hazardous risks. Let me give you another quote from Mises, who was extremely farsighted in all of this:
The psychic forces which are active in every living thing, including man, in the form of a will to health and a desire to work, are not independent of social surroundings. Certain circumstances strengthen them; others weaken them. The social environment of an African tribe living by hunting is decidedly calculated to stimulate these forces. The same is true of the quite different environment of the citizens of a capitalist society, based on division of labor and on private property. On the other hand a social order weakens these forces when it promises that if the individual's work is hindered by illness or the effects of a trauma he shall live without work or with little work and suffer no very noticeable reduction in his income. Matters are not so simple as they appear to the naive pathology of the army or prison doctor.
Social insurance has thus made the neurosis of the insured a dangerous public disease. Should the institution be extended and developed the disease will spread. No reform can be of any assistance. We cannot weaken or destroy the will to health without producing illness.
The CartelsLet me add some final remarks on the high prices we have to pay for healthcare. Insurance regulation is only one reason for this mess. There are also the significant problems of the FDA and the AMA.
To repair the healthcare system, we need to abolish the US Food and Drug Administration (FDA) and all bureaus of public health and safety, which require all pharmaceutical products to be licensed by them before they can be marketed. These institutions delay the production and delivery of drugs, raise the costs of production, and thereby cause unnecessarily high prices as well as the unnecessary death and suffering that result from the fact that effective drugs do not appear on the market until many people have died or suffered for many years.See Dale Steinreich, "Playing God at the FDA."
In addition to insurance regulation and pharmaceutical licensing, all welfare states have highly restrictive licensing requirements for medical schools, hospitals, and pharmacies, for medical doctors, and other healthcare personnel. That is to say, the supply of doctors, for instance, is systematically restricted. Like all professions, the medical profession has made the attempt to cartelize the industry — to reduce the supply of doctors and thereby raise the price for medical services. The American Medical Association (AMA) has been more successful in this regard than have other professions. They have engaged in what are basically unionizing policies, the cartelizing of their form of labor.
The tool that the AMA used to create and maintain their labor cartel is government licensing of medical schools. As you know, there is a huge demand for people to attend medical school. Why then are there shortages in the provision of medical education? In an unhampered market, the normal response to such shortages would be the creation of new medical schools. So why don't these shortages disappear? Why are there long lines of people who are declined and cannot go to medical school? The answer is, of course, because the opening of new medical schools has been outlawed.
And who is behind this outlawing of new schools? The same people who even attempt to force existing medical schools not to fill all the open slots they have: the currently established medical doctors.See Dale Steinreich's articles for Mises.org, "100 Years of Medical Robbery," and "Real Medical Freedom." See also Henry Jones, "How Medical Boards Nationalized Health Care." Now by eliminating all licensing requirements for medical schools and for medical doctors, the supply of healthcare products and services would almost instantly rise and prices would generally fall, and in addition a greater variety of healthcare products would appear on the market.
What about the quality of the new supply of products and practitioners? Competing voluntary accreditation agencies would take the place of the compulsory governmental licensing that exists currently, assuming that healthcare providers believe that such accreditation would enhance their reputations, and healthcare seekers believe it would enhance their safety. Doctors would apply to the most restrictive accreditation board whose standards they believe they could meet. Some would apply to the Harvard Medical Accreditation Board, some to the Tennessee Valley Authority Accreditation Board, or whatever it happens to be. Customers would refer to the accreditation or ratings from the boards they most trust for the doctors they can best afford.
For those who believe that consumer safety would be hurt under such an open, competitive system (a free market in healthcare), let me use an analogy. Suppose you were to say, "Look, some people have crummy Chevy cars, which are less safe and less comfortable. This falls short of our goal that all consumers get only the best. Therefore we should insist that all cars live up to the standards of a BMW or a Mercedes." Would we all wind up with the comfort and safety of driving luxury cars? Of course not. Many of us would have to resort to bicycles or go on foot. If all cars had to be luxury cars, very few of us would be able to ride in any sort of car.
With respect to doctors, a similar situation has been put in place. We have basically outlawed all Chevy doctors who focus on the less expensive minor health problems (which is, in fact, all that most people have) and are forced instead to use Mercedes doctors who charge Mercedes prices even for ailments that can be fixed by people with significantly less training.
This article is based on "The Economics of Risk and Insurance," a talk Professor Hoppe gave at Mises University 2004 and 2005, available in MP3.
In this article, J.H. Huebert reviews Richard A. Posner's Catastrophe: Risk and Response.
Volume 20, Number 4 (2006)
The Free Market 26, no. 9 (September 2005)The term "hedonics" is derived from ancient Greek and means "pleasure doctrine." It is also the doctrine which the Bureau of Labor Statistics (BLS) applies when calculating the price indices and for the computation of the real gross domestic product and of productivity.
The idea behind hedonic price index calculation is to incorporate quality changes into prices. This way, a product may be on the market at a higher price, but when the product qualities have augmented more than the price in the eyes of the BLS, it will calculate that the price of this product has actually fallen.
Applying the hedonic technique to a host of goods and services means that even when prices are generally rising, but product improvement is deemed to be larger than the price increases, the calculated inflation rate will fall. With a lower inflation rate, the transformation of nominal gross domestic product (GDP) into real GDP will render a higher result.
Likewise, given a constant labor input, productivity will increase. Hedonics opens the door to producing magical results: a lower inflation rate with generally rising prices, a higher growth rate although the economy may be weaker, and a higher productivity number, though productivity would have been declining without the hedonic imputations.
The BLS felt compelled to incorporate "quality changes" into its calculation of the price statistics in the second half of the 1990s when many new and modified goods and services appeared on the market and studies were launched that suggested that the conventional statistics overestimates the "true inflation rate."
With hedonics, the BLS wants to introduce more "objectivity" into the calculation of price changes, but it needs a human being to determine quality in the first place. Not any new gadget can go through as an improvement of the product. Before determining its inflationary or deflationary price change, there must be a BLS official who has to ponder the problem of whether this new or modified good or service really provides more or less "pleasure" to the user than the chosen reference product.
A product, like a refrigerator, for example, is not just a refrigerator in the view of the BLS. Contrary to the act of use and consumption by the individual and contrary to the fact that one normally buys the whole product and not only a few parts, the BLS calculates price changes on the basis that the refrigerator or a certain TV set or a CD player consist of various different parts or product features.
While the BLS avoids claiming to know exactly how to calculate the pleasure that the whole product renders, the Bureau maintains that it is in a position to determine whether the electrical generator in the fridge has improved or not. This improvement then gets compared with a reference element of the product, as it was earlier on the market. Depending on what the expert decides, the overall product receives a new price from the BLS that is different from the market price of the product.
Quality, so the BLS determined, has many aspects. For this purpose they run a so-called hedonic regression through their computers. Whatever the type of regression that gets applied in order to calculate the "true price," first of all an official from the BLS must determine whether a certain feature constitutes a quality change or not.
Ludwig von Mises observed this problem long ago:
"All methods suggested for a measurement of the changes in the monetary unit’s purchasing power are more or less unwittingly founded on the illusory image of an eternal and immutable being who determines by the application of an immutable standard the quantity of satisfaction which a unit of money conveys to him. It is a poor justification of this ill-thought idea that what is wanted is merely to measure changes in the purchasing power of money."
The company, which offers the new or modified product, will be happy to say that there is an improvement, and the technicians, who developed the product, will be eager to provide exact calculations of this quality change. However, how many technical improvements are being offered every day and there is no market for them? How many inventors have patents that are registered but there are only a few or no buyers at all for the product?
The crucial point here is that only pseudo-standards are available for evaluation, the assessment of the utility of a product is subjective and individual, and for the individual himself, the standards of evaluation change according to the specific situation.
It is quite obvious that hedonic imputations open the way to all kinds of manipulation. Given the implicit pressure that governments and central banks want to hear low inflation rates reported, due delivery would suggest to search mainly for quality improvements, and to calculate these even when they are of a dubious nature.
The impact of the techniques that get applied by the BLS reaches far beyond pure price statistics. The indices are not only used as indicators of price inflation, but with the price indices the statistician holds in his hands the key to a series of other prominent economic figures. In order to calculate productivity, real output, real input, and real investment and their changes, one needs a deflator, and a deflator is derived from the price index.
Given a certain nominal GDP (in dollars or any other currency unit), the number for the deflator determines the size of real GDP and its real growth rate. If the measured inflation rate is low, the real GDP will be higher and vice versa, and along with that one also gets higher or lower numbers for productivity changes.
Determining price changes for a modern economy characterized by the modification of products, the emergence of new products, and a high share of services, the calculation of the price index and thus of real economic growth and a series of other indicators becomes a dubious statistical construct. Different assumptions and techniques bring about dramatic changes of results.
Most of what appears like an objective standard of measurement in economic statistics is a deeply flawed endeavor to measure the non-measurable. As the price statistician must admit, there is no meaningful way to measure the "price level." At best, it is changes of the price level that can be constructed. But even with these changes, the measurement is flawed, because one cannot measure something, when both the measurement rod and the object of measurement are subject to change.
The price statistician constructs a basket of products in order to measure the changes of the value of money. He claims that this basket is representative. But he cannot ignore the fact that the composition of this basket changes over time. Some products become obsolete, other products get modified and new goods and services appear. So he will change the composition of the basket. By this procedure, however, he implicitly changes also the units of measurement.
It was this problem, after all, that caused the headaches at the BLS. Therefore it resorted to the hedonic technique as a way to make the basket "constant." The current endeavors of the statistical bureau are directed at constructing a basket, which is not just representative, but also constant in terms of quality or rather in terms of the pleasure the product gives to the consumer. However, no sophistication can surmount the principle barrier that the claim of being "representative" or that of determining what is an improvement can be settled in an objective way.
Economists call the unnoticed effect of monetary changes on prices the "money illusion." Likewise one may call the price index a "statistical illusion" based on the chimera of a fixed basket of products as the unit of measurement. Both illusions consist in taking something as stable that is not constant. In both cases, no correct measurement and no solid assessment occur.
The published inflation rate along with the derived numbers for real economic growth and productivity get utmost attention, while the dubious nature of these figures is widely ignored.
In order to measure something one needs a constant measuring rod. One cannot measure something in a meaningful sense when both are variables: the price changes as the object of measurement and the goods basket as the meter.
The problem with the price index is that both do change: the composition of the individual basket of goods changes and the quantity of money.
The urge to measure the "price level" appeared after the demise of the gold standard. Under the gold standard, money was fairly stable, at least to a degree that allowed individuals and business to perform sound economic calculation. With the abandonment of the gold standard, the necessity emerged to "measure" the purchasing power of money.
With money now as the variable, a "representative" basket of products was said to serve as the measuring rod. The BLS felt rightly so that the traditional way of calculating the price index was flawed. Now they use hedonics. However, the critique against measuring the non-measurable as put forth by Ludwig von Mises still holds that the "notion of stability and stabilization are empty if they do not refer to a state of rigidity and its preservation."
Who needs these statistics anyway other than governments and central banks that claim to be in charge of "the economy," and the econometricians and prognosticators who build their models on these numbers? The consumer himself will judge to his best knowledge and preferences whether he likes the product or not. With respect to its price, he will decide to buy or to abstain. Companies may use "hedonics" and other techniques as long as they are based on technical criteria. But it is something quite different when the statistics are said to measure the overall economy and its performance, and to measure the so-called price level and the value of money.
Governments want the best available figures for the economy as a whole, for such indicators as real economic growth and productivity. If the government asks for it, the statisticians can deliver. However, what is published as the number for inflation is a highly crude number at best and a very deceiving one at worst. When taken naïvely at its face value, the inflation rate as it gets published not only distorts policy decisions, but also those of the private investor.
Antony P. Mueller is a professor of economics at the University of Caxias do Sul in Brazil and an adjunct scholar of the Ludwig von Mises Institute (antonymueller@yahoo.com).
Insights and ExaggerationsEconomists of the Austrian school put special emphasis on subjectivism. This article reviews why subjectivist insights are important, but it also warns against exaggerations. The latter part, while briefer, particularly warrants attention in Austrian circles.
Various writers define subjectivism in ways that, though not necessarily inconsistent, do seem quite different. Empirical concepts (as opposed to mathematical concepts, like “triangle”) necessarily have an “open texture” (Waismann 1965). An open-textured concept just cannot be defined so precisely and comprehensively as to rule out the possibility of an unforeseen situation or case or example that would require modifying the previously framed definition. I feel no duty, then, to start with a definition. Instead, the meaning of subjectivism will emerge from the topics covered and from contrasts with non-subjectivist attitudes.
Materialism versus Subjectivism in PolicySubjectivist insights contribute to positive economics—to understanding how the world works (or would work with circumstances changed in specified ways). They do not bear primarily on policy. As an expository device, however, it is convenient to begin by considering subjectivism being applied—or being ignored—in policymaking.
Perhaps the broadest subjectivist insight is that economics deals with human choices and actions, not with mechanistically dependable relations. The economy is no machine whose “structure” can be ascertained and manipulated with warranted confidence. Economics knows nothing comparable to Avogadro’s number, atomic weights and numbers, the speed of light in a vacuum, and similar constants of nature (Mises 1963, p. 55). Or if such constants do exist, an economist could earn a great reputation by demonstrating a few of them. No amount of cleverness with econometrics can make the nonexistent exist after all.
One reason why no enduring “structural parameters” characterize the economic system is that the way people behave in markets, as in other aspects of life, depends on their experiences and expectations and on what doctrines they have come to believe. (Here is one area of overlap between Austrian economics and the rational-expectations school currently, or recently, in fashion.)
The circumstances mentioned are inherently changeable. One implication warns against policies whose success presupposes unrealistic kinds of degrees of knowledge. It warns against overambition in attempting detailed central control of economic life.
Subjectivist economics points out, for example, what is lost when policy makes simplistic distinctions between necessities and luxuries or when, unlike voluntary transactions, policy fails to take account of subtle differences between the circumstances and tastes of different people. (My discussion passes over personal rights, not because they are unimportant but only because my present topic is, after all, rather different.)
Examples abound, in Third World countries and elsewhere, of attempts to conserve scarce foreign-exchange earnings for “essentials” by exchange controls, multiple exchange rates, import quotas, and selective import duties designed to limit or penalize the waste of foreign exchange on “luxury” imports and other “nonessential” uses.
The arguments offered for such controls, like arguments for consumer rationing in wartime, are not always sheer nonsense. But subjectivist considerations severely qualify them. It is impossible to make and implement a clear distinction between luxuries and essentials. Suppose that a government tightly rations foreign exchange for pleasure cruises and travel abroad but classifies oil as an essential import. Some of the oil may go for heating at domestic resorts operating on a larger scale than if the cruises had not been restricted. The restrictions may in effect divert factors of production from other activities into providing recreation otherwise obtainable at lower cost through foreign travel. Because of poor climate at home, it may well be that the marginal units of foreign exchange spent on imported oil go to satisfy wants of the same general sort—while satisfying them less effectively—as wants otherwise satisfied by foreign travel. Restricting travel and supposedly nonessential imports is likely to promote imports of their substitutes and also divert domestic and imported resources or materials into home production of substitutes. The diversions may also impede exports that earn foreign exchange.
It is particularly dubious to try to distinguish between essential and frivolous imports according to whether they serve production (or “economic growth”) or mere consumption. All production supposedly aims at satisfying human wants, immediately or ultimately. Producing machinery or building factories is no more inherently worthy than producing restaurant meals or nightclub entertainment, for the machinery or factories are pointless unless they can sooner or later yield goods or services that do satisfy human wants. To favor production-oriented (or export-oriented) imports over consumption-oriented imports is to prefer a roundabout achievement of ultimate consumer satisfactions to their more direct achievement merely because of the greater roundaboutness. It is to confuse ends and means.
People obtain their satisfactions in highly diverse ways (even altruistic ways). Some policymakers evidently do not understand how the price system brings into play the dispersed knowledge that people have about their own tastes and circumstances. A journalist illustrated such misunderstanding when badgering Alan Greenspan, then Chairman of the Council of Economic Advisers, with questions about whether business firms would continue producing essential goods when frivolous goods happened to be more profitable. As Greenspan properly replied (in Mitchell 1974, pp. 74-76), people differ widely in their tastes. Some choose to buy extraordinary things and deliberately deprive themselves of other things generally counted as necessities.
One might conceivably—which is not to say conclusively—urge controls as correctives for specific market distortions. Barring such identified distortions, the idea naturally occurs to subjectivist economists of letting ultimate consumers appraise “essentiality.” Sweeping philosophical comparisons are unnecessary. People can act on their own comparisons of the satisfactions they expect from additional dollar’s worths of this and that. Consumers and businessmen can judge and act on the intensities of the wants that various goods can satisfy, either directly or by contributing to further processes of production.
Standard theoretical reservations about this suggestion—standard arguments for government discriminations in favor of some and against other particular goods and services—invoke the concepts of externalities, of merit wants and goods, and of income redistribution. Yet how can policymakers be confident that supposed externalities are genuine and important, that supposed merit wants really deserve cultivation, or that discriminating among goods will accomplish the desired redistribution of real income? Any one of many goods, considered by itself, might seem deserving of special favor; yet how relatively deserving different goods are may remain highly uncertain, particularly when no one knows just how severely the diversion of resources into particular lines of production will impair production in other lines that might even be more meritorious by the policymaker’s criteria. (Tunnel vision is a failing of policymakers not thoroughly familiar with the idea of general economic interdependence.)
More fundamentally, particular goods do not possess qualities deserving special consideration globally, or by their very nature. On the contrary, usefulness or desirability is a relation between things and human wants. The usefulness of something—specifically, its marginal utility—is the smaller the more abundant the thing is. Ideally, decisions about adjusting quantities of various things should consider their usefulness at the margin. It is easy to imagine circumstances in which an additional dollar’s worth or an additional ounce of penicillin or polio vaccine would contribute less to human satisfaction than an additional unit of orchids.
The concept of priorities does not properly apply in the contexts considered here. For the reasons mentioned, and also in view of how the political process works and of ample experience with controls, it is unrealistic to expect the government to choose “social priorities” reasonably. Consider, for example, the botch of energy policy, including the long record of subsidizing energy consumption in travel and transport (through the underpricing of road and airport facilities) and also including tax exemptions and subsidized loans granted to rural electric cooperatives, even while government officials plead for energy conservation.
Policies adopted or advocated during the energy crises of 1974 and 1979 betray ignorance of subjectivist insights. Examples are rationing of gasoline not so much by price as by the inconvenience and apprehension of having to hunt around for it and wait in long lines to buy it, or being allowed to buy gasoline only on odd- or even-numbered days according to one’s license-plate number. A former chairman of Inland Steel Company (Joseph L. Block in Committee for Economic Development in 1974, pp. 79-80) suggested requiring each car owner to choose one day of the week when he would be forbidden to drive. That prohibition, enforced with appropriate stickers, would supposedly have eliminated some needless driving and encouraged use of public transportation. Another example was a decision by the California Public Utilities Commission banning natural-gas heating of new swimming pools (Charlottesville, Daily Progress, 29 February 1976, p. E11).
Such measures and proposals underrate the value of freedom and flexibility. Arbitrary measures burden some people lightly and others heavily because different people’s lives afford different scopes of substituting away from the restricted consumption and make advance scheduling of activities difficult and unrestricted flexibility important in widely differing degrees. In unrestricted voluntary transactions, by contrast, people can allow for such differences.
A narrowly technological outlook is often linked with puritanical moralizing. (I am reminded of my maternal grandmother, who used to bewail the waste of using a teabag only once if it could be made to serve twice and of using and washing a large plate if the food could be crammed onto a small plate.) Recovery techniques left too much oil and gas in the ground, natural gas on the continental shelf was flared, and the prevailing practice in coal mining left half of a seam in the ground merely because it was needed there as a supporting column or because getting it all out was too expensive—so went one complaint (Freeman 1974, pp. 230-232). Energy has been wasted by “too little” insulation of buildings.
Yet so-called waste was probably sensible at the lower energy prices of the past. There can be such a thing as too much conservation; for example, producing aluminum for storm windows installed under tax incentives even consumes energy in other directions. Ample heat and air conditioning brought comfort, and fast driving saved valuable time. Not having to concentrate on ferreting out ways to conserve energy saved mental capacity for other purposes. Now, at today’s higher prices, a dollar spent on energy no longer buys as much comfort or saves as much time or thought as before; and people respond accordingly. Conceivably, of course, the energy prices of the past, distorted downward by interventions, may have led people to consume more energy than they would have done at free-market prices; but if so, the specific distortions should have been identified and addressed. Moralizing about ways of consuming less was off the track.
Such moralizing almost regards waste as something perpetrated only with material resources, not with people’s time or comfort or peace of mind. Ironically, this strand of materialism sometimes occurs among people who announce Galbraithian scorn for the alleged materialism of the affluent society. Another apparent strand sometimes found in the attitude of such people is selfcongratulation on heroic hard-headedness in recognizing necessary austerities. (Speaking at a conference in Beverly Hills on 26 April 1975, Senator Gaylord Nelson welcomed the challenge of helping to create the new and simpler lifestyles of the future.)
Materialistic energy-conservation proposals illustrate a kind of thinking related to what F.A. Hayek (1952) has called scientism. It is something quite different from science or the scientific outlook. A full definition is unnecessary here, but one aspect is the feeling that results somehow do not count unless they have been deliberately arranged for. A person with the scientistic attitude does not understand how millions of persons and companies, trading freely among themselves, can express and arrange for satisfying the wants they themselves consider most intense. He does not appreciate self-adjusting processes, like someone’s decision to forgo a gas-heated swimming pool, or any pool at all, in view of the prices to be paid. He assumes that a grandmotherly state must take charge, and he performs feats of routine originality in thinking of new ways for it to do so—as by requiring that cars get 30 miles to the gallon, by imposing standards for building insulation, or by banning pilot lights in gas appliances. Tax gimmicks and ideas are a dime a dozen—incentives for storm windows and solar heating and the plowback of profits into oilfield development and what not. The current, or recent, vogue for partial national economic planning under the name of “industrial policy” provides further examples.
Subjectivist insights illuminate the issue of the military draft. (For early discussions by University of Virginia Ph.D. graduates and graduate students, see Miller 1968.) Many persons have advocated the draft on the grounds that an all-volunteer force is too costly. They understand cost in an excessively materialistic and accounting-oriented way. In truth, costs are subjective— unpleasantnesses incurred and satisfactions forgone—in keeping down monetary outlays, the draft conceals part of the costs and shifts it from the taxpayers being defended to the draftees compelled to serve at wages inadequate to obtain their voluntary service. Furthermore, the draft increases total costs through inefficiency. It imposes unnecessarily large costs on draftees who find military life particularly unpleasant or whose foreclosed civilian pursuits are particularly rewarding to themselves and others. At the same time it wastes opportunities to obtain relatively low-cost service, meaning service at costs subjectively appraised as relatively low, from men who happen to escape the draft but would have been willing to serve at wages below those necessary to obtain voluntary service from men in fact drafted. The opposite method—recruiting the desired number of service men and women by offering wages adequate to attract them as volunteers—brings to bear the knowledge that people themselves have of their own abilities, inclinations, and alternative opportunities. So doing, the market-oriented method holds down the true, subjectively assessed, costs of staffing the armed forces. (Of course, considerations in addition to these also figure in the case against the military draft.)
Subjectivist insights help one understand why compensation at actual market value for property seized under eminent domain probably will not leave the former owner as well off as he had been. His having continued to hold the property instead of having already sold it suggests that he valued it more highly than the sales proceeds or other property purchasable with those proceeds.
Neglect of subjectivism is central to the fallacy of “comparable worth.” According to that doctrine, currently fashionable among feminists and interventionists, the worth of work performed in different jobs can be objectively ascertained and compared. People performing different jobs that are nevertheless judged alike, on balance, in their arduousness or pleasantness, their requirements in ability and training, the degrees of responsibility involved, and other supposedly ascertainable characteristics should receive the same pay; and government, presumably, should enforce equal pay. Formulas should replace wage-setting by voluntary agreements reached under the influences of supply and demand.
This idea ducks the questions of how to ration jobs sought especially eagerly at their formula-determined wages and how to prod people into jobs that would otherwise go unfilled at such wages. It ducks the questions of what kind of economic system and what kind of society would take the place of the freemarket system, with its processes of coordinating decentralized voluntary activities. (Though writing before comparable worth became a prominent issue, Hayek, 1960, chapter 6, aptly warned against displacing market processes by nonmarket assessments of entitlements to incomes.) The comparable-worth doctrine neglects the ineffable individual circumstances and subjective feelings that enter into workers’ decisions to seek or avoid particular jobs, employers’ efforts to fill them, and consumers’ demands for the goods and services produced in them. Yet wages and prices set through market processes do take account of individual circumstances and personal feelings (a point I’ll say more about later on).
Subjectivist economists recognize the importance of intangible assets, including knowledge, a kind of “human capital.” They recognize the scope for ingenuity in getting around government controls of various kinds, whereas the layman’s tacit case for controls involves a mechanistic conception of the reality to be manipulated, without due appreciation of human flexibility. Controls, and responses to them, destroy human capital by artificially hastening the obsolescence of knowledge; they impose the costs of keeping abreast of the artificially changing scene and divert material and intellectual resources, including inventiveness, from productive employments. Credit-allocation measures and other controls on financial institutions, for example—even reserve requirements and interestrate ceilings—have bred innovations to circumvent them. Managers have to be trained and other start-up costs borne for new institutions and practices, and customers must spend time and trouble learning about them. Price and wage controls and energy-conservation rules provide further illustrations of such wastes.
Arbitrariness and unfairness figure among the costs of controls intended to buck market forces. As controls become more comprehensive and complex, their administrators are less able to base their decisions on relatively objective criteria. Bureaucratic rules become more necessary and decisions based on incomplete information less avoidable. Multiplication of categories entitled to special treatment invites the pleading of special interests. Even morality, another intangible asset, is eroded.
The complexity of detailed monitoring and enforcement suggests appealing for voluntary compliance, compliance with the spirit and not just the letter of the regulations. (Controls over foreign trade and payments for balance-of-payments purposes, such as President Johnson attempted in the mid-1960s, provide still further examples; see Yeager 1965.) Whether compliance is avowedly voluntary, or whether ease of evasion makes compliance voluntary in effect, such an approach tends to penalize public-spirited citizens who do comply and gives the advantage to others. Exhorting people to act against their own economic interest tends to undercut the signaling and motivating functions of prices. How are people to know, then, when it is proper and when improper to pursue economic gain? To exhort people to think of compliance as in their own interest when it plainly is not, or to call for self-sacrifice as if it were the essence of morality, is to undercut the rational basis of morality and even undercut rationality itself.
A kind of perverse selection results. Public-spirited car owners who heed appeals for restraint in driving thereby leave more gasoline available, and at a lower price than otherwise, to less public-spirited drivers. Sellers who do comply with price ceilings or guidelines must consequently turn away some customers unsatisfied, to the profit of black-marketeers and other less scrupulous sellers. Eventually such effects become evident, strengthening the idea that morality is for suckers and dupes.
Subjectivists know better than to erect efficiency, somehow conceived, into the overriding criterion either of particular processes or institutions or of entire economic systems. The principle of comparative advantage discredits the idea that each product should necessarily be produced wherever it can be produced most efficiently in the technological sense. No presumption holds, furthermore, that any particular line of production necessarily should be carried on in the technologically most advanced way; for the resources required in such production are demanded by other industries also, where they may well contribute more at the margin to consumer satisfactions, as judged by what consumers are willing to pay.
Efficiency in the sense of Pareto optimality is often taken as a criterion of policy. Pareto efficiency is indeed a useful concept in the teaching and study of microeconomic theory. It is useful in contemplating outcomes of the market process in the form of particular—but abstractly conceived—allocations of resources and goods. Economists seldom if ever face an occasion or opportunity to appraise concrete, specific allocations, in the real world. As Rutledge Vining properly emphasizes, legislators and their expert advisors necessarily are choosing among alternative sets of legal and institutional constraints rather than among alternative specific results or allocations. (See Vining 1985 and Yeager 1978.) Such constraints are rules of the game within which people strive to make the most of their opportunities amidst ceaseless change in wants, resources, and technology. The very point of having rules and institutions presupposes their having a certain stability and dependability, which would be undermined by continual efforts to make supposedly optimal changes in them.
What is useful in policy discussions, then, is not the supposed benchmark of Pareto efficiency but rather comparison of what alternative sets of rules add up to in terms of alternative economic and social systems. If we must have a standard against which to appraise reality, we might well adopt the view of a competitive market economy as a collection of institutions and practices for gathering and transmitting information and incentives concerning not-yet-exhausted opportunities for gains from trade (including “trade with nature” through production or rearrangements of production).
Knowledge and CoordinationSubjectivists recognize the many kinds of information that market prices and processes bring to bear on decisions about production and consumption. These kinds include what F.A. Hayek (1945) called “knowledge of the particular circumstances of time and place,” knowledge that could hardly be codified in textbooks or assembled for the use of central planners, knowledge that can be used, if at all, only by numerous individual “men on the spot.” It includes knowledge about all sorts of details of running business firms, including knowledge of fleeting local conditions. It includes what people know about their own tastes and particular circumstances as consumers, workers, savers, and investors. Subjectivist economists recognize how such factors not only underlie the prices that consumers are prepared to pay for goods but also underlie costs of production.
Each consumer decides how much of each particular good to buy in view of the price of the good itself, the prices of other goods, his income and wealth, and his own needs and preferences. Subject to qualifications about how possible and how worthwhile precise calculation seems, he leaves no opportunity unexploited to increase his total satisfaction by diverting a dollar from one purchase to another. Under competition, the price of each good tends to express the total of the prices of the additional inputs necessary to supply an additional unit of that good. These resource prices tend, in turn, to measure the values of other marginal outputs sacrificed by diversion of resources away from their production. Prices therefore tell the consumer how much worth of other production must be foregone to supply him with each particular good. The money values of forgone alternative production tend, in turn, to reflect consumer satisfactions expectedly obtainable from that foregone production. (I say “reflect”—take account of—in order not to claim anything about actual measurement of what is inherently unmeasurable. I speak only of tendencies, furthermore, for markets never fully reach competitive general equilibrium.)
With prices bringing to their attention the terms of choice posed by the objective realities of production possibilities and the subjective realities of other persons’ preferences, consumers choose the patterns of production and resource use that they prefer. Their bidding tends to keep any unit of a resource from going to meet a less intense willingness to pay for its productive contribution (and thus the denial of a more intense willingness). Ideally—in competitive equilibrium, and subject to qualifications still to be mentioned—no opportunity remains unexploited to increase the total value of things produced by transferring a unit of any resource from one use to another. Changes in technology and consumer preferences always keep creating such opportunities afresh, but the profit motive keeps prodding businessmen to ferret them out and exploit them.
To determine how resources go into producing what things in what quantities, consumers need freedom to spend their incomes as they wish, unregimented by actual rationing. But they need more: opportunities to make choices at unrigged prices tending to reflect true production alternatives.
We could speak then of “consumers’ sovereignty,” but the term is a bit narrow. Insofar as their abilities permit, people can bring their preferences among occupations as well as among consumer goods to bear on the pattern of production. In fact, investors’ preferences, including notions about the morality and the glamor of different industries and companies, also have some influence; and we might speak of “investors’ sovereignty” as well. (See Rothbard 1962, p. 452, n. 12, and pp. 560-562 on what Rothbard calls “individual sovereignty.”)
Suppose that many people craved being actors strongly enough to accept wages below those paid in other jobs requiring similar levels of ability and training. This willingness would help keep down the cost of producing plays, and cheap tickets would draw audiences, maintaining jobs in the theater. Suppose, in contrast, that almost everyone hated to mine coal. The high wages needed to attract miners would enter into the production cost and price of coal, signaling power companies to build hydroelectric or nuclear or oil-burning rather than coal-burning plants and signaling consumers to live in warmer climates or smaller or better-insulated houses than they would do if fuel were cheaper. Such responses would hold down the number of distasteful mining jobs to be filled. The few workers still doing that work would be ones whose distaste for it was relatively mild and capable of being assuaged by high wages.
No profound distinction holds between workers’ sovereignty and consumers’ sovereignty or between getting satisfactions or avoiding dissatisfactions in choosing what work to do and in choosing what goods to consume. Consumer goods are not ultimate ends in themselves but just particular means of obtaining satisfactions or avoiding dissatisfactions. People make their personal tastes and circumstances count by how they act on the markets for labor and goods alike.
Our broadened concept of consumers’ and workers’ sovereignty by no means upsets the idea of opportunity cost. We need only recognize that people choose not simply among commodities but rather among packages of satisfactions and dissatisfactions. The choice between additional amounts of A and B is really a choice between satisfactions gained and dissatisfactions avoided by people as consumers and producers of A and satisfactions gained and dissatisfactions avoided by people as consumers and producers of B. Choosing package A costs forgoing package B. Ideally, the prices of products A and B indicate the terms of exchange, so to speak, between the entire combinations of satisfactions gained and dissatisfactions avoided at the relevant margins in connection with the two products. Prices reflect intimately personal circumstances and feelings as well as physical or technological conditions of production and consumption.
None of this amounts to claiming that different persons’ feelings about goods and jobs (and investment opportunities) can be accurately measured and compared in terms of price or in any other definite way. However, people’s feelings do count in the ways that their choices are expressed and their activities coordinated through the price system, and changes in their feelings do affect the pattern of production in directions that make intuitively good sense.
Clearly, then, economic theory need not assume that people act exclusively or even primarily from materialistic motives. Pecuniary considerations come into play, but along with others. As the laws of supply and demand describe, an increase in the pecuniary rewards or charges—or other rewards or costs— attached to some activity will increase or decrease its chosen level, other incentives and disincentives remaining unchanged. Money prices and changes in them can thus influence behavior and promote coordination of the chosen behaviors of different people, even though pecuniary considerations do not carry decisive weight and perhaps not even preponderant weight.
Value TheoryThe role of subjectivism in solving the diamond-and-water paradox, replacing the labor theory or other real-cost theories of value, and accomplishing the marginalist revolution of the 1870s, is too well known to require more than a bare reminder here. Subjectivism must be distinguished from importing psychology into economics (Mises 1963, pp. 122-127, 486-488). Diminishing marginal utility is a principle of sensible management rather than of psychology: a person will apply a limited amount of some good (grain, say, as in Menger 1950, pp. 129-130) to what he considers its most important uses, and a larger and larger amount will permit its application to successively less important uses also.
Subjectivists do not commit the error of John Ruskin, who thought that “Whenever material gain follows exchange, for every plus there is a precisely equal minus” (quoted in Shand 1984, p. 120). They recognize that wealth is produced not only by physically shaping things or growing them but also by exchanging them. In the words of Henry George (1898/1941, pp. 331-332), who independently achieved several Austrian insights, “Each of the two parties to an exchange . . . [gets] something that is more valuable to him than what he gives. . . . Thus there is in the transaction an actual increase in the sum of wealth, an actual production of wealth.”
Subjectivists recognize nonmaterial elements in costs as well as demands. Every price is determined by many circumstances classifiable under the headings of “subjective factors” and “objective factors” (or “wants” and “resources and technology”). An alternative classification distinguishes between demand factors and supply factors. This alternative is not equivalent to the first classification because there is no reason to suppose that subjective factors operate only on the demand side of a market while objective factors dominate the supply side.
On the contrary, subjective factors operate on both sides. The supply schedule of a good does not reflect merely the quantities of inputs technologically required for various amounts of output, together with given prices of the inputs. The input prices are themselves variables determined by bidding among various firms and lines of production in the light of the inputs’ capabilities to contribute to producing goods valued by consumers. Consumers’ subjective feelings about other goods thus enter into determining the money costs of supplying quantities of any particular product.
Subjective factors operate in both blades of Marshall’s scissors. (Misleadingly, Marshall 1920, pp. 348, 813ff., had referred to a utility blade and a cost blade, as if utility and cost were quite distinct.)
By the logic of a price system, then, money cost brings to the attention of persons deciding on production processes and output volumes in any particular line—and ultimately to the attention of its consumers—what conditions prevail in all other sectors of the economy, including persons’ attitudes toward goods and employments. Money prices and costs convey information about subjective conditions outside the direct ken of particular decisionmakers.
At this point the subjectivism of Austrian economists reinforces their awareness of general economic interdependence and their concern with coordination among the plans and actions of different people. They are wary (as many textbook writers seem not to be) of focusing so narrowly on the choices of the individual household and individual firm as to detract attention from the big picture.
Recognizing the subjective aspects of cost, we gain insights into the dubiousness of expecting prices to correspond to costs in any precise way. Costs represent values of forgone alternatives: costs are intimately linked with acts of choice.
Cost curves are no more objectively given to business firms than are demand curves for their products. A large part of the task of entrepreneurs and managers is to learn what the cost (and demand) curves are and to press the cost curves down, so to speak, through inspired innovations in technology, organization, purchasing, and marketing. Outsiders are in a poor position to second-guess their decisions.
Subjectivists appreciate the role of expectations. Well before the recent vogue of “rational expectations” in macroeconomics, Ludwig von Mises (1953/1981, pp. 459-460) recognized that an inflationary policy could not go on indefinitely giving real “stimulus” to an economy; people would catch on to what was happening, and the supposed stimulus would dissipate itself in price increases. Von Mises also argued (1963, p. 586) that disorders such as the corn-hog cycle would be self-corrective. Unless the government protected farmers from the consequences of unperceptive or unintelligent behavior, farmers would learn about the cycle, if it did in fact occur; and by anticipating it would forestall it. (Those who did not learn would incur losses and be eliminated from the market.)
Much expressed nowadays are notions such as “the market’s” expectation of some future magnitude—the dollar-mark exchange rate in three months, or whatever. Subjectivists are skeptical. They understand that “the market” does not form expectations or change light bulbs (“How many right-wing economists does it take to change a light bulb?”) or do anything else. People do, people acting and interacting on markets. Since expectations are formed by people, they are understandably loose, diverse, and changeable.
All this intertwines with the inherent unpredictability of future human affairs. It is not even possible to make an exhaustive list of all possible outcomes of some decision, let alone attach probability scores to outcomes (Shackle 1972, especially p. 22). Policymakers should take this point to heart and restrain their optimism about being able to control events.
This is not to deny that some predictions can be made with warranted confidence, notably the if-this-then-that predictions of economic theory and of science in general. Foretelling the future is quite another matter. Economists, like other people, have only limited time and energy. It is reasonable for each one to stick to work exploiting his own comparative advantages and hunches about fruitfulness and not let himself be badgered into foretelling the unforetellable.
Further Policy ImplicationsThe ultrasubjectivist view of cost put forward by James Buchanan (1969) and writers in the London School tradition (some of whose articles are reprinted in Buchanan and Thirlby 1981) has been largely adopted by Austrian economists (Vaughn 1980 and 1981, Seldon 1981).
In examining this view, we must avoid false presuppositions about how words relate to things. It is not true that each word has a single definite and unequivocal meaning and that it labels a specific thing or action or relation objectively existing in the real world. On the contrary, many words have wide ranges of meaning. One way to learn what writers mean by a word is to see what implications they draw from propositions containing it.
This is true of “cost” as interpreted by Buchanan and the London economists. Those writers associate particular policy positions with the fuzziness that they attribute to cost. They heap scorn on cost-oriented rules for managing enterprises.
Advocates of such rules typically attribute important welfare properties to them. Probably the most prominent such rule is the one requiring the output of an enterprise to be set at such a level that price equals marginal costs. (In the same general cost-oriented family, however, would be rules like the one that total revenue should just cover total cost.) One strand of argument for socialism, in fact, is that socialized enterprises could be made to follow such rules, unlike unregulated private enterprises. Even under capitalism, such rules supposedly might be useful in the framing of antimonopoly policy and the regulation of public utilities. They might also figure in other government economic interventions and in the simulation of market results in nonmarket settings, as in tort settlements.
The case for socialism and milder government economic interventions can be weakened, then, by discrediting the measurability and even the conceptual definiteness of “cost.” This, I conjecture, is a clue to the ultrasubjectivist view of the concept. “Cost,” says Buchanan (1969, pp. 42-43), “is that which the decisionmaker sacrifices or gives up when he makes a choice. It consists in his own evaluation of the enjoyment or utility that he anticipates having to forego as a result of selection among alternative courses of action.” If cost can thus be portrayed as a thoroughly subjective concept or magnitude, if no one but the individual decisionmaker (entrepreneur or manager) can know what cost is or was, and if such knowledge is ineffable and practically incommunicable, then no outside authority can reasonably impose cost-oriented rules on him. The case for displacing or overriding the market dissolves.
This line of argument has merit. In particular, as already observed, cost curves do not objectively exist. Instead, business decisionmakers have the task of discovering or inventing them and modifying them by happy innovations. Unfortunately, as a later section of this article shows, Buchanan and the London economists carry their subjectivist line too far and so tend to discredit it.
Subjectivist insights about expectations have other notable policy implications. The history of energy policy, and of politicians’ demagogy, provides reason for expecting future repetition of past infringements on property rights. Firms and investors must recognize that if they make decisions that turn out in some future energy crisis to have been wise—for example, stockpiling oil, cultivating nonconventional energy sources, adopting conservation measures, or building flexibility into their facilities and operations so as to be able to cope relatively well with energy squeezes—then they will not be allowed to reap exceptional profits from their risk bearing, their correct hunches, and their good luck. They will be victimized by seizure of oil stocks, by adverse treatment under rationing schemes, by price controls, or in other ways. Government reassurances, even if made, would nowadays not be credible.
The benefits of diverse private responses to diverse expectations about energy supplies are thus partly forestalled.
This example reminds subjectivists of a broader point about remote repercussions of particular policies, repercussions remote in time or in economic sector affected. A violation of property rights may seem the economical and expedient policy in the individual case. Yet in contributing to an atmosphere of uncertainty, it can have grave repercussions in the long run.
Because expectations influence behavior, a policy’s credibility conditions its effectiveness, as the rational-expectations theorists, and William Fellner (1976) before them, have emphasized. The question of the withdrawal pangs of ending an entrenched price inflation provides an example. When money-supply growth is slowed or stopped, the reduced growth of nominal income is split between price deceleration and slowed real production and employment. Expectations affect how favorable or unfavorable this split is. If the anti-inflation program is not credible—if wage negotiators and price-setters think that the policymakers will lose their nerve and switch gears at the first sign of recessionary side-effects—then those private parties will expect the inflation to continue and will make their wage and price decisions accordingly; and the monetary slowdown will bite mainly on real activity. If, on the contrary, people are convinced that the authorities will persist in monetary restriction indefinitely no matter how bad the side-effects, so that inflation is bound to abate, then the perceptive price-setter or wage-negotiator will realize that if he nevertheless persists in making increases at the same old pace, he will find himself out ahead of the installed inflationary procession and will lose customers or jobs. People will moderate their price and wage demands, making the split relatively favorable to continued real activity.
It is only superficially paradoxical, then, that in two alternative situations with the same degree of monetary restraint, the situation in which the authorities are believed ready to tolerate severe recessionary side-effects will actually exhibit milder ones than the situation in which the authorities are suspected of irresolution. Subjectivists understand how intangible factors like these can affect outcomes under objectively similar conditions.
Capital and Interest TheoryCapital and interest theory is a particular case or application of general value theory, but its subjectivist aspects can conveniently occupy a section of their own.
Subjectivist insights help dispel some paradoxes cultivated by neo-Ric-ardians and neo-Marxists at Cambridge University. These paradoxes seem to impugn standard economic theory (particularly the marginal-productivity theory of factor remuneration), and by implication they call the entire logic of a market economy into question.
Reviewing the paradoxes in detail is unnecessary here (see Yeager 1976 and Garrison 1979). One much-employed arithmetical example describes two alternative techniques for producing a definite amount of some product. They involve different time-patterns of labor inputs. In each technique, compound interest accrues, so to speak, on the value of invested labor. Technique A is the cheaper at interest rates above 100 percent, B is cheaper at rates between 50 and 100 percent, and A is cheaper again at rates below 50 percent.
If a decline of the interest rate through one of these two critical levels brings a switch from the less to the more capital-intensive of the two techniques, which seems normal enough, then the switch to the other technique as the interest rate declines through the other switch point is paradoxical. If we view the latter switch in the opposite direction, an increased interest rate prompts a more intensive use of capital. Capital intensity can respond perversely to the interest rate.
Examples of such perversity seem not to depend on trickery in measuring the stock of capital. The physical specifications of a technique, including the timing of its inputs and its output, stay the same regardless of the interest rate and regardless of whether the technique is actually in use. If one technique employs physically more capital than the other in relation to labor or to output at one switch point, then it still employs more at any other interest rate. This comparison remains valid with any convention for physically measuring the amount of capital, provided only that one does not change measurement conventions in mid-example. If the capital intensities of the two techniques are such that the switch between them at one critical interest rate is nonparadoxical, then the switch at the other must be paradoxical—a change in capital intensity in the same direction as the interest rate. We cannot deny perversity at both switch points—unless we abandon a purely physical conception of capital.
The paradox-mongers commit several faults. They slide from comparing alternative static states into speaking of changes in the interest rate and of reponses to those changes. They avoid specifying what supposedly determines the interest rate and what makes it change.
The key to dispelling the paradoxes, however, is the insight that capital—or whatever it is that the interest rate is the price of—cannot be measured in purely physical terms. One must appreciate the value aspect—the subjective aspect—of the thing whose price is the interest rate. It is convenient to conceive of that thing as a factor of production. Following Cassel (1903, pp. 4Iff. and passim), we might name it “waiting.” It is the tying up of value over time, which is necessary in all production processes. (This conceptualization is “convenient” not only because it conforms to reality and because it dispels the paradoxes but also because it displays parallels between how the interest rate and other factor prices are determined and what their functions are: it brings capital and interest theory comfortably into line with general microeconomic theory.)
In a physically specified production process, a reduced interest rate not only is a cheapening of the waiting (the tying up of value over time) that must be done but also reduces its required value-amount. It reduces the interest element in the notional prices of semifinished and capital goods for whose ripening into final consumer goods and services still further waiting must be done. Increased thrift is productive not only because it supplies more of the waiting required for production but also because, by lowering the interest rate, it reduces the amount of waiting required by any physically specified technique.
The amounts of waiting required by alternative physically specified techniques will in general decline in different degrees, which presents the possibility of reswitching between techniques, as in the example mentioned. When a decline in the interest rate brings an apparently perverse switch to a technique that is less capital-intensive by some physical criterion, the explanation is that the decline, although reducing the waiting-intensities of both techniques, reduces them differentially in such a way as to bring a larger reduction in the overall expense of producing by the adopted technique.
Preconceived insistence on measuring all factor quantities and factor-intensities in purely physical terms clashes with the fact of reality—or arithmetic—that the amount of tying up of value over time required in achieving a physically specified result does indeed depend on that factor’s own price. Not only the waiting-intensity of a physically specified processes but also the relative waiting-intensities of alternative processes really are affected by the interest rate. When a switch of technique occurs, the technique adopted really is the more economical on the whole, the inputs, waiting included, being valued at their prices. When a rise in the interest rate triggers a switch of techniques, the displace done has become relatively too waiting-intensive to remain economically viable. It is irrelevant as a criticism of economic theory that by some other, inapplicable, criterion the displaced technique counts as less capital-intensive.
Further discussion of the supposed paradoxes would display parallels between reswitching and the conceivable phenomenon of multiple internal rates of return in an investment option, which is hardly mysterious at all (Hirshleifer 1970, pp. 77-81). Already, though, I’ve said enough to show how a subjectivist conceptualization of the factor whose price is the interest rate can avoid fallacies flowing from a materialist or objective conceptualization.
“I Am More Subjectivist than Thou”On a few points, some Austrian economists may not have been subjectivist enough. Murray Rothbard (1962, pp. 153-154) seems to think that a contract under which no property has yet changed hands—for example, an exchange of promises between a movie actor and a studio—is somehow less properly enforceable than a contract under which some payment has already been made. Blackmail is a less actionable offense than extortion through application or threat of physical force (1962, p. 443, n. 49). If a villain compels me to sell him my property at a mere token price under threat of ruining my reputation and my business by spreading vicious but plausible lies, his action is somehow less of a crime or tort than if he had instead threatened to kick me in the shins or trample one of my tomato plants (Rothbard 1982, especially pp. 121-127, 133-148, and personal correspondence). The material element in a transaction or a threat supposedly makes a great difference.
I may be at fault in not grasping the distinctions made in these examples, but it would be helpful to have further explanation of what superficially seems like an untypical lapse from subjectivism into materialism.
Far more common is the lapse into overstating the subjectivist position so badly as to risk discrediting it. F.A. Hayek is not himself to blame, of course, but a remark of his (1952, p. 31) has been quoted ad nauseam (for example by Ludwig Lachmann in Spadaro 1978, p. 1; Walter Grinder in his introduction to Lachman 1977, p. 23; and Littlechild 1979, p. 13). It has had a significance attributed to it that it simply cannot bear. “It is probably no exaggeration to say that every important advance in economic theory during the last hundred years was a further step in the consistent application of subjectivism.”
This proposition of doctrinal history could be strictly correct without its implying that every subjectivist step was an important advance. Moreover, past success with extending subjectivism in certain degrees and directions does not imply that any and all further extensions constitute valid contributions to economics.
A theorist is not necessarily entitled to take pride in being able to boast, “I am more subjectivist than thou.” More important than subjectivism for its own sake is getting one’s analysis straight.
The most sweeping extensions of subjectivism occur in remarks about a purely subjective theory of value, including a pure time-preference theory of the interest rate. Closely related remarks scorn the theory of mutual determination of economic magnitudes, the theory expounded by means of systems of simultaneous equations of general equilibrium. The ultrasubjectivists insist on monocausality instead. Causation supposedly runs in one direction only, from consumers’ assessments of marginal utility and value and the relative utilities or values of future and present consumption to prices and the interest rate and sectoral and temporal patterns of resource allocation and production (Rothbard 1962, pp. 302-303).
Taken with uncharitable literalness, the ultrasubjectivist slogans imply that people’s feelings and assessments have everything to do and the realities of nature, science, and technology have nothing to do with determining prices and interest rates and all interrelated economic magnitudes. Actually, these objective realities do interact with people’s tastes. They condition how abundant various resources and goods are, or could be made to be, and so help determine marginal utilities.
For two reasons I know that the ultrasubjectivists do not really believe all they say. First, the propositions in question, taken literally, are too preposterous for anyone to believe. Second, subjectivist writings sometimes discuss production functions, the principle of diminishing marginal physical product, and other physical relations, conceding some importance to such matters.
What I am objecting to, then, is not so much substantive beliefs as, rather, the willful use of misleading language, language that sometimes misleads even its users, language adopted on the presupposition that subjectivism is good and more of it is better.
Subjectivists may contend that physical reality counts only through people’s subjective perceptions of it and the valuations they make in accord with it. But that contention does not banish the influence of objective reality.
Businessmen (and consumers) who perceive reality correctly will thrive better on the market than those who misperceive it. A kind of natural selection sees to it that objective reality does get taken into account.
Full-dress argument for purely subjective value and interest theory and for unidirectional causality appears rarely in print, probably because such notions are not defensible. They do keep being asserted in seminars, conversation, and correspondence, however, as I for one can testify and as candid Austrians will presumably acknowledge. Furthermore, such assertions do appear in authoritative Austrian publications. (For example, see Rothbard 1962, pp. 117, 122, 293, 307, 332, 363-364, 452, n. 16, 455, n. 12, 457, n. 27, 508, 528, 557, 893, n. 14; Rothbard, introduction to Fetter 1977; Taylor 1980, pp. 26, 32, 36, 47, 50; and Shand 1984, pp. 23, 44, 45, 54, 56. Garrison 1979, pp. 220-221, avoids the word “pure” in recommending a time-preference theory of interest and a subjectivist theory of value in general, but he does contrast them favorably with what he calls “eclectic” theories, such as the “standard Fisherian” theory of interest. For outright avowal of a pure-time-preference interest theory, see Kirzner’s manuscript.)
The point repeatedly turns up in Austrian discussions that goods that people consider different from each other are indeed different goods, no matter how closely they resemble each other physically. This point is not downright fallacious, but the significance attributed to it is excessive, and its use in question-begging ways is likely to repel mainstream economists. An example is the contention that when a manufacturer sells essentially the same good under different labels at different prices, he is nevertheless not practicing price discrimination; for the goods bearing the different labels are considered by the consumers to be different goods, which makes them different goods in all economically relevant senses. The manufacturer is supposedly just charging different prices for different things.
Quite probably his practice is not one that perceptive economists and social philosophers would want to suppress by force of law; but we should not let our policy judgments, any more than our subjectivist methodological preconceptions, dictate our economic analysis or remove certain questions from its scope. It may be more fruitful to recognize that price discrimination is indeed going on, with the different labels being used to separate customers according to their demand elasticities.
Crypticism sometimes accompanies insistence on pure subjectivism. An example is a line of attack taken against mainstream interest theory, which enlists considerations of intertemporal transformability (that is, the productivity of investment) as well as the subjective time-preference element. This theory is epitomized by Irving Fisher’s diagram (1930, pp. 234ff., Hirshleifer 1970, passim) showing a transformation curve between present and future goods (or consumption), as well as a map of indifference curves between present and future goods. A familiar Austrian objection is to insist that the diagram, specifically the transformation curve, fails to make the required distinction between physical productivity and value productivity.
If not deliberate obscurantism, this objection does indicate misunderstanding of Fisher’s theory (or impatience with or prejudice against it). Of course, some technological change that increases the physical productivity of investment in some specific line of production, say widgets, may not increase the value productivity of such investment. The increased physical amount of future widgets obtainable for a given present sacrifice may indeed have a reduced total value in terms of other goods and services in general (the future demand for widgets may be price-inelastic). Some of the new opportunities created by technological change will indeed be unattractive to investors. In invoking the greater productivity of more roundabout methods of production, Böhm-Bawerk (1959, II, 82-84, III, 45-56) was referring to “well-chosen” or “skillfully chosen” or “wisely selected” methods; and a similar stipulation applies to the present case. Technological changes that increase the physical productivity of particular roundabout methods broaden the range of opportunities among which investors can exercise wise choice, and implementing some of those choices does add to the demand for waiting, tending to bid up the interest rate.
The ultrasubjectivist objection is open to another strand of reply. It is il-legtimate to invoke a contrast between physical productivity and value productivity by restricting the discussion to examples of sacrificing specific present goods to get more future goods of the same kind. What is conveyed by borrowing and lending (and other transactions in waiting) is not command over investible resources that would otherwise have gone into producing specific present goods but command over resources in general. It is legitimate to do what Fisher’s diagram helps us to do: to conceive of present goods in general being sacrificed for larger amounts of future goods in general.
With their admirable general emphasis on process and on the decisions and actions of individual persons, Austrian economists should not rest content with attacks on mainstream capital and interest theory that rely on cryptic allusions to a distinction between physical productivity and value productivity (or, similarly, to assertions that factor prices will adjust). They should defend their pure subjectivism on this topic, if they can, with a detailed process analysis of how persons act.
Next I turn to exaggerations in the subjectivist cost doctrines of Buchanan and the London school. These theorists interpret the cost of a particular course of action as the next-best course perceived and forgone by the decisionmaker. Ronald Coase (quoted with approval in Buchanan 1969, p. 28) says that “The cost of doing anything consists of the receipts which would have been obtained if that particular decision had not been taken. ... To cover costs and to maximize profits are essentially two ways of expressing the same phenomenon.”
Well, suppose the best course of action open to me is, in my judgment, to open a restaurant of a quite specific type in a specific location. The next-best course, then, is presumably to open a restaurant identical in all but some trivial detail, such as the particular hue of green of the lampshades. If so, the cost of the precise restaurant chosen is presumably an all but identical restaurant worth to me, in my judgment, almost fully as much. Generalizing, the cost of a chosen thing or course of action is very nearly the full value that the decisionmaker attributes to it.
My counterexample to the Coase-Buchanan cost concept may seem frivolous, but it raises a serious question. How far from identical to the chosen course of action must the next best alternative be to count as a distinct alternative? The point conveyed by questions like this is that either radical error or sterile word-jugging is afoot. (Nozick, 1977, especially pp. 372-373, expresses some compatible though not identical doubts about subjectivist concepts of cost and preference.)
More ordinary concepts of cost, however, are meaningful, including the interpretation of money cost in a particular line of production as a way of conveying information to decisionmakers in it about conditions (including personal tastes) in other sectors of the economy.
Buchanan (1969, p. 43) draws six implications from his choice-bound conception of cost, and Littlechild (in Spadaro 1978, pp. 82-83) quotes them all with apparent approval. I’ll quote and comment only on the first, second, and fifth.
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Most importantly, cost must be borne exclusively by the decision maker; it is not possible for cost to be shifted to or imposed on others.
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Cost is subjective; it exists in the mind of the decision maker and nowhere else.
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Cost cannot be measured by someone other than the decisionmaker because there is no way that subjective experience can be directly observed.
As for the first word and second implications, of course cost can be imposed on others in quite ordinary senses of those words; it is not always kept inside the mind of the decisionmaker. What about adverse externalities—smoke damage and the like? What about losses imposed on stockholders by an incompetent business management? What about the costs that a government imposes on a population by taxation or inflation (or its command of resources, however financed)? Isn’t it notoriously true that a government official need not personally bear all the costs of his decisions? What about involuntarily drafted soldiers? Even an ordinary business decision has objective aspects in the sense that the resources devoted to the chosen activity are withdrawn or withheld from other activities.
Of course the costs incurred in these examples have subjective aspects also—in the minds or the perceptions of the draftees and of persons who would have been consumers of the goods from whose production the resources in question are competed away. What is odd is the contention that no cost occurs except subjectively and in the mind of the decisionmaker alone.
As for the fifth implication, it is true that cost cannot be measured—not measured precisely, that is, whether by the decisionmaker or someone else. But measureability itself is evidently what is at issue, not the admitted imprecision of measurement of cost, as of other economic magnitudes. The money costs of producing a definite amount of some product, or the marginal money cost of its production, can indeed be estimated. Estimates of money cost take into account, in particular, the prices multiplied by their quantities of the inputs required to produce specified amounts of marginal amounts of the good in question. True, cost accounting has no objective and infallible rules and must employ conventions. For this and other reasons, estimates of money cost are just that—estimates. But they are not totally arbitrary; they are not meaningless.
Money costs of production, as well as the input prices that enter into estimating them, play a vital role in conveying information to particular business decisionmakers about conditions in other sectors of the economy. Money costs and prices reflect—do not measure precisely, but reflect—the values and perhaps even the utilities attributed by consumers to the goods and services whose production is foregone to make the required inputs available to the particular line of production whose money costs are in question. (Money costs and factor prices also reflect, as noted above, the preferences and attitudes of workers and investors.)
It is therefore subversive to the understanding of the logic of a price system to maintain that cost is entirely subjective, falls entirely on the decisionmaker, and cannot be felt by anyone else.
Perhaps this risk of subversiveness is being run in a good cause. A healthy skepticism is in order about socialism, nationalization, and the imposition of cost rules on nationalized and private enterprises. However, we should beware of trying to obtain substantive conclusions from methodological preconceptions. Sound conclusions and policy judgments incur discredit from association with questionable verbal maneuvers.
Valid subjectivist insights join with the fact that general equilibrium never actually prevails in recommending skepticism about policies that would unnecessarily impose imitation markets or the mere feigning of market processes. The fact of disequilibrium prices does not, of course, recommend junking the market system in favor of something else. Market prices, although not precise indicators of the trade-offs posed by reality, are at least under the pressures of supply and demand and entrepreneurial alertness to become more nearly accurate measures.
The recommended skepticism does have some application, however, with regard to compensation for seizures under eminent domain, damage awards in tort cases, and the development of case law. It also has some application with regard to benefit-cost studies. Personal rights, not such exercises, should of course dominate many policy decisions.
Again, though, I want to warn against overstatement. Admittedly, costs and benefits are largely subjective, market prices are at disequilibrium levels, and other bases of making estimates are inaccurate also. But what is to be done when some decision or other has to be made—about a new airport, a subway system, a dam, or a proposed environmental regulation? Does one simply ramble on about how imponderable everything is, or does one try in good faith to quantify benefits and costs? Of course the estimates will be crude, even very crude, but perhaps the preponderance of benefits or costs will turn out great enough to be unmistakable anyway. In any case, expecting the advocates of each of the possible decisions to quantify their assertions and lay them out for scrutiny will impose a healthy discipline on the arguments made. It will weaken the relative influence of sheer poetry, oratory, demagogy, and political maneuvering.
My last example of subjectivism exaggerated and abused is what even some members of the Austrian school have identified as a “nihilism” about economic theory. Nihilistic writings stress the unknowability of the future, the dependence of market behavior on divergent and vague and ever-changing subjective expectations, the “kaleidic” nature of the economic world, and the poor basis for any belief that market forces are tending to work toward rather than away from equilibrium (if, indeed, equilibrium has any meaning). Some of these assertions are relevant enough in particular contexts, but ultrasubjectivists bandy them sweepingly about as if willing to cast discredit not merely on attempts to foretell the future but even on scientific predictions of the if-this-then-that type. It is hard to imagine why an economist who thus wallows in unknowability continues to represent himself as an economist at all. (One hunch: he may think he has an all-purpose methodological weapon for striking down whatever strand of analysis or policy argument he happens not to like. But then his own analysis and arguments—if he has any—would be equally vulnerable.)
There is no point trying to conceal from knowledgable Austrian readers what economist I particularly have in mind, so I’ll refer to the writings of Ludwig Lachmann listed in the references (including his articles in Dolan 1976 and Spadaro 1978), as well as Lachmann’s admiration of Shackle’s writings on the imponderability of the future. Also see O’Driscoll’s refreshing criticism (in Spadaro 1978, especially pp. 128-134) of Lachmann for practically repudiating the concepts of the market’s coordinating processes and of spontaneous order.
Most recently, Lachmann has shown evident delight in the phrase “dynamic subjectivism.” “[A]t least in the history of Austrian doctrine, subjectivism has become progressively more dynamic” (1985, p. 2). “To Austrians, of all people, committed to radical subjectivism, the news of the move from static to dynamic subjectivism should be welcome news” (1985, pp. 1-2).
The word “committed” is revealing. Instead of the scientific attitude, Lachmann evidently values commitment—commitment to a doctrine or to a methodology. Recalling Fritz Machlup’s essay on “Statics and Dynamics: Kaleidoscopic Words” (1959/1975), I wish Machlup were alive today to heap onto “dynamic subjectivism” the ridicule it deserves.
Concluding ExhortationsAs Gustav Cassel wrote in a book first published over sixty years ago, it was an absurd waste of intellectual energy for economists still to be disputing whether prices were determined by objective factors or subjective factors (1967, p. 146). Referring to interest theory in particular, Irving Fisher (1930, p. 312) called it “a scandal in economic science” that two schools were still crossing swords on the supposed issue. Prices, including interest rates, are determined by factors of both kinds. As noted earlier, saying so does not mean identifying objective factors with the supply side and subjective factors with the demand side of markets, nor vice versa. Both sorts of factors operate on both sides.
For a grasp of how subjective and objective factors thoroughly intertwine in a system of economic interdependence, a study of the simplified general-equilibrium equation system presented in Cassel’s (1967) chapter 4 is well worthwhile. The reader should pay attention, among other things, to the role of the technical coefficients, that is, coefficients indicating the amounts of each input used in producing a unit of each product. Cassel does not need to suppose, of course, that these coefficients are rigidly determined solely by nature and technology. On the contrary, an elaboration of his system can take account of how many of these coefficients are themselves variable and subject to choice in response to prices, which are themselves determined in the system of mutual interdependence.
Study of Cassel’s chapter (or similar expositions) should also disabuse the open-minded reader of any lingering belief in unidirectional causality. Mutual determination of economic variables is a fact of reality; and no blanket prejudice against general-equilibrium theory, which does afford important insights, should blind one to that fact.
Of course, when one investigates the consequences of a specified change— say in tastes, technology, taxes, or a fixed exchange rate—it is not enough (nor, realistically, is it possible) to solve a general-equilibrium equation system with one or more parameters changed and then compare the new and old solutions. An adequate analysis traces out, perhaps even sequentially, the reactions of the persons involved and shows the reasonableness of their theorized reactions from their own points of view. But insisting on such a causal analysis does not presuppose belief in monocausality. The specified disturbance does indeed impinge on a system of mutual determination. Both the new and old constellations of economic activities result from multidirectional interactions of a great many subjective and objective factors.
Austrian economists have important messages to convey about subjective elements that, on all sides, pervade market behavior, signals, and outcomes. Their insights have important implications for policy. It is a shame to impede communication by remarks about purely subjective value theory, pure-time-preference interest theory, and the alleged fallacy of multidirectional causality.
Austrians cannot really mean what such remarks, taken literally, convey. They mislead and repel people outside the inner circle. The main goal of the Austrians is presumably not to recite slogans that reinforce cozy feelings of camaraderie among members of an elite. Instead, their goal, shared with other economists who wish well for mankind, is presumably to gain and communicate understanding of economic (and political) processes in the world as it is, has been, and potentially could be. They want to extend and communicate such knowledge so as to increase whatever chance there may be that man’s deepest values will ultimately prevail. Respect for the straightforward meanings of words will aid in that endeavor.
Besides shunning deceptive slogans, Austrian economists should beware of surrounding their doctrines with a fog of methodological preachments, preachments suggestive, moreover, of pervasive sniping and sour grapes (as, for example, about the elegant formal theory that some other economists rightly or wrongly delight in). Above all, Austrians should avoid discrediting the sound core of their doctrine by contaminating it with bits of downright and readily exposable error (or what comes across as error on any straightforward reading of the words used). Austrians have positive contributions to make and should make them.
Volume 12, Number 1 (Fall 1990)
The method of Austrian economics stresses the use of words and concepts rather than mathematics, but, unlike mathematics, words and concepts change their meaning through time. That f '(x) < 0 implies a negatively sloping curve was as clear. to Newton as it is to a modern mathematical economist. The meaning Carl Menger ascribed to the term utility, however, differed from that of Mises. Furthermore, the meaning of words in one context can infuse and distort the meaning in another context. This is why, as Austrian economists, we must occasionally "clean house," re-examine our concepts, and clarify any that have become distorted.
Recorded at the Austrian Economics and Financial Markets conference at The Venetian Hotel Resort Casino, Las Vegas, 02-18-2005 [22:21]
It is obvious from his review of my book that J.H. Huebert holds me in genuine high esteem. This saddens him all the more for, in his view, I have squandered my talents on so unworthy a topic as Restoring the Lost Constitution: The Presumption of Liberty, which he characterizes as “an unfortunate waste of talent for a powerful mind such as Randy Barnett’s”. While there is much that I disagree with in Huebert’s review, in this Reply I will focus on one crucial respect in which he misunderstands my thesis. This concerns the concept of constitutional legitimacy I develop and defend in my book.
Volume 19, Number 4 (2005)
Lookism is prejudice toward people because of their appearance. It has been receiving increasing attention, and it is becoming an important equal-opportunity issue. People we find attractive are given preferential treatment and people we find unattractive are denied opportunities.
Volume 19, Number 2 (2005)
Frank van Dun, in his article “Against Libertarian Legalism,” criticizes prior articles by N. Stephan Kinsella and me. Although his article constitutes, in part, a radical if not blistering attack on my prior article, at least it has the merit of fully understanding that which it criticizes. All too often, negative appraisals of libertarianism address themselves to straw men. Say what you will about Van Dun’s article —and I will have many critical things to say about it—it cannot be fairly asserted that he does not comprehend his target.
Volume 18, Number 2 (2004)
In this article, Frank van Dun offers a reply to Walter Block's paper reviewing one of Dun's previous works.
Volume 18, Number 2 (2004)
The Declaration of Independence maintains that:
We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are Life, Liberty, and the pursuit of Happiness.
If what is meant by this is that people should have the right not to be murdered, their persons and legitimately owned property should not be invaded, and that they may pursue happiness in any way they wish as long as they do not thereby violate the equal rights of all others to do the same, this is perfectly compatible with libertarianism, the philosophy based on homesteading, personal and property rights, the non-aggression axiom, contract, and laissez faire capitalism.
Unfortunately, however, the doctrine of inalienability as construed by many is very different from this. So much so, I shall argue, that it is almost diametrically opposed to the libertarian notion of private property and free enterprise.
Volume 17, Number 2 (2003)
Arguments based on hypothetical consent are widely used in legal, political, and moral philosophy. The notion of hypothetical consent has been important to political philosophy at least from the 17th century, when the first classical forms of contractarian political theories were formulated. In bioethics, especially in literature concerning medical paternalism, arguments based on hypothetical consent have drawn much attention. In recent years, these arguments have become popular in legal theory as well. In fact, one finds these arguments not only in law review articles but in actual court opinions.
Volume 17, Number 3 (2003)
In this article, David Gordon and Roberta A. Modugno review of J.C. Lester's Escape From Leviathan: Liberty, Welfare, and Anarchy Reconciled.
Volume 17, Number 4 (2003)
Some influential Wall Street economists are alarmed that cost cutting by many companies in order to secure profits is a major threat to the economy. They say that if everyone tries to cut costs and save more, demand for goods and services from fired workers will fall, which in turn will hurt corporate revenues and, thus, profits. This, in turn, sets in motion new firings, and this again eats into revenues and makes profits disappear.
The process supposedly feeds on itself until there are not enough workers and salaries left to generate sales and profits. Economists call this "the corporate paradox of thrift." In short, if everyone tries to cut costs and save more, then no one saves more. Therefore, if every company decides to cut costs, this ultimately will hurt revenues and hence profits.
The conclusion, then, is that, collectively, it is impossible to lift profits through cost cutting. On the contrary, it will lead to an economic slump. What these economists recommend, then, is that the Fed should maintain its easy monetary policy in order to counter the negative side effect of cost cutting. Thus is this theory yet another rationale for inflation.
"The corporate paradox of thrift" is a modified version of the famous Keynesian "paradox of thrift," which asserts that an attempt by an economy as a whole to increase aggregate savings not only will not succeed but in fact may lower aggregate output, income, and employment. This is because increased savings at a given level of aggregate income means decreased consumption. As a result, with a fall in aggregate income, people will find it much harder to save, and this thus implies that aggregate savings in the economy will fall because people have decided to save more.
According to Keynes: "Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself."John Maynard Keynes, The General Theory of Employment, Interest and Money, Macmillan & Co Ltd, 1964, p. 84.
Also, Baumol and Blinder have suggested: "So while saving may pave the road to riches for an individual, if the nation as a whole decides to save more, the result may be poverty for all!"William J. Baumol and Alan S. Blinder, Economics, HBJ Second Edition, p. 187.
Does the "paradox of thrift" make sense?According to mainstream thinking, saving is seen as a leakage that weakens the flow of spending, thereby weakening the overall economic growth. Is this true? When a baker produces 10 loaves of bread and consumes one loaf, his saving is nine loaves of bread. The baker may decide to do several things with his saved bread. He could use the saved bread to sustain himself over the next week; he could exchange some of the bread for other consumer goods; or he could exchange it for various parts that will enhance his oven.
Observe that, contrary to conventional thinking, at no time has his saved bread caused a "leakage" in economic activity and, hence, a fall in economic activity. On the contrary, saving is exactly what sustained the economic activity.
When the baker exchanges his bread for shoes or shirts, he enhances his well-being and also enhances the well-being of the shoemaker and the shirt producer. In summary, his saved bread sustains the shoemaker and the shirt producer, enabling them to continue in their production of shoes and shirts. Furthermore, by exchanging his bread for various parts that improve his oven, the baker’s productivity increases and his production of bread follows suit. This, in turn, enables the baker to save more and acquire a greater variety of goods and services.
There are, of course, difficulties in saving various perishable goods, so this is where money steps in and solves the problem of storing perishables. Instead of storing his bread, the baker can now exchange his bread for money. In other words, his unconsumed production is now stored, so to speak, in money.
Note that money here fulfills the role of the medium of savings. Observe also that the money is fully backed up by the goods that the producer has produced. In the case of our baker, the money is a receipt, so to speak, for his saved bread. There is, however, one proviso in all of this--that the flow of the production of goods and services continues unabated. This means that whenever a holder of money decides to exchange some of that money for goods, these goods are there for him. So whenever a producer who has exchanged his production for money decides to exchange his money for the goods that he requires, he can always do so.
Note that when the baker exchanges his nine loaves of bread for five dollars with a shoemaker, he in fact supplies the shoemaker with his real savings, which is nine loaves of bread. These loaves of bread will sustain the shoemaker in his production of shoes. Likewise, when a baker decides to exchange his five dollars for the services of a technician to enhance his oven, he is in fact supplying the technician with access to various unconsumed goods, i.e., the real savings of other producers.
For instance, by exchanging the five dollars for vegetables, the technician is in fact exchanging his five dollars for a proportionate amount of the real savings of a vegetable farmer. These vegetables, in turn, will sustain and maintain the well-being of the technician. Again, at no stage has saving caused a "leakage" that weakens economic activity; on the contrary, it reinforces its pace.
What would happen if people were to decide to hold on to their money and not spend it? Would this curtail the demand for goods and services and collapse economic activity? Hoarding of money, however, is not saving; it is merely raising the demand for money. But what would it mean that people would have unlimited demand to hold money? It would mean that they would not use it to exchange for the goods and services required for maintaining their life and well-being. Obviously, this is not a realistic proposition.
So long as people want to stay alive, they will always exchange money for goods. Moreover, as long as people aspire to maintain their life and well-being, they will have to produce and trade goods and services. This, in turn, requires that they must use money in the exchange of one good for other goods. The whole idea of hoarding money for its own sake, i.e., not using money in exchange, doesn't correspond to the nature of human beings, in that they must consume in order to maintain their life and well-being.
Now, if everyone decided to raise their level of savings, i.e., to raise the amount of goods and services supplied to the market, how could this lower the pace of economic activity? On the contrary, a greater production of goods and services would only support a greater demand for goods and services. After all, when a baker produces bread, he is not producing everything for his personal consumption. Most of the bread that he is producing is exchanged for other goods and services that he needs. Hence, his production enables him to acquire goods and services. Thus we can conclude that the so-called paradox of thrift is an erroneous idea.
Why cost cutting is good for the economyIf a company trims costs in order to make a profit, what is wrong with this? By making the transition from a loss to a profit, the company in fact makes more efficient use of its resources. In short, the use of its resources now generates a positive return; i.e., the company has created real wealth.
According to Mises,
"The only goal of all production activities is to employ the factors of production in such a way that they render the highest possible output. The smaller the input required for the production of an article becomes, the more of the scarce factors of production is left for the production of other articles."Ludwig von Mises, Planning For Freedom, Libertarian Press, p. 121.
Consider a farmer who plants 10 seeds and harvests only five seeds. Obviously, he cannot continue with this practice for long before he eventually runs out of seeds. Consequently, he will be faced with the threat of starvation. Hence, the farmer is forced to alter his conduct, i.e., to find better land or acquire a better way of planting his seeds. So why would this change that generates a surplus be bad? With a greater crop, the farmer could improve his well-being and also increase his saving, thus giving rise to a much greater future crop, all other things being equal.
The principle of the example we have employed can be applied to any company. The crux of the matter remains the same in that profit adds to real wealth and hence raises the living standards of individuals in the economy. In short, an expansion in real wealth due to the cost cutting by an initial wealth producer will strengthen his demand for goods and services of another wealth producer. This, in turn, will boost the demand for goods and services of a third wealth producer, etc.
What about all the workers that were fired? Surely their incomes will fall and this will hurt the demand for goods and services. We have shown, however, that a general rise in profits as a result of cost cutting lifts the overall real wealth in an economy. In a market economy, fired workers would have to adjust to new conditions and find jobs elsewhere; they would have to find jobs that contribute to wealth creation.
The currently observed actions of many companies aimed at trimming costs is the only way companies can correct erroneous decisions brought about by the loose monetary policies of the central bank. What various companies are trying to do, in the face of past business errors that resulted in losses, is to normalize the situation through the liquidation of various excesses. Any attempt, therefore, to stifle their adjustment measures by means of a new dosage of monetary pumping only amounts to a further stifling of the economy and to economic impoverishment.
Obviously, liquidations are painful, but just consider the alternative, which could be even harsher. The only way to eliminate the pain of adjustment is, not to increase the dosage of monetary pumping, but to forbid the central bank to pump money and tamper with interest rates. Also, all the loopholes that allow the banking sector to create credit out of "thin air" must be completely sealed off.
ConclusionThe alarm raised by mainstream economists that corporate cost cutting will undermine the real foundation of the economy is based on a flawed view of the essence of savings. On the contrary, cost cutting is an important means in correcting previous erroneous decisions in order to be able to return to a situation where real wealth can be generated again. The suggestion by the proponents of "the paradox of corporate thrift" that the central bank must stimulate demand by means of more monetary pumping is, in fact, a recipe for economic disaster.
What should be the attitude of classical liberals toward nationalist aspiration and sentiment? Should classical liberals value and cultivate these attitudes in themselves and others—at least in their ostensibly less xenophobic and aggressive forms? Or should they look on all forms and manifestations of nationalism as nothing more than atavistic remnants of pre-modernity? That is, should nationalism be viewed as an outmoded form of attachment which, ideally, should be expunged from humanity? Should it be replaced by a cosmopolitan individualism the universal adoption of which will mark the liberation of humanity from all divisive partial allegiances and attachments? Alternatively, should classical liberals regard nationalist sentiment and allegiance as a purely private matter, one that has nothing to do with their political outlook as such?
Volume 16, Number 1 (2002)
Frédéric Bastiat did not devote much attention to the problem of the firm, so taking an interest in his thoughts on the topic could seem strange. Yet, the foundations for a realistic theory of the firm (and, more generally, of the distribution of human activities) are found in chapter 14, “Wages,” of Bastiat’s classic book Economic Harmonies. Further, the way that Bastiat lays the foundations are both original and profound. In this article, I will review Bastiat’s approach, develop it more fully, and draw some practical and theoretical conclusions about the nature of the firm.
Volume 16, Number 3 (2002)
In this article, Frank van Dun offers a retort to Paul Gottfried's critique.
Volume 16, Number 3 (2002)
In this article, Professor Hans-Hermann Hoppe discusses immigration, natural order, and private property.
Volume 16, Number 1 (2002)
At the doctor's office, we are faced with long waiting periods in crowded waiting rooms, and when the doctor finally sees us, he is rushed for time. The quality of service and the attention to detail suffer in such a situation, increasing the level of frustration for both doctor and patient.
The doctor's every action is monitored-either directly, by government bureaucrats, or indirectly, by trial lawyers. The regulatory burden faced by doctors is enormous and escalating, requiring them to employ staffs of workers whose sole job is to comply with reams of paperwork. It doesn't help that the process of becoming an M.D. has been made hopelessly expensive. It is common for young doctors to finish their residencies with debts in the six figures, and that encourages them to enter high-paying specialties and to avoid general medicine.
This is all by design. Licensure laws and federal regulations reduce the number of doctors in legal markets. Some doctors may complain about the system, but from the beginning, its purpose was to reduce entry into the medical field so that existing practitioners could maintain more control over their prices.
A growing number of physicians are seceding from this system. Frustrated by the regulatory quagmire that affects their quality of service, not to mention their peace of mind, these doctors are jumping on the trend for "carriage trade" in medical services. Under this system, doctors inform their patients that they are switching to a new pricing system involving a large annual premium that allows access to the doctors' services.
Patients who pay this premium are entitled to premium services, such as no-wait appointments, same-day lab tests, and home drug delivery. Depending on the market, these premiums can vary anywhere from $1,500 to $20,000 a year. Once the premium is paid, however, the prices charged for medical services are the same as those currently charged by the medical profession as a whole. (Patients who dislike this multitariff pricing scheme are given ample time to switch to another doctor.)
Doctors that opt for this pay-for-privilege service are finding that they have more time to spend with individual patients and give better care as a result, while the patients that can afford the care are able to opt out of many of the problems associated with visits to the doctor's office. One particular (and reassuring) advantage of the system applies to patients who are prone to medical emergencies. They can see their personal physician whenever they want.
One doctor who switched to a carriage-trade pricing scheme told The Wall Street Journal that his patient list dropped from more than 3,000 to about 600 (an 80-percent decrease), and that, for him, the choice boiled down to either switching or retiring. Under his old practice, he saw anywhere from 20 to 30 patients a day, and the quality of his care suffered. Now he has more time to engage in the type of activities that attracted him to the medical profession in the first place.
What attracts people to medicine has nothing to do with complying with a myriad of regulations decreed from Washington bureaucracies. Though cloaked with good intentions, these regulations increase the full cost of providing medical care and produce adverse consequences as a result. How many doctors retire early instead of choosing continued compliance with Washington's edicts? How many resources are diverted from increasing the number of medical services offered (and thus from placing a downward pressure on prices)? How many doctors redirect their human capital investment into high-priced specialties so as to justify the increased costs that accompany a career in the medical field?
In other words, for any seen benefit of a regulation, how many unseen costs are produced as a result?
Predictably, the trend for carriage trade has caught the attention of those who currently collect economic rents from the existing medical system in the U.S. After all, such freedom of choice draws attention to the shortcomings of the existing system, in much the same way that the success of Federal Express and United Parcel Service draws attention to the shortcomings of the U.S. Post Service. Its critics have termed carriage-trade practices "concierge care," in an effort to create class resentments toward those who want to opt out of the current system. Since socialism can only be successful when everyone suffers equally, the powers that be have come out against carriage-trading.
For example, Arthur L. Caplan, director of the Center for Bioethics at the University of Pennsylvania, calls the carriage-trade trend "abysmally sad," adding, "We don't want our doctors to be frazzled or inattentive, which has happened by unleashing market forces with inadequate resources. I might pay a fee to talk to the doctor, too. But I'd hope we could create a system where the doctor could talk to me for more than a minute without a surcharge."
What is "abysmally sad" about this statement is its ignorance of the price system. When the costs for a service such as meeting with a doctor are socialized, then no one individual has an incentive to conserve his consumption of such a service. The resulting excess demand decreases the possibility that anyone will ever have quality time with a physician. This, in a nutshell, is why the U.S. medical system is such a mess today.
But note Dr. Caplan's broader point: When onerous regulations force firms (or, in this case, physicians) to reduce the quality of their services, the blame must be placed on market forces, not on the regulations themselves. To suggest otherwise would be committing a secular heresy in our current zeitgeist. Again, his defense of the regulatory state unmasks ignorance of the market process. Many of the products we use and take for granted every day were first marketed solely to the rich. Why wouldn't the same process apply to medical services?
The answer, of course, is that the government, in league with the American Medical Association, won't allow it. Falling prices mean smaller profits for existing providers. Any attempts to circumvent the present system, which is really a cartel in health care, must be attacked lest it weakens the system.
Carriage-trade medical services have already been established in most major municipalities throughout the United States. They will continue to thrive, provided the medical establishment doesn't succeed in squelching their growth.
A recent trip to Santa Monica, California, provided me with a clear explanation of why Californians, despite all their wealth, talent, and resourcefulness, have the energy supply system of a Third World country. Like so many tiny Latin American dictatorships, or the outer provinces of India, Californians can no longer rely on a steady supply of electricity.
During my trip, the power went out for hours at a time in much of the Los Angeles area, causing traffic accidents, millions of dollars in lost business, and looting. "If we can only have a summer where we’re socked in by fog for most of the day," said one Los Angeles television weatherman, "we’ll all be better off" because of the reduced electricity use. Wonderful.
The next day the media were abuzz with word that the governor of the state was going to hold a news conference to discuss the energy situation. Docile, state-worshipping newscasters seemed convinced that Governor Gray Davis was about to rescue them. The press conference was hilariously funny—funnier than anything I’ve seen on any Hollywood-produced television show in years.
With great solemnity, the governor introduced the state’s "energy czar," a woman with a cheerleader-type voice who cheerily announced that "Californians are very proud—VERY PROUD—of their devotion to alternative energy sources," such as windmills. Accordingly, she was VERY PROUD to announce that the state had assisted in restructuring the payment schedules for a few windmill operators who produce a minuscule amount of electricity .
That’s it. In the midst of a severe energy supply crisis, that was THE BIG ANNOUNCEMENT. The windmills will continue to spin. Californians may sweat to death in the dark this summer, but they apparently are very, very, very proud of being on the far edge of the lunatic fringe when it comes to environmental policy.
Since my throat was feeling a little dry after all that laughing, I decided to stroll down to a nearby Starbucks for some liquid refreshment. I was met by a mob of "protesters" that was blocking the entrance to the establishment. They were holding large signs, warning me that if I ordered a Tall Latte, I just might turn into Frankenstein. No kidding. Their signs read "NO FRANKEN-LATTE." Apparently, someone convinced these young high-school dropout types, all of whom were dressed like bums, that Starbucks used genetically-engineered products that could transform them all into Young Frankensteins. Oh yes, and the "protesters" were also upset that Starbucks apparently engages in (horror of horrors!) free trade.
Later on in the afternoon, I passed by the same Starbucks. The "protest" was over, but I recognized one of the "protesters" who was still sitting on the sidewalk. This time he said to me, "Got any spare change, man?" And to the next person, and the next person . . .
The local media were all over the "protesters," treating them like celebrities. I overheard one local television reporter actually coaching one of them so that they would look better on television and do a better job of promoting their cause.
I wanted to pick up some reading material for the flight home, so my next stop was a Borders bookstore. The checkout girl was wearing a "Dave Mathews Band" T-shirt and had a stack of the band’s CDs piled up next to the cash register. The customer in front of me asked, "Who’s Dave Mathews?" to which the clerk replied, "Oh, he’s the greatest. He’s the only rocker who hasn’t sold out to corporate America. He tells the record companies to shove it."
The local papers were filled with stories of alleged "price gouging" by the electric companies, reminiscent of all the anti-capitalistic conspiracy theories that were spun during the government-induced energy crisis of the 1970s. No mention was made in any of the articles as to why the electric companies do not always "price gouge"— that is, why they waited until this year and ignored all those potential profits. Logic doesn’t really matter with people like this, however; they will always blame the problems caused by government intervention on "evil capitalists."
This attitude is not restricted to high-school dropouts. California’s two senators, Diane Feinstein and Barbara Boxer, have been demanding that the Bush administration impose price controls to "solve" the California energy crisis. Such gross economic ignorance, combined with a knee-jerk insistence that virtually all the state’s problems are caused by malevolent capitalists, guarantees that Californians will continue to suffer from one government-induced crisis after another in the years to come.
Classical liberalism arose at a time when Christian orthodoxy was still vibrant. Liberalism and Christian orthodoxy, sharing a number of fundamental ideas about the nature of man and of interpersonal relations, presuppose the same moral ontology of natural law. The high tide of Christian orthodoxy and classical liberalism belongs to the era when natural law was the fundamental concept of all serious thought about the human world.
Volume 15, Number 3 (2001)
In this article, Frank van Dun discusses the differences between The Universal Declaration of Human Rights (UD) versus Natural Rights .
Volume 15, Number 4 (2001)
Subjective Values, Objective WorldMises Review 4, No. 4 (Winter 1998)THE FOUNDATIONS OF AUSTRIAN ECONOMICS FROM MENGER TO MISES: A CRITICO-HISTORICAL RETROSPECTIVE OF SUBJECTIVISMAllen OakleyEdward Elgar, 1997, x + 258 pgs.
Have another look at that subtitle. It suggests that readers of Foundations of Austrian Economics are in for a long haul, and I fear that expectation is correct. Professor Oakley writes in an almost impenetrable academic prose. You know at once that you are not browsing through H.L. Mencken's collected works.
But I can forgive Professor Oakley much. (I cannot and will not forgive his use of the barbarism "mitigate against.") Although he does "not like very much the free-market, 'survival-of-the-fittest' ideology that has become identified with most Austrian economists, and their literature" (p. ix), he thinks that Menger and Mises have made essential contributions to economic method. These he endeavors to describe, often in an illuminating fashion.
His admiration for the great Austrians is apparent; he refers, e.g., to "the genius of...Ludwig von Mises," grouping him in that category with Max Weber (p. 232). But he does not think that Menger and Mises were entirely successful. Though they grasped the importance of subjectivism, they failed to carry out their insights to the full extent possible. In this contention, as it seems to me, our author entirely fails.
As Professor Oakley sees matters, many economists have been beguiled by a fata morgana--formalism. They think that economics, to be a true science, must ape the methods of mathematical physics. Unfortunately for those who hold this view, the economy arises from the actions of human beings. And our species, among other faults, does not operate according to rigidly deterministic laws. Instead, human action is creative, and people respond freely to the world as they perceive it.
Correct economic method, then, must start from human action, not differential equations. (You can see why Professor Oakley finds Mises congenial company.) In a phrase to which our author is much partial, neoclassical economists wrongly give precedence to epistemology over ontology. This is just a fancy way of making the point that mathematical physics isn't the appropriate model for economics.
It is the singular merit of Carl Menger, according to Professor Oakley, to have realized this vital truth. "Menger's ontology concerned itself primarily with phenomena that are generated by the deliberations, plans and actions of individual agents in that most fundamental of human preoccupations, the endeavor to satisfy material and other essential life needs and wants" (p. 54). (Well, I warned you that Oakley isn't Mencken.) Menger's stress upon the subjective point of view is all to the good, but his pioneering insight soon left him with a problem, at least according to Oakley. Menger also wished to develop economics as a rigorous science. Professor Oakley maintains that subjectivism and scientific rigor do not fit together well; since human action is creative, subjective, etc., it cannot be reduced to strict laws. At best, we can by empathy with others grasp how they might act in typical situations.
Menger, by failing to realize this, fell into error. Menger's "inconclusive and truncated treatment of his ontological insights into the nature and role of subjectivism and individualism meant that these principles were left only as guideposts for those who were to follow him" (p. 87). Alas, the blandishments of scientific rigor proved too much forour nascent subjectivist.
I cannot think that Professor Oakley's complaint against Menger withstands scrutiny. Our author is of course right that mathematical methods that ignore causality are a poor way to study human action. But it does not follow from that alone that economics cannot be a rigorous science. For Oakley's conclusion to follow validly, he needs the additional premise that the mathematical method he challenges is essential to science. Why not a rigorously developed study of human action that is non-mathematical? The considerations advanced by Professor Oakley leave this possibility entirely open.
Just the path indicated was taken by Menger, a fact of which Oakley is well aware. As an Aristotelian in good standing, Menger held that a true scientist can discern real necessities in nature. Applied to our discipline, the economist can by insight and deduction grasp the essences of the human actions he studies. By doing so, the economist can achieve "an exact orientation that has as its aim 'the determination of strict laws of phenomena'" (p. 81). There we have it: scientific rigor without mathematics. Menger has escaped the dilemma in which Oakley has attempted to imprison him.
Our author is not convinced--you didn't think he would be, did you? He raises an objection to Menger's method that, as far as I can decipher it, amounts to this. Menger cannot show that "hidden variables" do not account for the phenomenon he professes to explain. And even if he could, in a given case, show this, he has not excluded the possibility that something else can cause the phenomenon in other cases.
The first part of Oakley's objection against Menger begs the question. Menger claims to find causal necessities in human action. Oakley answers that he may have overlooked hidden variables. Well, if Menger is right, he didn't. All Oakley's comment amounts to is the triviality that Menger's claim may be wrong.
A similar response applies to the remainder of Oakley's objection. If Menger says that only certain causes produce a given effect, but something else can also produce it, then he is wrong. But the mere unsupported claim that it is always possible that something else produce the effect has by itself no force. Again, all that Oakley is saying is that maybe Menger is wrong. This is not much of an objection.
I shall pass over without extensive comment those chapters that Oakley devotes to Dilthey, Rickert, and Weber. According to our author, Menger might have advanced even further in his study of subjectivism had he known of Dilthey's insights. But as to the nature of these insights, I can make neither hide nor hair. Suffice it to say that Dilthey was a pioneer in hermeneutic philosophy. Verbum sat sapientiae! The mysteries of Heinrich Rickert I shall leave for others to fathom.
Fortunately, Professor Oakley descends to earth and favors us with an informative chapter on Mises. He gives an excellent account of Mises's concept of human action and praises him for his development of subjectivism beyond the point at which Menger had left matters. He singles out one of Mises's insights for special commendation: "It is evident that Mises understood much about the import of time for action and its implications for the empirico-historical human sciences" (p. 203).
But, as with Menger, our author is not fully satisfied with Mises. Again, an Austrian pioneer has failed fully to emancipate himself from scientism. Mises tried to deduce logically a science of praxeology from the axiom of human action. He did not fully realize that the theorems of this science cannot apply completely to particular human actions, since these are "contingent."
Once more, the objection amounts to very little. To say that human actions are contingent, in a sense that defeats praxeology, is just to assume without argument that Mises is wrong. If Mises has derived his theorems properly, then human action is not fully contingent; Oakley has given this term no content other than "not amenable to deductive explanation."
Further, although Oakley rightly discerns neo-Kantian influences on Mises's thought, he wrongly thinks it follows from this influence that Mises considered praxeology a construction rather than part of the real world. The real world that concerns economists is the world to which the categories have been applied. Even if Mises holds, in his neo-Kantian moods, that praxeology depends on a grid of humanly imposed categories, its results are real enough. Professor Oakley also misunderstands a passage in which Mises calls equilibrium an "imaginary construction." His thinking this does not gainsay the fact that praxeology applies with perfect exactitude to the real world.
In sum, we can say of Oakley what he says of Menger and Mises: his work is valuable but flawed.
Presented at the Mises Institute's "First Annual Advanced Instructional Conference in Austrian Economics" at Stanford University; June 21–27, 1987.
Yet Another Example of how Intellectual Property is Partial Enslavement: Professional wrestler Diamond Dallas Page sued rapper Jay-Z claiming that he has illegally adopted Page's trademark hand gesture, the 'Diamond Cutter,' as his own."
"Diamond Cutter" hand gesture is shown above
In response to my post Objectivist Law Prof Mossoff on Copyright; or, the Misuse of Labor, Value, and Creation Metaphors, Skip Oliva, founder of the Voluntary Trade Council, has written a fascinating, original, and insightful critique of the "intellectual property" and related theories of Objectivism.
A popular idea in finance theory is that the prices of financial assets fully reflect all available and relevant information and that adjustment to new information is virtually instantaneous. Modern portfolio theory (MPT) postulates that market participants are at least as good at price forecasting as any model that a financial market scholar can come up with, given the available information.Horace W Brock and Jeffrey A. Frankel, "Review of the Efficient Market Hypothesis," Strategic Economic Decision (November 1991).
In this way of thinking, asset prices respond only to the unexpected part of any information, since the expected part is already embedded in prices, so changes in asset prices occur because of news that cannot be predicted in a systematic manner. The proponents of the MPT argue that if past data contains no information for the prediction of future prices, then it follows that there is no point in paying attention to fundamental analysis. A simple policy of random buying and holding will suffice, as asserted by one of the pioneers of the MPT, Burton G. Malkiel, in his famous book A Random Walk Down Wall Street.
Malkiel also suggests that “a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by the expert.”Ibid.
Proponents of MPT claim that attempts to extract information from historical data, such as fundamental or technical analysis, are of little help because anything an analyst uncovers in the data is already known to the market and hence is not going to assist in “making money.”
MPT Claims Diversification Reduces Risk A security expected to generate returns that are not expected to deviate significantly from the historical average is termed by the MPT as a low risk, while a security that generates returns that are volatile from year to year is regarded as risky. The MPT assumes that investors are risk averse and want high guaranteed returns. According to the MPT, if an investor wants to reduce investment risk, he should practice diversification.
The basic idea of MPT is that volatile stocks (i.e., risky stocks) can be combined into a portfolio and this will lead to the reduction of overall risk. The guiding principle for combining stocks is that each stock represents activities affected by given factors differently. Once combined, these differences will cancel each other out, thereby reducing the total risk.
The theory indicates that risk can be broken into two parts. The first part is associated with the tendency of returns on a stock to move in the same direction as the general market. The other part of the risk results from factors peculiar to a particular company. The first part of the risk is labeled systematic risk; the second part, unsystematic. According to the MPT, through diversification, only unsystematic risk can be removed. Systematic risk cannot be removed through diversification. Consequently, it is held that returns on any stock or portfolio will be always positively related to the systematic risk—i.e., the higher the systematic risk, the higher the return.
The systematic risk of stocks captures the reaction of individual stocks to general market movements. Some stocks are more sensitive to market movements, while other stocks display less sensitivity. The relative sensitivity to market moves is estimated by means of statistical methods that establish a beta, which is the numerical description of systematic risk. If a stock has a beta of 2, it means that on average it swings twice as much as the market. If the market goes up by 10 percent, the stock tends to rise by 20 percent. If, however, the stock has a beta of 0.5, then it tends to be more stable than the market.
Does the MPT Framework Make Sense? The major problem with the MPT is that it assumes that all market participants have the same expectations about future securities returns. Yet if participants have similar expectations, then why should there be trade? Trade, after all, implies the existence of different expectations, which is what bulls and bears are about. A buyer expects a rise in the asset price, while a seller expects a fall in the price.
Even if we believe that modern technology gives all market participants equal access to news, we still must deal with how people interpret news. In the MPT framework, market participants have the same knowledge. Asset price forecasts by market participants are clustered around the true value, with deviations from the true value randomly distributed, implying that profits or losses are random phenomena.
MPT's tenets also mean that since, on average, everybody knows the true underlying value, then no one will need to learn from past errors, since errors are random and, therefore, any learning will be futile. However, if every individual has different knowledge, then this difference will have an effect on his forecast, and in fact, individuals do have different knowledge. Success or failure in predicting asset prices will not be completely random, as the MPT suggests, but must also be attributed to each individual's knowledge. Writes Hans-Hermann Hoppe:
If everyone's knowledge were identical to everyone else's, no one would have to communicate at all. That men do communicate demonstrates that they must assume that their knowledge is not identical.Hans-Hermann Hoppe, "On Certainty and Uncertainty, or How Rational Can Our Expectations Be?" Review of Austrian Economics 10, no. 1 (1997): 49–78.
The Stock Market Does Not Have a Life of Its Own The MPT framework gives the impression that the stock market can exist separately from the real world. However, the stock market does not have a life of its own, which is why an investment in stocks should be regarded as an investment in business, and not just as an investment in stocks, since as Murray N. Rothbard writes in America’s Great Depression, “the stock market tends to reflect the ‘real’ developments in the business world” (p. 79).
By becoming an investor in a business, an individual has engaged in entrepreneurial activity by committing his capital with a view to supply the most urgent needs of consumers. For an entrepreneur, the ultimate criteria for investing his capital is to employ it in those activities which will produce goods and services that are consumers' highest priority. It is this striving to satisfy the most urgent needs of consumers that produces profits, and it is this alone that guides entrepreneurs.Ludwig von Mises, Human Action: A Treatise on Economics, 3rd rev. ed. (Chicago: Contemporary Books, 1963), p. 520.
Is it valid to argue that past information is completely imbedded in prices and therefore of no consequence? It is questionable whether the market participants can discount the duration and the strength of effects. For instance, according to the MPT a market-anticipated lowering of interest rates by the central bank, while seen as old news and not supposed to have real effects, is going to set in motion the boom-bust cycle. In addition, various processes, initially only affect some individuals' real income, but as time goes by, the effects of these causes spread across a wider spectrum of individuals.
Obviously, these changes in the real incomes of individuals are likely to produce changes in the relative prices of assets. To suggest, then, that somehow the market will quickly incorporate all future changes because of various present causes without telling us how it will be done is questionable. It has to be realized that markets comprise individual investors who require time to understand the implications of various forces and their implications for the prices of financial assets.
Even if the market anticipated a particular impact, that does not mean it was understood correctly and therefore discounted. It is hard to imagine that the effect of a particular cause, which begins with a few individuals and then spreads over time across many individuals, can be assessed and understood instantaneously.
For this to be so, market participants would have to be able to immediately assess future consumers' responses and counterresponses to a given cause. This, of course, mean that market participants not only know consumers' preferences but also how these preferences are going to change. Note, though, that consumer preferences cannot be revealed before consumers have acted.
Are Profits Random Phenomena? The proponents of the MPT claim that the main message of their framework is that excessive profits cannot be secured out of public information. They maintain that any successful method of making profits must ultimately be self-defeating.
It is true that profits as such can never be a sustainable phenomenon, but the reasons for this are not those presented by the MPT. Profit emerges once an entrepreneur discovers that the prices of certain factors are undervalued relative to the potential value of the products that these factors, once employed, could produce. By recognizing the discrepancy and doing something about it, an entrepreneur removes the discrepancy—i.e., eliminates the potential for a further profit. According to Rothbard:
Every entrepreneur, therefore, invests in a process because he expects to make a profit, i.e., because he believes that the market has underpriced and undercapitalized the factors in relation to their future rents.Murray N. Rothbard, Man, Economy, and State, 2. vols. (Los Angeles: Nash Publishing, 1970), vol. 2, p.466.
The recognition of the existence of potential profits means that an entrepreneur has particular knowledge that other people do not have. This unique knowledge means that profits are not the outcome of random events, as the MPT suggests. For an entrepreneur to make profits, he must engage in planning and anticipate consumer preferences. Consequently, those entrepreneurs who excel in their forecasting of consumers' future preferences will make profits.
Profits Drive Entrepreneurs, Not Risk In the words of Ludwig von Mises:
A capitalist never chooses that investment in which, according to his understanding of the future, the danger of losing his input is smallest. He chooses that investment in which he expects to make the highest possible profits.Mises, Human Action, pp. 809–10.
In an attempt to minimize risk, practitioners of the MPT tend to pursue a high degree of diversification. However, having a large number of stocks in a portfolio might leave little time to analyze the stocks and understand their fundamentals, raising the likelihood of putting too much money in bad investments. This way of conducting business would not be an entrepreneurial investment but rather naked gambling.
Note that the guiding principle of MPT for combining stocks is that each stock represents activities that are affected by given factors differently. Once combined, these differences are expected to cancel each other, thereby reducing the portfolio risk. However, it does not necessarily always work this way. During a large financial crisis, for example, various asset prices that normally have an inverse correlation become positively correlated and fall together.
John Maynard Keynes himself had misgivings about using portfolio diversification to reduce risk. On August 15, 1934, he wrote to Francis Scott, the Provincial Insurance chairman:
As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one's risk by spreading too much between enterprises about which one knows little.
Conclusion The modern portfolio theory gives the impression that there is a difference between investing in the stock market and investing in a business. However, the stock market does not have a life of its own. The success or failure of investment in stocks depends ultimately on the same factors that determine the success or failure of any business. Proponents of the MPT argue that diversification is the key to the creation of the best possible consistent returns. The key should be the profitability of various investments, not diversification as such. MPT also claims that if one wants to secure higher profit one needs to take a greater risk. The size of an entrepreneur's return on his investment, however, is determined not by how much risk he assumes, but by rather whether he complies with consumers' wishes.
Pokémon Go, an extremely popular mobile game released last month, uses the GPS and camera on players’ phones to turn the real world into an adventure land filled with cartoon creatures, called Pokémon, which can be found and caught by exploring real-world places and throwing Pokéballs at them before other players do the same.
The most common varieties of Pokémon (Rattatas, Pidgeys, Jigglypuffs, etc.) turn up everywhere and in great abundance, and so seldom lead to dust-ups between ambitious Pokémon trainers. Anyone who downloads the app is likely to find these so-called normal-type Pokémon inside their own homes, ready to be caught from the comfort of the couch.
Rare Pokémon necessarily require more work to catch. The real world has been divided up into biomes by the game’s creators, meaning different types of Pokémon tend to stay in specific areas. For example, grass-type Pokémon are usually found in verdant places, like parks, farms, and forests.
Video Games as Pain ReliefPokémon Go upsets the narrative, advanced by critics of capitalism, that video games are an “opiate of the masses.” Playing video games, taking drugs, and overeating are all seen from this perspective as slow motion self-immolations in protest of individualist society. Video games are played in dark rooms by dejected man-children who have been chewed up and spat out by dastardly markets.
But Pokémon Go does not fit that bill. Players must go on Pokéwalks if they want to play the game properly, which bring them into contact with other players, fresh air and historical landmarks (re-branded as gyms and Pokéstops by the game’s GPS).
A broody, disaffected dissident would not find this level of unironic engagement enjoyable. If video games are primarily about escape, shouldn't the most popular ones be those which insulate us most thoroughly from the outside world? With Pokémon Go sitting pretty at number one on the Google Play chart, we might be pardoned for doubting the supposed centrality of escapism.
Unearned Inequality in Pokémon Go In fact, far from being a respite from the economic system of present, Pokémon Go contains many elements of capitalism, even those which its critics most revile.
For example, the game imposes a degree of non-meritocratic inequality on its players. Certain people’s homes are richer catching and training grounds, simply because of their differential proximities to parks, areas of historical interest, and cities.
But players accept this, because it is an inevitable consequence of a world with geographic heterogeneity. The alternative would be bland uniformity, without much room for individualized player experiences and with no incentive at all to explore.
Interestingly, a great proportion of inequality in the real world is also born of mother nature's womb. Jared Diamond, a well-renowned economic historian, famously argued in his book Guns, Germs, and Steel that modern day differences in incomes of countries are partly attributable to differences in geographic endowments. For example, sub-Saharan Africa has no native animals suitable for domestication, which hobbled its early transport capacities and slowed its development.
The Role of RandomnessPokémon Go replicates real-world capitalism in another respect by making success partly dependent on blind luck. The most intrepid trainer, with a portable phone battery and unlimited phone data, can still be undone by happenstance because the exact locations in which Pokémon appear is random.
Fixing this “problem” with the game would make things fairer. Losing a prospective Pokémon to an unworthy foe feels unjust; indeed, according to a report from the BBC, one player in England felt so slighted by such an incident they reported it to the police.
But would anyone really prefer a game in which Pokémon appeared like clockwork in certain locations, to be captured exclusively by the most punctual trainers? Anybody who has played the game knows that much of the excitement is in the unpredictability with which the digital creatures appear.
Pokémon Go’s meteoric rise undermines the dreary “opiate of the masses” hypothesis; in addition, it presents us with an opportunity to reconsider the appeal of video games more generally. Any explanation which can account only for games of the past and not for the Pokémon phenomenon must be downplayed.
Meanwhile, though millennials have tended to explicitly reject capitalism at ballot boxes around the world, their embrace with Pokémon Go betrays an unexpected acceptance of inequality as well as a penchant for playing the odds in red-in-tooth-and-claw competition.
A rigorous application of methodological individualism is perhaps what most separates the Austrian and Public Choice schools from most others. The idea that the individual should be the unit of analysis has spared public choice and Austrian economists from many of the mistakes of what might be called collectivist economics. The Austrians, for example, have exposed a great deal of macroeconomic nonsense due to the fact that Keynesian theory largely ignored aggregation problems. The Austrian conception of markets, based on the interaction among individuals and on man's inherent "propensity to truck, barter and exchange," is also more useful and informative, in my view, than the perfect competition model.
Buchanan and other public choice theorists have greatly improved our understanding of the political process by scrapping the "organic" view of collective action, which describes government, more or less, is a benevolent despot, making decisions that are assumed to be in the public interest."
Not so long ago, in 1968, Buchanan remarked:
Most ... economists take an approach different from my own, and one that I regard as both confused and wrong. In my vision of social order, individual persons are the basic component units, and "government" is simply that complex of institutions through which individuals make collective decisions, and through which they carry out collective as opposed to private activities. Politics is the activity of persons in the context of such institution.JamesBuchanan, "An Economists's Approach to Scientific Politics," in M. Parons, ed., Perspectives in the Study of Politics (Chicago: Rand McNally, 1968),p. 78.
Of course, the economics profession has changed significantly since then, particularly in light of the public choice revolution. Methodological individualism has replaced more collectivist views in academic circles.
Nevertheless, it is far from clear that there has been a decisive "victory." Social welfare functions still clutter the economics journals. Moreover, there is no shortage of recommendations for government intervention in the name of the mythical "public interest." Proponents of methodological individualism have made great strides, but the collectivist mind set dies a slow death.
Buchanan has also long been considered a proponent of the Austrian view of the 'market process. In this regard he is more than jus a "fellow traveler"; his work has played an important role in helping to distinguish between the theory of the market as a process and the alternative, neoclassical theory of competitive equilibrium. Thus, in addition to his seminal work on subjective cost theory, Buchanan has helped clarify the Austrian view of the market as a process.
In his 1963 presidential address to the Southern Economic Association, Buchanan explained how the economics profession was apparently being led astray by its focus on the "theory of resource allocation." He forcefully argued that the standard neoclassical definition of economics as the study of the allocation of scarce mean among competing ends "has served to retard, rather than advance scientific progress.JamesBuchanan, "What Should Economists Do?" Southern Economic Journo (January 1964): 213-22. " The reason for this, according to Buchanan, is that there is very little economic content in much of modern economics. What neoclassical economics, all too often involves is a computation problem, the computation of equilibrium prices, for example which "to the subjectivist, [seems] an absurd exercise.'"'JamesBuchanan, "General Implications of Subjectivism In Economics," In Geo frey Brennan and Robert D. Tollison, eds., What Should Economrsts Do? (Indianapoh Ind.: Liberty Press, 19791, p. 85.
A good example is the work of Nobel Laureate Tjalling Koopmans who began his career by working out the optimal allocation of a set of tankers carrying oil across the Atlantic during World War II. Buchanan properly labels such work as engineering, not economics and claims that he must have been "a confirmed subjectivist long before I realized what I was because I recall thinking in 1946, when Koopmans was lecturing...at the University of Chicago, that there seemed to be absolutely no economic content in what he was doing."Ibid.
Buchanan has attempted to persuade the economics profession to abandon its fixation on allocation problems per se, for "if there is really nothing more to economics than this, we had as well turn it all over to the applied mathematician.JamesBuchanan, "What Should Economists Do?"p. 217. " This does appear to be the direction the profession has been heading; for "developments of note ...during the past two decades consist largely of improvements in...computing techniques, in the mathematics of social engineering."Ibid.
Instead of becoming weakly-trained mathematicians (at least by the standards of professional mathematicians), Buchanan suggested replacing the theory of resource allocation with the theory of markets.
This would require paying more attention to
a particular form of human activity, and upon the various institutional arrangements that arise as a result of this form of activity. [Namely,] man's behavior in the market relationship, reflecting the propensity to truck and to barter, and the manifold variations in structure that this relationship can take.Ibid.
These, Buchanan has written, are the proper subjects of economics.
This approach helps us understand why, in perfect competition, there is no competition (or any trade, for that matter). It also reveals how a market is not competitive by definition, as in the neoclassical model, but that a market becomes competitive. "It is this becoming process, brought about by the continuous pressure of human behavior in exchange, that is the central part of our discipline...not the dry rot of postulated perfection."Buchanan,Cost and Choice, p. 83.
Thus, Buchanan's view of the market system may properly be labeled Austrian. Furthermore, he has urged us to apply this same notion of the economic process to the study of political institutions. This is why public choice theory is largely a study of political processes, with policy recommendations usually focusing on altering institutional processes, rather than political outcomes or end states.
Excerpted from The Subjectivist Roots of James Buchanan's Economics
According to The Daily Mail, a recent study suggests that people value ordinary objects differently depending on what they are told about the objects
According to the new research, being told that something is art automatically changes our response to it, both on a neural and a behavioural level.
In this case, researchers in Rotterdam, Netherlands told subjects to rate how they valued objects in photographs. When told those objects were "art" people valued them differently.
In other words, the perceived value of objects could change without any additional labor added to the objects, and without any physical changes at all.
The value, it seems, is determined by the viewer, and we're reminded of Carl Menger's trailblazing observations about value:
Value is a judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men.
One moment, the viewer may think he's looking at garbage, which he has likely learned is of little value. When told that said "junk" is really "art" then the entire situation changes. (Of course, we would need to see their preferences put into real action via economic exchange to know their preferences for sure.)
The change, as both Menger and Mises understood, is brought about not by changes to the object itself, but by changes in context, and in the subjective valuation of the viewer.
A glass of water's value in a parched desert is different than that of a glass next to a clean river, Indeed, a glass of water displayed in a museum as art — as in the case of Michael Craig-Martin's "An Oak Tree" — is different from water found in both deserts and along rivers. Similarly, the value of a urinal displayed in a museum as art — as with Marcel Duchamp's "Fountain" — is different from a physically identical urinal in a restroom.
The Daily Mail article attempts to tie the researchers' observations to the theories of Immanuel Kant on aesthetics. But, one need know nothing about aesthetics at all to see how this study simply shows us something about economic value: it is, to paraphrase Menger, found in the "consciousness of men."
And it is largely due to this fact that centrally planning an economy is so impossible. How can a central planner account for enormous changes in perceived value based on little more than being told something is art?
Is a glass of water best utilized on a shelf in a museum, or is it best used for drinking? Maybe water is best used for hydro-electric power? Exactly how much should be used for each purpose?
When discussing the problems of economic calculation in socialism, Mises observed that without the price system, there simply is no way to say that a specific amount of water if best used for drinking instead of being used for modern-art displays. Nor is the fact that people need water for drinking the key to determining the value of water. (See the diamond-water paradox.)
In a functioning market, consumers will engage in exchanges involving water in a way they reflects how much they prefer each use of water to other uses. At some moments, some consumers may prefer to drink it. At other moments, some may prefer to water plants with it. At still other moments, they may want to contemplate an art display composed of little more than a glass of water. The price of water at each time and place will reflect these activities.
Without these price signals, attempting to create a central plan for how each ounce of water should be used is an impossible task.
Do we need to know why people change their views of object when told they are art? We do not. Indeed, were he here, Mises would perhaps be among the first to remind us that economics is silent as to the mental processes that lead to people preferring different uses for different objects. Maybe the subjects in the Rotterdam study changed their views of objects because they wanted to be seen as sophisticated. Or maybe they truly felt making an ordinary object into art is a wonderful thing. Maybe others changed their minds because of some childhood trauma.
We can't know why each individual values drinking water over "art water," or vice versa. And a government planner or regulator — it should be noted — can't know this either.
Ryan McMaken is the editor of Mises Wire and The Austrian. Contact: email, twitter.
President Trump has lambasted the NFL more than 20 times for players’ “Total Disrespect of Our Great Country.” Ratings are down for NFL games and Trump figures it’s because some players aren’t standing, hand over heart, and mouthing the words to the national anthem.
Trump may have made some political hay out of all this, but one only has to follow the money to learn the real reason pro football ratings are down — competition from college football. The fact is, “Their product isn’t very good these days,” Nick Bogdanovich told the Las Vegas Sun. He is the chief oddsmaker for William Hill, which operates 107 sportsbooks in Nevada.
The league that used to claim any team could win on “any given Sunday” has turned into a predictable “If you have a quarterback, you have a chance. If you don’t, you don’t,” as Ben Volin wrote of the Boston Globe at the finish of last year’s regular season. As evidence, he pointed to “the four quarterbacks remaining in the playoffs — Tom Brady, Ben Roethlisberger, Aaron Rodgers, and Matt Ryan.”
Jimmy Vaccaro has been running sports books for four decades. He says, it used to be, “Nearly $4 on the NFL for every buck on a college game.” That is no longer the case. Now it is more like 60–40 with the college betting handle gaining.
Joe Drape writes of the sportsbook legend,
And when Vaccaro says he is becoming bearish on the betting health of professional football, you lean in and listen. Last month, for three consecutive weeks, for the first time that he can remember, betting on college football at South Point surpassed betting on the NFL, by as much as $400,000.
The Wall Street Journal did a study back in 2010 and found that of the 174 minutes of an NFL broadcast there was 11 minutes of game action. The WSJ found there was about 60 minutes of commercials and “As many as 75 minutes, or about 60% of the total air time, excluding commercials, is spent on shots of players huddling, standing at the line of scrimmage or just generally milling about between snaps.”
This has only become worse with the advent of constantly replaying questionable calls. Meanwhile, many college teams have gone to the no-huddle offense to squeeze in more plays.
Making accurate point spreads on 16 pro games is much easier than getting 50 college games right. “There’s more volatility and room for mistakes in the college game,” John Avello, a bookmaker at the Wynn Las Vegas, told the Sun. “You can find an edge there, and that is what gamblers do. We are hard to beat when it comes to the NFL.”
Professional gambler Chris Lawless wagers more on college games not only because there are flawed betting lines to take advantage of, but also because the games are more enjoyable. “There are more momentum shifts and more exciting plays and more passion,” Lawless said.
Vaccaro believes betting on college football will continue to gain on NFL action. Overall, Nevada sports books are expected to post their eighth consecutive year of record handle, with Las Vegas taking in $5 billion in sports wagers.
September saw Nevada set a new betting handle record of $558.4 million, and the Nevada Gaming Control Board has now revealed that the handle in October came in at $522 million, the best-ever performance by Nevada sportsbooks in the month of October, as well as the third consecutive month of a betting handle in excess of $500 million.
Chris Johns at the Irish Times is dismayed by all the support he sees for Brexit. He's vexed by the fact so many of Brexit's boosters are — in Johns's eyes—going against their own economic interests.
Johns notes, for example, that Brexit may take a significant toll on British manufacturing, and may be problematic for income growth and tax revenues. Resigned to Brexit as a fact, Johns suggests trying to make the transition as painless as possible, but insists, "Britain will either be poorer or much poorer." But it's too late the avert at least some damage. Thus, the narrative goes something like this: "we tried to warn you people about the dangers of Brexit to your pocketbook. But you went ahead and supported it anyway. So now you're worse off."
Johns is missing a big part of the economic argument made by Brexit supporters.
At the moment, even the economic data suggests the British are better off today, but the Brexit gambit for many has always been one in which supporters calculate political independence will bring long-term economic gains, even if there are problems in the short term. This hardly proves supporters are acting against their own economic interests, or that they don't understand economic realities. It simply shows their predictions of the future are different from Johns's.
But Johns's misunderstanding is bigger even than this. A big part of why he assumes people will soon be worse off thanks to Brexit is because he is too limited in how he understands the process of calculating costs and benefits. Once we move beyond "homo economicus" notions of benefits being limited to monetary gains, we realize the benefits of Brexit can be found in ways that aren't tracked by any government office, and don't show up in any statistical data. Economists and pundits who limit their calculations to measurable statistics are missing a big chunk of how humans measure and value the world around them.
We Can't Put a Number on the Opportunity Cost of EU Membership Government statistics have been devised to keep track of identifiable and countable events and dollar amounts. This is why numbers such as "unemployment rates" and "median incomes" form the backbone of government stats. They can be identified and counted with relative ease based on survey data or direct observation. But these numbers are hardly comprehensive in measuring the real world.
But much of the concern over EU membership has focused on issues that are hard to quantify, such as government regulations and lost opportunities. How exactly does one quantify a new regulation on British businesses handed down by EU bureaucrats? An individual business might be able to hazard a guess, but aggregate data is far less reliable and far less available.
Even harder to count is the opportunity cost of EU membership. As noted by EU critics, for example, membership in the EU has limited the ability of the UK to expand trade outside the EU bloc. There's no way to put a number on how much these lost opportunities have cost British households. Certainly some researchers have tried. But we end up debating the accuracy and relevance of the research. Ultimately, it all requires a judgment call as to whether or not EU membership is "worth it" to a specific person.
The "Psychic Profit" of Leaving the EU Other things are even harder to quantify than lost opportunities. These are what many voters perceive as the intangible benefits of leaving the EU.
For example, a pro-Brexit voter might argue that British laws should be decided in Britain—even if this means paying higher tariffs. Thus: political independence is more valuable than selling goods to France at a lower tariff rate. Obviously, there's no way to determine exactly how much benefit "political independence" produces for a person who values it. But the value is real.
We're now in the realm of "psychic profit," which is the profit that a person perceives in his own mind from a certain action or state of affairs. The problem with psychic profits is that they are not quantifiable as money profits are. As economist Ludwig von Mises noted, at a fundamental level, profits and lossses are "psychic qualities and not reducible to any interpersonal description in quantitative terms." Moreover, Mises notes that the "psychic phenomena" from which these valuations derive involve "incalculable intensive magnitudes." Even if a person values Brexit more than low-tariff trade, it's impossible to put a number on how much more.
A similar accounting problem arises with the immigration issue. Some voters support Brexit because they suspect or hope that it will reduce immigration. In this case, some have concluded that their psychic profits are improved by being surrounded by people of similar language and culture.
Faced with the idea that greater controls on migrant labor could push up the cost of living, some may nonetheless conclude the psychic loss resulting from immigration outweighs the monetary benefits of low-cost labor at the supermarket.
All of this should illustrate that when we're talking about a voter's decision to support a certain policy, we're not exactly employing an exact science. By supporting policies that might ultimately lead to higher prices or higher foreign tariffs, one is not necessarily falling victim to economic illiteracy. One is simply taking a position that, in one's mind, something that can't be measured in pounds is more valuable than something that can be measured in pounds. There is a rational—and possibly well-informed—process of calculation going on here. It's just a calculation that's impossible to quantify.
Some economists find this sort of thing quite irksome, however. Johns, for instance, bemoans the fact that the "culture war" behind Brexit has led to " the economy tak[ing] acceptable collateral damage." He apparently means that voters have abandoned what he considers to be sound economic thinking in favor of "benefits" that can't be counted in any ledger. In the minds of pundits like Johns, people are "irrational" if they chose a policy that might reduce their incomes as measured in dollars or pounds.
The Real Problem: Majorities Forcing Policies on Minorities Brexit critics like Johns would do well to admit their adversaries aren't necessary irrational economic illiterates. But even if we all agree different people calculate economic benefit in their own non-measurable ways, we haven't solved our political problems.
Policies like Brexit will always be problems so long as people who make very different value judgments are forced to live under a common government. We have a problem because the democratic majority can impose a preferred policy on the losing minority.
In the case of Brexit, for example, nearly half the population appears to be either indifferent to membership in the EU or actively in support of it. And just as statistical economic data can't tell us whether or not pro-Brexit supporters are "right," it can't make a judgment about EU supporters. Many EU advocates simply like the fact the EU hands down lots of environmental regulations to all member states. Supporters may like that EU membership (presumably) increases total immigration for reasons totally unrelated to economic factors. Some feel they benefit emotionally from a politically united Europe.
But this doesn't mean that this minority of voters ought to be forced into leaving the EU because 51 percent of the population says so.
The ideology underlying democracy offers no answer to this. We have a situation in which about half of the population believes that it profits (psychically or otherwise) from one policy. But about half of the population believes it profits from the opposite policy. This problem becomes even worse when reduced to a regional level. An outright majority of residents in Scotland, for example, apparently opposes Brexit. Now that Brexit is a reality, a slim majority of Scots support independence. It would seem to violate basic notions of justice to insist that Scotland be held to the dictates of the English majority forever.
Scottish Separatists Are Now the "Irrational" Ones In spite of years of being told how economically inept they are for supporting Brexit, some are now turning the same arguments on the Scots. This pundit, for example, might as well be saying "look at those crazy Scots. They want to cut themselves off from their best trading partner (England)!" In the minds of those opposing independence, the dictates of economic good sense mean that Scotland should stay in the UK. But the anti-independence pundits may be making the same mistake the anti-Brexit pundits were making. It could be pro-independence Scots feel that they would gain more from independence than from unity—even if government stats say otherwise. If many Scots truly believe this strongly, it will be very hard to convince them otherwise, no matter how many studies by economists are trotted out.
Ultimately, we're still left with a political problem that can't be solved by insisting all the intelligent people agree with us because our spreadsheets and bean counters tell us which political position is "best" for us.
None of this should be construed to suggest that sound economics is wrong. Yes, low tariffs are better than high tariffs. Yes, business owners ought to be free to hire workers regardless of what country those workers are from. Yes, government regulations on businesses are a destructive burden, whether imposed by London or by Brussels. But the Brexit debate wasn't really about whether high tariffs are better than low tariffs. It was about who should decide tariffs, and where and how. It was about issues far beyond whether or not an additional 1 percent growth could be wrung out of GDP next quarter. Many have tried to turn Brexit into just a debate about economic policy. But economics as imagined by mainstream number crunchers has never been sufficient to understand how people calculated the value of leaving the EU.
Related articles:
"Brexit: Predictions of Economic Doom Show Why People Ignore 'Experts'" by Ryan McMaken"The Homo Economicus Straw Man" by Ryan McMaken
Why do individuals value bread less than gold, when bread is obviously more “useful” than gold? To provide an answer to this question economists refer to the law of diminishing marginal utility.
Mainstream economics explains the law of diminishing marginal utility in terms of the satisfaction that one derives from consuming a particular good. For instance, an individual may derive vast satisfaction from consuming one cone of ice cream. However, the satisfaction he will derive from consuming a second cone might also be great, but not as much as the satisfaction derived from the first cone. The satisfaction from the consumption of a third cone is likely to diminish further, and so on.Karl E. Case and Ray C. Fair, Principles of Microeconomics, 7th ed. (Amsterdam: Prentice Hall, 2003).
From this mainstream economics concludes that the more of any good we consume in a given period, the less satisfaction, or utility, we derive out of each additional, or marginal, unit. From this it is also held that if the marginal utility of a product declines as we consume more and more of it, the price that we are willing to pay per unit also declines.
Since various goods generate different magnitudes of utility, mainstream thinkers have concluded that consumers should allocate their money income in such way that the marginal utility per dollar spent is the same for all goods purchased.
Now, according to mainstream thought, since gold is relatively scarcer than bread it follows then that the price of gold should be higher than the price of bread, because the marginal utility derived from bread is going to be much lower than the marginal utility derived from gold. On the same basis we can also derive that notwithstanding that air is essential for human life, due to its almost unlimited supply individuals are likely to assign to air a much lower price than to bread.
Utility in this way of thinking is presented as a certain quantity that increases at a diminishing pace as one consumes or uses more of a particular good. Given that utility is presented as some total quantity, also called total utility, it becomes possible to introduce mathematics here to ascertain the addition to this total, which is referred to as additional utility or marginal utility. However, does it make sense to discuss the marginal utility of a good without referring to the purpose that it serves?
Menger’s Explanation According to Carl Menger, the founder of the Austrian school of economics, individuals assign priorities to the various goals that they wish to achieve. As a rule, according to Menger, the highest priority will be assigned to life maintenance. The various ends that an individual will find useful for his life maintenance will be assigned a descending rank in accordance with his own preferences:
As concerns the differences in the importance that different satisfactions have for us, it is above all a fact of the most common experience that the satisfactions of greatest importance to men are usually those on which the maintenance of life depends, and that other satisfactions are graduated in magnitude of importance according to the degree (duration and intensity) of pleasure dependent upon them. Thus if economizing men must choose between the satisfaction of a need on which the maintenance of their lives depends and another on which merely a greater or less degree of well-being is dependent, they will usually prefer the former.Carl Menger, Principles of Economics, trans. James Dingwall and Bert F. Hoselitz (1976; Auburn, AL: Ludwig von Mises Institute, 2007).
Consider John the baker, who has produced four loaves of bread. The four loaves of bread are his resources, or the means that he employs to attain various goals.
Let us say that his highest priority or highest end is to have one loaf of bread for himself. The loaf of bread is of utmost importance for John in order to sustain his life. This means that John will retain for his personal consumption one loaf of bread.
The second loaf of bread helps John secure his second most important goal, as far as life is concerned, which is to consume five tomatoes.
Let us say that John was successful and finds a tomato farmer who agrees to exchange his five tomatoes for a loaf of bread.
John exchanges his third loaf of bread to achieve his third most important end, which is to have a shirt. Finally, John decides that he will allocate his fourth loaf toward feeding wild birds.
To attain the second and the third ends John had to exchange his resources—loaves of bread—for the goods that would serve to achieve his ends.
To secure the end of having a shirt, John had to exchange his loaf of bread for the shirt. The loaf of bread is not suitable in itself to provide the services that the shirt does.
Ends Determine the Value of Means A given end dictates or establishes, so to speak, the specific means or resources that the individual will choose for its attainment. For instance, to secure the end of having a shirt John must decide whether it is going to be a leisure shirt or a work shirt.
John will have to select from among various shirts the most suitable for his specific end—let us say that it is to have a work shirt.
Being a baker, John may conclude that the shirt must be of a white color and made of a thin rather than thick material to keep him comfortable while working next to a hot oven.
Feeding wild birds is ranked lowest among the ends that John is aiming at given his pool of resources—four loaves of bread.
Observe that the first loaf of bread is employed to secure the most important end, the second loaf of bread the second most important end, etc. From this we can infer that the end also assigns an importance to the resource employed to secure the end.
This implies that the first loaf of bread carries much higher importance than the second loaf, because of the more important end that the first loaf secures.
The Value of Each Unit of Resources Is Determined by the Least Important End Now, because John regards each of the four loaves of bread in his possession as interchangeable, he assigns to each loaf the importance as imputed from the least important end, which is feeding wild birds. Why does the least important end serve as the standard for valuing the loaves of bread?
Imagine that John uses the highest end as the standard for assigning value to each loaf of bread. This would imply that he values the second, third, and fourth loaves much more highly than the ends he secures.
However, if this is the case, what is the point of trying to exchange something that is valued more for something that is valued less? We have seen that to satisfy his second end, to obtain five tomatoes, he would exchange one loaf of bread. If, however, John values a loaf of bread more than five tomatoes, obviously no exchange will take place.
Since the fourth loaf of bread is the last unit in John's total supply, it is also called the marginal unit, i.e., the unit at the margin. This marginal unit secures the least important end. Alternatively, we can also say that as far as life is concerned, the marginal unit provides the least benefit.
If John had only three loaves of bread, it would mean that each loaf would be valued according to the end number three—having a shirt. This end is ranked higher than the end of feeding wild birds.
From this we can infer that as the supply of bread declines the marginal utility of bread rises. This means that every loaf of bread will be valued more highly now than before the decline in the supply of bread.
Conversely, as the supply of bread rises, its marginal utility falls and each loaf of bread is now valued less than before the increase in the supply took place. The law of declining marginal utility is derived here from the fact that individuals use means to secure various goals or various ends.
However, ends are not set arbitrarily but graded in accordance with their importance in maintaining life. If John had ranked his ends randomly, then he would have run the risk of endangering his life. For instance, if he had allocated most of his resources to clothing and feeding wild birds and very little to feeding himself, he would have run the risk of weakening his body and becoming seriously ill.
Utility Is Not Some Sort of Quantity That Can Be measured Marginal utility is not, as the mainstream perspective presents it, an addition to a total utility but rather the utility of the marginal end. There is no such thing as the addition to total utility as a result of an additional unit of a good. As we have seen, utility is not about quantities, but about priorities—the rankings that each individual sets with respect to his life.Murray N. Rothbard, Man, Economy, and State with Power and Market, scholar's ed., 2d ed. (Auburn, AL: Ludwig von Mises Institute, 2009), pp. 302–10.
Obviously one cannot sum priorities up as such. Since total utility does not exist, the various mathematical methods that were introduced in economics based on it are questionable. According to Rothbard,
Many errors in discussions of utility stem from an assumption that it is some sort of quantity, measurable at least in principle. When we refer to a consumer’s “maximization” of utility, for example, we are not referring to a definite stock or quantity of something to be maximized. We refer to the highest-ranking position on the individual’s value scale. Similarly, it is the assumption of the infinitely small, added to the belief in utility as a quantity, that leads to the error of treating marginal utility as the mathematical derivative of the integral “total utility” of several units of a good. Actually, there is no such relation, and there is no such thing as “total utility,” only the marginal utility of a larger-sized unit. The size of the unit depends on its relevance to the particular action.Ibid., pp. 305–6.
Menger’s Marginal Utility Theory Is Drastically Different from the Mainstream Both the mainstream approach and Menger’s emphasize the importance of the relative quantity of a good in its price determination. The difference, however, is that the mainstream relies on psychology while Menger emphasizes the importance of the purpose that a good helps to achieve.
The mainstream approach regards utility as some kind of quantity which can be subjected to the rules of mathematics. This is not so in Menger’s framework, where utility refers to the ranking of goods with respect to life and well-being.
Given that goods are evaluated with respect to various ends (with life assigned as the highest priority), the marginal utility theory as developed by Menger is drastically different from the mainstream approach.
In addition, in the mainstream approach there is a strong emphasis on indifference curves, which supposedly can be helpful in understanding individuals’ choices. Indifference, however, has nothing to do with individuals’ purposeful conduct. In pursuing purposeful actions, individuals cannot be indifferent to various goods. When confronted with various goods an individual makes his choice based on their suitability to be employed as means to various ends. (Note again that the ends are ranked with respect to his life.)
It does not make sense to discuss the marginal utility of a good without referring to the purpose that it serves. The marginal utility theory as presented by popular economics describes an individual without any goals, and who is driven by psychological factors. This individual is not aiming consciously to reach his goals. In this sense, popular economics describes not a human being but a human robot.
A standard objection to the use of markets in organizing society’s production and consumption is that individuals are “malleable” — subject to social influence. They use a two-step approach. First, critics bring up the tiresome strawman of a hyper-rational homo economicus whose preferences are determined, constant, and transitive. Second, they point to common human behavior that contradicts the ideal homo economicus. Conclusion: markets are frail, economists are charlatans and we can’t trust individuals to make decisions in their own lives.
Frequently making an appearance in discussions over marketing, the malleability objection complements this interventionist strategy by saying that — actually — our preferences aren’t “ours” at all. Rather than originating from some deep and independent individuality of our own minds, they are processes of social internalization, development and community esteem. In economics speak, preferences are endogenous: we want what our community teaches us to want — not what we actually want. Preferences are, at least partially, socially determined and so subject to what is called ‘ cumulative advantage — or the Matthew Effect: a slight, even fleetingly random, advantage in taste evolves into an extreme dominance for no other reason than its initial random advantage. This, of course, would be a problem for most economic reasoning since methodological individualism and humility before individuals’ ultimate ends is a cornerstone of Austrian and mainstream thinking alike.
Here’s a classic example. 14,000 online music enthusiasts were asked to rate and download songs they have never heard before. They were divided into nine different groups, eight self-contained “worlds” where participants could only see the ratings and downloads of members of their own world, and a ninth control group that weren’t shown any ratings at all. Duncan Watts, one of the co-authors of the study , describes the study in a New York Times article:
we didn’t manipulate any of these rankings — all the artists in all worlds started out identically, with zero downloads — but because the different worlds were kept separate, they subsequently evolved independently of one another.
If people’s music preferences were entirely exogenous (driven by their own independent taste), the ratings and downloads ought to have been roughly the same across all nine worlds – other people’s opinions of what was good music wouldn’t alter ratings and downloads very much compared to the uninfluenced ninth group. And the, objectively speaking, “best” songs ought to have come out on top in all worlds. Results:
“the particular songs that became hits were different in different worlds, just as cumulative-advantage theory would predict. Introducing social influence into human decision making, in other words, didn’t just make the hits bigger; it also made them more unpredictable.”
The market critic would quickly jump at such results, relegating the market’s ability to satisfy consumer wants to the dustbin of failed economic theories. One conclusion that could be drawn: those who became rich via entrepreneurship weren’t actually entrepreneurial or apt at delivering the goods or kind of music the masses wanted. They were just lucky, subject to the cumulative-advantage effect. Moreover, since they got rich without displaying providing any real service or insight, we can now freely take their incomes, houses, and yachts.
Consumers Must Narrow Down their Choices Here's the ironic thing: anybody accepting a world of spontaneous order and less-than-perfect information ought to have expected as much. In a time scarce world, with never-before-seen access to more books, music, art or items that you could ever hope to survey, even perfectly rational individuals could take others’ actions into account. Indeed, failing to do so would be utterly irrational and subject to extreme hubris: nobody else’s taste in music could ever be informative to me.
An individual, facing a decision, may it be “which car best suits me?”, “which t-shirt should I buy?”, or “do I like this song/toothpaste/
So, for somebody to realize their time and effort constraint into surveying all the world’s music (it would take you six lifetimes to listen to everything that’s on Spotify today), allowing others’ display of taste some weight into my own decision-making is perfectly rational. Heavily relying on the advice of friends and a song’s popularity in the general population is the necessary trade-off of a world with less-than-perfect information.
Letting Others Do the Work (of Consumer Decision-Making) For You Indeed, on a more fundamental economic level, this is the logical conclusion of division of labor. Taking information from others is how we survive in large-scale complex market societies. This is easy to see when discussing a broken car or leaking pipes: you could probably learn how to fix those pipes yourself and develop your car mechanic skills to be able to repair the car, but it would likely take much more time, effort and money than you’re willing to part with — hiring a specialist makes economic sense. Similarly, you can think of relying on others’ tastes when it comes to music or food flavors or TV shows to be a trove of useful information, deflated appropriately by how much you tend to like what others like.
That is, allowing additional information about others' tastes (even marketing!) is not simply marketing brainwashing or mindless steps in following the communitarian herd, but a thoughtful — indeed, quite possibly a rational — process of trading off other resources along other dimensions. For some (say for experts, or those enjoying the challenges of learning and overcoming problems) it might make sense to extensively survey the market or devote time to learn how to repair a car.
For most of us, it's a waste of time and energy.
What is a “non-profit” organization? Are they subject to economic calculation? What can economic theory tell us about their functions?
With Hillary Clinton under fire for (among other scandals) using the Clinton Foundation as “a kind of globalist grift,” and with promising new lines of research into social entrepreneurship by Professor McCaffrey and the economics of gifts by Professor Hülsmann, we should take a closer look at “non-profit” organizations and how they fit into the market, if at all.
Since the term includes “profit,” a good place to start would be to distinguish between two types of profit.
Psychic ProfitAll human action is directed toward the attainment of some desired end, but requires the use of specific means. Acting man forgoes the attainment of less desired ends for the sake of higher valued ends. In this sense, every action is profit-motivated because of the “psychic profits” attained in successful action and “psychic loss” is incurred from regrettable, unsuccessful action.
Mises covers these fundamentals in Human Action, p. 287: “We cannot even think of a state of affairs in which people act without the intention of attaining psychic profit and in which their actions result neither in psychic profit nor in psychic loss.”
Money Profit and Economic CalculationIn economics, the term “profit” is more frequently used to convey “money profits.” When an entrepreneur purchases factors of production for less than the revenues from the sale of the output of the production process, including considerations for interest, we say that money profits have been earned. These profits only come from the efficient production of goods consumers value.
This phenomenon is only possible through economic calculation, whereby the entrepreneurs appraise the costs of production and the anticipated revenues. Economic calculation is the driving force of growing and flourishing market economies because it is the only way to economize the use of resources. Not only are resources economized between production and consumption, but also between various production projects. Only the most valuable projects are rewarded with profits, while wasteful projects are abandoned to free up resources to be used in other, hopefully profitable ventures.
Thus the consumers are sovereign in their choices for what shall be produced, but only if entrepreneurs are allowed to engage in economic calculation. Heavy government interventions and socialism hinder and disallow this important process.
The Case of a Charity for the PoorNow let us turn to the enigma of the “non-profit organization.”
We are not all cold-hearted, greedy Scrooges, and so many of us value helping others in need. We form voluntary associations dedicated to distributing funds and resources to the poor, and these organizations can sort of look like other firms in the market.
One could argue that, for those who donate, they (vaguely) produce the knowledge that the donors’ gifts are used to benefit people in need. This seems flimsy, however, because no market price can emerge for such a feeling. Nevertheless, the donation does yield psychic profit for the donors, and the receivers obviously profit from the gift, or else they would not voluntarily take it. Either way, profit is an important part on both ends of the charity’s function.
Can charities like the one described engage in economic calculation? One could argue this as well, but we’d be on very shaky ground. To make this stretch, donated funds would have to be viewed as revenues to the charity in the same way standard businesses receive revenues from the sale of their product. Also, the necessary expenditures to create and maintain the functions of the charity, including the distribution of funds or other resources to the recipients would have to be considered their costs of “production.” Only then could one claim charities engage in economic calculation. It’s easier just to say that the charity might make decisions geared toward the maximization of donations.
The inherent difficulty in applying these economic concepts to charity comes from the fact that there are no market prices and because we can’t pinpoint who is fulfilling what economic function in the organization. Are the donors the consumers, or are the recipients? Who owns the resources, or who is the capitalist-entrepreneur? How are the resources economized?
However, these ambiguities do not prevent us from being able to say with certainty that profit, even if it is psychic profit, is present in the function of any so-called “non-profit” charity. The donors give because they prefer the charity and, ultimately, the recipients to have the funds than the donors. This action yields psychic profit for the donors, just like any action.
The Case of a Firm with Multiple FunctionsThe emergence of firms with an explicit dedication to social causes is another interesting phenomenon along these lines. This is where Professor McCaffrey’s research is focused. He has introduced his research at the most recent Austrian Economics Research Conference, and I’m looking forward to what he will produce.
Unlike a charity that merely takes money from donors and gives it to certain recipients, some firms sell goods with the promise that their product was produced in a certain way (like fair trade coffee, or “Proudly Made in the USA” goods). Other firms may make promises that all or some of their income is automatically reinvested in the organization with a certain mission (like ideological or political institutions) or donated to other charities (like Newman’s Own or Firehouse Subs).
Rothbard wrestled with this topic in “The Myth of Neutral Taxation,” found in Economic Controversies:
We have been describing two polar cases: the business firm, and the nonprofit organization. Probably most real-world institutions on the market fall into one of these categories. In some cases, however, an organization can partake of both modes. Let us consider two cases. First, a charitable organization, instead of, or in addition to, giving away alms, may sell some products to the poor at a low, subsidized price. In this case, while the donors provide the overall thrust and guidance, part of the feedback gained by the firm is willingness to buy goods by the recipients. In some sense, the recipients of alms provide a guide to their interest in the organization. There are now two sets of consumers: the donors, and the charity recipients, each of whom demonstrates its preference for this organization in contrast to other uses for its money. But the overall purpose of the organization is not to make a profit, but rather to serve the values and goals of the donors, and so the donors must be considered the regnant consumers in this situation.
Another case is a profit-making business firm where the owner or owners decide to accept a lesser monetary profit on behalf of some other goals of the owners: for example, because a certain line of product is considered immoral by the owners or because the owner wishes to hire incompetent relatives in order to keep peace in the family. Here once again, these are two sets of consumers—the buyers of the product, and the producers or owners themselves. Because of his own values as a “consumer,” the owner decides to forego monetary profit because of his own moral principles or because he holds keeping peace in the family high on his value scale. In either case, the owner is foregoing some monetary profit in order to achieve psychic profit. Which motive will dominate depends on the facts of each particular case. Since the market is generally characterized by a division of labor between producers and consumers, however, the general tendency will be for monetary profit, or service to non-owning consumers, to dominate the decisions of business firms.
Rothbard concluded that even in these weird cases where it can be difficult to apply economic theory, profit, and intention to profit are present at each step, even if monetary profits are exchanged for psychic profits or vice versa.
One clear statement we can make regarding organizations like these is that involuntary associations must be treated in a totally separate way. Government programs that may look like charities for the poor or other socially beneficial bureaucracies are not what they appear to be. If the funds are forcefully taken, we can categorically reject that their stated purpose is economizing or even beneficial, or else the funds would not have had to be forcefully taken in the first place. Rothbard’s “Toward a Reconstruction of Utility and Welfare Economics” is crucial to understanding this point.
ConclusionApplying economic theory to charities or social businesses is difficult, but I’m optimistic that new lines of research will get us closer to answering the questions outlined above.
Although these questions are difficult to answer, we can say with certainty that any voluntary association must involve profit in one way or another. Therefore, there really is no such thing as a purely non-profit organization.
I picked up a new vice a month ago: homemade espresso. Of course, to enjoy this delight, I first had to purchase an espresso machine. Like almost every product on the market, a wide range of espresso machines is available. A simple online search reveals prices ranging from $29.99 to well over $1000. As a certified cheapo, I spent just a little over 30 bucks and began pouring cups of foamy sunshine.
Now, the connoisseurs out there are going to smirk, "That's not espresso. In order to sip the real stuff, you need a machine that has features x, y, and z." Certainly, my faux espresso is not the same as that served to the Parisian, yet when balanced against other wants that are still chasing scarce resources, my investment suits me just fine.
Now, suppose that you are the connoisseur who believes that espresso must be served to the taste of the sophisticated Frenchman. Anything less is substandard and wasteful, if not immoral. Yet the evil entrepreneur will take advantage of simpletons such as me; those not as wise as the connoisseur. To think, someone is actually selling a machine that does not generate sufficient pressure, produces water outside the preferred temperature, and whose crema (reddish-brown foam) sinks rather than floats.
You as the connoisseur, and I as the cheapo, simply disagree. Our preferences differ yet go satisfied in the free market.
Herein lies the contrast between the free market and interventionism. I simply want to enjoy affordable espresso. Nothing fancy, just a little flavor and lots of kick. Absent regulations, the market is there to satisfy. Add the "expert" into the mix, and now I'm forgoing my morning cup because the product I want to buy, and the product an entrepreneur is willing to produce, do not meet some arbitrary standard.
Arbitrary standards are the product of government. Whether in education or automobiles, the politician and bureaucrat create silly standards that satisfy some political or personal agenda; standards that fail to satisfy the desires of the consumer.
Sure, to the connoisseur, I've been ripped off, and to the regulator — the politician and bureaucrat, I'm in need of protection. Yet, I enjoy this fraud every morning, and on the occasional weekend afternoon.
Pope Francis and Ludwig von Mises do not see eye-to-eye on the value of consumer choice. The Pope condemns what Mises defends, and their disagreement goes beyond the obvious.
As everyone knows, the Pope condemns what he calls “consumerism.” In a speech delivered in 2015, for example, he said: "Today consumerism determines what is important. Consuming relationships, consuming friendships, consuming religions, consuming, consuming... . Whatever the cost or consequences. A consumption which does not favor bonding, a consumption which has little to do with human relationships. Social bonds are a mere 'means' for the satisfaction of 'my needs.' The important thing is no longer our neighbor, with his or her familiar face, story and personality.” People spend too much on material goods, he claimed, and ignore what really matters in life. Why spend money on useless fripperies like household pets and cosmetics?
Mises of course did not know Pope Francis, but he long ago responded to those who raise this sort of complaint against free-market capitalism. Capitalism, he pointed out, is a system of mass production for the masses. It gives people what they want, so long as what they want can be profitably produced. If you do not like what people want, do not blame capitalism. As though he had read the Pope’s remarks, he says in The Anti-Capitalistic Mentality, “Nonetheless many people, and especially intellectuals, passionately loathe capitalism. As they see it, this ghastly mode of society's economic organization has brought about nothing but mischief and misery. Men were once happy and prosperous in the good old days preceding the 'Industrial Revolution.' Now under capitalism the immense majority are starving paupers ruthlessly exploited by rugged individualists. For these scoundrels nothing counts but their moneyed interests. They do not produce good and really useful things, but only what will yield the highest profits. They poison bodies with alcoholic beverages and tobacco, and souls and minds with tabloids, lascivious books and silly moving pictures.”
Mises responds that capitalism is a system of mass production for the masses. It gives people what they want, so long as it is profitable to do so. “The characteristic feature of modern capitalism is mass production of goods destined for consumption by the masses. . . On the market of a capitalistic society the common man is the sovereign consumer whose buying or abstention from buying ultimately determines what should be produced and in what quantity and quality.”
It is exactly at this point that the opposition between Mises and Pope Francis deepens. Whether the Pope has read Mises I do not know, but he is familiar with the argument Mises gives. His response is that even if capitalism does give people what they want, it is still deficient. What Mises considers a virtue of capitalism is in fact a vice. The Pope says, "The result is a culture which discards everything that is no longer 'useful' or 'satisfying' for the tastes of the consumer. We have turned our society into a huge multicultural showcase tied only to the tastes of certain 'consumers',”
In brief, it is wrong to give consumers what they want if they want the wrong things. To answer the Pope, we need to address two points. First, even if people do choose badly, are they not acting within their rights? To coerce them into a simpler and less materialistic style of life would be to interfere with their freedom to spend their money as they wish.
Of course, the Pope could, and no doubt would, answer this by denying that people have robust property rights. Rather, the spending they are permitted to indulge in must be guided by the “common good.”
Here, though, the Pope would need to confront another problem to which Mises called attention. After citing several theologians with views of capitalism like that of Pope Francis, Mises pointed out: “They fail to recognize the speculative character inherent in all endeavors to provide for future want-satisfaction, i.e., in all human action. They naively assume that there cannot exist any doubt about the measures to be applied for the best possible provisioning of the consumers. . .The advocates of a planned economy have never conceived that the task is to provide for future wants which may differ from today’s wants and to employ the various available factors of production in the most expedient way for the best possible satisfaction of these uncertain future wants.” ( Human Action, Scholars Edition, p.672) In brief, the Pope would have to solve the socialist calculation problem.
The argument just given is that even if the Pope is right to criticize consumerism, he fails to indicate a workable alternative system. One can also, though, criticize the Pope’s argument more directly. Is it in fact bad for people to spend vast sums of money on consumer goods? Lew Rockwell has ably argued that it is not. “Sure, it's easy to look at all this and shout: ghastly consumerism!. . . Maybe you think quality of life is no big deal. Does it really matter whether people have access to vast grocery stores, drug stores, subdivisions, and technology?. . . Consider life expectancy in the age of consumerism. Women in 1900 typically died at 48 years old, and men at 46. Today? Women live to 80, and men to 77. This is due to better diet, less dangerous jobs, improved sanitation and hygiene, improved access to health care, and the entire range of factors that contribute to what we call our standard of living. Just since 1950, the infant mortality rate has fallen by 77 percent. Population is rising exponentially as a result.
It's easy to look at these figures and suggest that we could have achieved the same thing with a central plan for health, while avoiding all this disgusting consumerism that goes along with it. But such a central plan was tried in socialist countries, and their results showed precisely the opposite in mortality statistics. While the Soviets decried our persistent poverty amidst rampant consumerism, our poverty was being beaten back and our longevity was increasing, in large part because of the consumerism for which we were being reviled.”
I was having an interesting discussion via email about one of Walter Block's arguments. A quick summary. Block says that just as nature abhors a vacuum, libertarianism "abhors" unowned property; that the "whole purpose" of homesteading is to bring hitherto unowned virgin territory into private ownership.
Block imagines someone who homesteads a donut-shaped circle of land, and won't let anyone use his land to get to the unowned property in the middle of his donut. He argues that libertarian homesteading theory "abhors" land which cannot be claimed nor owned because of the land ownership pattern of a "forestaller"--a person who has encircled the land. In other words, if your property is somehow "necessary" for others to use, to get to unowned property, they have a sort of easement over it.{C}(Block argues this in Libertarianism, Positive Obligations and Property Abandonment: Children's Rights; "Roads, Bridges, Sunlight and Private Property: Reply to Gordon Tullock," Journal des Economistes et des Etudes Humaines 8, no. 2/3 (June-September 1998): 315-26; and other publications, such as some of his articles on abortion: e.g. "Terri Schiavo: A Libertarian Analysis"; "Compromising the Uncompromisable: A Private Property Rights Approach to Resolving the Abortion Controversy"; "Stem Cell Research: The Libertarian Compromise"; "Abortion, Woman and Fetus: Rights in Conflict?"; "Toward a Libertarian Theory of Abortion.")
Now his purpose in making this argument is to make an argument about the duty of parents to notify others that they are abandoning their kid and to let them come rescue the child, but we are talking here about his "forestalling" argument itself.
As best I can understand it, Block's "forestalling" conclusion seems to be incorrect. It would imply a general easement right over everyone's property on behalf of everyone else if they "need" that property to "get to" some other property they want to be on. I see no special status of the unowned property; it's just property someone would like to go homestead. If they can't reach it, it's not the fault of those who have this resource surrounded.
In other words, after Rothbard, Hoppe (p. 246) and de Jasay (p. 91) have buried the Lockean proviso, Walter gives us a new one: the Blockean Proviso. The Lockean Proviso says that you may homestead an unowned good but only if "enough and as good" is left for others--that is, if you don't harm them by your homesteading action by making it more difficult for them to have a similar opportunity to homestead some goods of that type. Both Block and I would reject this. But the Blockean Proviso would say that you can only homestead property that is a potential means of access to other unowned resource so long as enough and as good access to the unowned resource remains available!
We can generalize this Blockean Proviso: You can only homestead property that is located between two arbitrary external locations A and B, where some third might potentially want to travel over the property to travel from A to B.
From comments to me, Block also seems to believe that if you own a circle of property and some people live in the territory inside the circle, you are "trapping" them if you don't let them use your property to "leave" the circle. This comment seems to confirm my concerns about his view and how it could be generalized to some kind of "necessity-easement" not limited to the homesteading case.
Let's imagine a rectangular island with 3 people: A, B, and C. B owns the middle stripe, A and B own the pieces on the ends. Suppose A wants to visit C. He has to cross B's property. He has a right to visit C, if C invites him, and if he has a means of getting there. But he has no means of getting there. So?
I assume Block would agree with me in this above example--that A has no easement over B's property; that he can only visit C if B permits him to. But in Block's theory, if C dies, all of a sudden this confers to A an easement-over-B's-land! How can this be?
Let me close with a final quote from Hoppe, pointed out to me by Johan Ridenfeldt:
In fact, what strikes Conway as a counterintuitive implication of the homesteading ethic, and then leads him to reject it, can easily be interpreted quite differently. It is true, as Conway says, that this ethic would allow for the possibility of the entire world's being homesteaded. What about newcomers in this situation, who own nothing but their physical bodies? Cannot the homesteaders restrict access to their property for these newcomers and would this not be intolerable? I fail to see why. (Empirically, of course, the problem does not exist: if it were not for governments' restricting access to unowned land, there would still be plenty of empty land around!) These newcomers come into existence somewhere - normally one would think as children born to parents who are owners or renters of land (if they came from Mars, and no one wanted them here, so what?; they assumed a risk in coming, and if they now have to return, tough luck!). If the parents do not provide for the newcomers, they are free to search the world over for employers, sellers, or charitable contributors -- and a society ruled by the homesteading ethic would be, as Conway admits, the most prosperous one possible! If they still could not find anyone willing to employ, support, or trade with them, why not ask "What's wrong with them?" instead of Conway's feeling sorry for them? Apparently they must be intolerably unpleasant fellows and had better shape up, or they deserve no other treatment. Such, in fact, would be my own intuitive reaction.Hoppe, Four Critical Replies, last page.
Now, it's interesting that Hoppe here criticizes the state for restricting access to unowned property -- but Block is criticizing private actors who do it... In any event, as Johan noted, the "tough luck!" line is key here. It is not directly relevant, only tangential, but the view expressed here seems to be compatible with my view that there is not any special problem if a would-be homesteader is unable to arrange for the permissions he needs to reach the target unowned resource.
Thoughts?
Update: Is Fermilab's Tevatron unlibertarian for encircling a plot of land (and presumably preventing access to it to minimize traffic vibrations interfering with the particle smasher's operation).
Update: My comment below refers to Roderick Long's post Easy Rider: my comments to that have the following updated link: http://aaeblog.com/2007/09/11/easy-rider/comment-page-1/#comment-30130.
In Justin Raimondo's fun and lively book Reclaiming the American Right: The Lost Legacy of the Conservative Movement, he makes an argument that I did not find convincing. He argued that Rand's 1957 novel Atlas Shrugged was clearly influenced by the 1922 Garet Garrett novel The Driver—that Rand never acknowledged this "source" and that if this was not quite plagiarism, then "Rand's silence on this subject amounted to a deliberate deception." I've never been convinced by this conclusion. There is no doubt that Atlas, whatever else may be said about it, is original. Even if Rand was influenced by Garrett, there is simply no case to made for plagiarism or deception. Yet the question of whether Rand did read The Driver is of interest. There are, as Raimondo points out, some thematic similarities between the novels. In Reclaiming, Raimondo he says that "the clearest evidence, albeit circumstantial, that Rand did indeed read The Driver" is a certain "stylistic device." That is, the question "Who is Henry Galt?", which is similar to Atlas's repeated line, "Who is John Galt?"Raimondo concludes, "From the overwhelming mass of evidence it is clear that Rand was influenced by Garrett. The similarities between The Driver and Atlas Shrugged are too numerous and too detailed to be coincidence." As noted, I find the deception/quasi-plagiarism charge to be completely unconvincing, but I was not even persuaded of the contention that Rand had even been influenced by Garrett (not that there would have been anything wrong if she had). But I just came across Garrett's Cinder Buggy: A Fable in Iron and Steel, a novel that
"chronicles the transformation of American industry from the age of iron to the age of steel." "The plot concerns an ongoing war between two industrialists, one the hero who is beaten in the first generation and the other who is malevolent but initially wins an ongoing struggle. The struggle continues through the second generation, which leads to the titanic struggle over whether steel or iron would triumph and why."Hmm. A steel industrialist. Hmm. One of the major characters in Atlas is Hank Rearden (2):
Iron-willed inventor, and founder of the Rearden Steel empire, Hank Rearden is, with Francisco and Galt, one of the novel's three major heroes. Rearden's quest to understand and resolve his moral and emotional conflicts is central to the plot. His revolutionary new alloy, Rearden Metal, makes him a target of predators in government, industry, and his own family.Yet another similarity? Maybe. I suppose—though I'm still not convinced—Rand may have read Garrett's novels, and the themes and use of industrialists (railroad; steel) may have influenced her. (I'm not sure I see any links, though, to Satan's Bushel, the third of Garrett's trilogy.) Food for thought. Update: Comments I wrote a friend about this:
I never read Garrett but from the way Raimondo described it, it was obvious that the argument for "plagiarism" is not only strained, but undefined. Ihis is the problem with intellectual property and related concepts. As an IP lawyer there is no doubt whatsoever in my mind that there is not a bit of a copyright infringement by Rand here. Even if she did read the driver even if she did adopt some of its motifs and even overall plot ideas. None. This is perfectly permissible. And I do not think she even read it. Why would she intentionally use the same name as the hero of that novel? It makes no sense. She wanted to be original. So all you have left is "plagiarism." But what is plagiarism? Another nebulous, undefined concept, bound up in the idea of IP. Real plagiarism is turning in a paper someone else wrote, with your name on it—that is, dishonestly pretending you are the author of something you are not. What in the world has this got to do with being influenced by others? EVERYONE is "influenced" by others. Rand's story is undoubtedly original. Therefore, it is not only clearly not copyright infringement, it is not plagiarism. You'd have to say Garrett wrote the story and she put her name on it. Rand obviously didn't do this. IP is influencing all this. For copyright we say you "stole" the other's work—"used it" "without permission". For plagiarism you "stole" someone else's work—put it forward with your name on it as if you wrote it; i.e., "stole" here means you LIED. All this mushy-mouthed reasoning, overuse of metaphors,imprecise use of concepts leads to equivocation. So all we have left is "failure to give attribution." But what clear ethical or scholarly rule requires the author of a NOVEL to drop fricking footnotes saying "I was influenced by XYZ on this theme/plot device"? I guess if you fail to drop a footnote to the right reference it's "theft" now?? If you are "influenced" by someone else, it's "theft." If you fail to drop a footnote admitting to your "theft," you are "deceptive" or a "plagiarist" to boot.IP corrupts everything.Appendix: Notes on Raimondo's Comments on Atlas and The Driver From p. 199 of Reclaiming the American Right:
"There is a second, and deper, level on which the assertion of Rand's utter uniqueness is a lie. ... The Randian claim to have given birth to a philosophy without antecedents, which amounts to an Objectivist version of the Virgin Birth, is proved false by the fact that Rand's novel, Atlas Shrugged, bears such a strong resemblance to Garet Garrett's 1922 novel The Driver, that there arises a real question as to whether Rand passed the boundaries of acceptable behavior in "borrowing" a little too much."Raimondo alludes to "the clearest evidence, albeit circumstantial, that Rand did indeed read The Driver" is a certain "stylistic device." He mentions Rand's "intellectual and artistic debt to Garet Garrett". More:
"From the overwhelming mas of evidence it is clear that Rand was influenced by Garrett. The similarities between the Driver and Atlast Shrugged are too numerous and too detailed to be coincidence. This is not a question of plagiarism. What is really at issue is the authenticity of Rand's claim to stand not at the end but at the beginning of a tradition. The Driver proves beyond the shadow of a doubt that this is untrue. The only question is whether this was a conscious lie on Rand's part." "My own theory is that Ayn Rand knew perfectly well what she was doing, and did not regard it as appropriating anything. ... I believe Rand never acknowledged Garrett as a source for two reasons. ... she probably considered him to be a minor writer whom she certainly did not intend to imitate or plagiarize, but only to improve on. ... while not plagiarism in the legal sense, the unacknowledged and—in my view—conscious use of Garrett's work as a starting point for her own does, in this case, constitute intellectual fraud." Rand's silence on this subject amounted to a deliberate deception. ... this is not a case of word-for-word plagiarism." See also p. 322 (middle paragraph) of The Age of Rand: Imagining an Objectivist Future World. Sciabarra writes:"4. Some of Walker's insights are original, including, for example, a unique, though improbable, thesis about the origins of Rand's chosen name (278). However, Walker too often reiterates points made by others: First, he mentions John Gall of the National Association of Manufacturers, with whom Rand corresponded, as a possible model for John Galt. Then he repeats Justin Raimondo's unsupported claims that Rand plagiarized Garet Garrett's The Driver. Neither Walker nor Raimondo suggest any similarity between the hero of Atlas Shrugged and the real-life John Galt, an "unusual type" of nineteenth-century "entrepreneur with talents in poetry and writing," who was involved in North American railroad investments. See Thomas E. Appleton's Ravenscrag: The Allan Royal Mail Line (Toronto: McClelland and Stewart, 1974), 63-64. Rand, of course, may not have even been aware of her character's real-life namesake. Thanks to Larry Sechrest for bringing this to my attention."
The last few days, I've seen so many things on Mises.com that I wanted to blog here, but there's really way too much: the best thing is to get over there now and get involved in what is turning out to be a wonderful conversation about liberty and economics. In any case, I do want to draw attention to this post and this picture: one of six Mises stickers on this car. Someone ask why he obeys speed limits if he is against government.
Response: "I drive at safe speeds out of respect for other people and their property as well as keeping my own person and property safe."
Ludwig von Mises is sometimes criticized for having a weak ethical component in his theory of praxeology. His basic idea, as he famously developed it in Human Action, is that people act. By this he means that every purposive behavior is aimed at replacing a less satisfactory state of affairs with a more satisfactory one. It is impossible to perform an action that would not be directed toward increasing the actor's satisfaction (or happiness). What we do represents our preferences. Of course, we can regret what we did, but can we regret what we are doing? I am not regretting that I am writing this article at this moment. If I were regretting it more than enjoying it, I would just stop writing. So, when we continue in our actions, it is our free choice. Hence, we cannot but want to do that which we do.
What about coercion? Obviously, we can be coerced to do something — which means that we would not do something voluntarily. For example, when somebody threatens us with a knife. But however brutal this might sound, it is still we who decide what to do — either we do what the aggressor wants us to do or we risk being killed. Insofar as we act, we prefer the action that is being performed to another that is not. What we do at a given moment, we choose to do in order to replace a less satisfactory state of affairs with a more satisfactory one. Or, as in the case of coercion, we chose not to worsen our situation — in other words, to stay alive.
This theory is valid regardless of the character and motives of our acts. Our values are subjective. They are ours. Even if objective ethics exist — as natural law libertarians, among others, believe — the values of a particular person are his subjective values. Everybody is free to have the values he wishes to have. Whatever we do, it is because we decide to do it. And we decide to do something because we prefer to do it, rather than not to do it. It is always in our interest to act in the way we do. Even when we are moral heroes, such as when we sacrifice ourselves for others, it would be false to say that we do not value or prefer the activities we perform. In other words, we can act altruistically, but even then we have to act to some extent in a self-oriented way.
This thesis has given rise to numerous protests from philosophers, theologians, and other representatives of the social sciences and humanities. One example is the following:
For instance, Mises is hard-pressed to explain a person's charitable action without expectation of payment or reward. According to Misesean praxeology, such an action must be motivated by the desire of the person to ameliorate an uneasiness. The person thus gives charitably to soothe a guilty conscience, or to ease the pain of viewing a person in need, or simply to feel the satisfaction of having helped someone.G. R. Beabout, R. F. Crespo, S. J. Grabill, K. Paffenroth, K. Swan, Beyond Self-Interest: A Personalist Approach to Human Action (Lexington, Mass.: Lexington Books, 2002), p. 100.Such protests are motivated by two notions. The first is that Mises was an ethical relativist. To some extent he was, but at the same time he was a utilitarian and a devoted supporter of classical liberalism. He believed that laissez-faire policy was the best way to promote the welfare and well-being of people. He preferred peace to war, wealth to misery, and truth to falsehood. But it is the second of the two notions — that Mises advocated the radical leveling of all values as such — that seems to underlie the whole critique of Misesean human action.
Almost everybody values charitable activity more than radical selfishness. We admire moral heroes and try to follow them. We would like to be as virtuous as they. But Mises argued that our actions are oriented toward alleviating uneasiness or satisfying desires, that when people do something for others, in fact they do it for themselves. It is easy, then, to conclude that the Misesean idea of human action is cynical, and even derogative.
But we do not need to interpret human action in this way. What Mises taught is only that every human action is directed toward satisfying the desire of the actor. Nevertheless, by accepting Mises's standpoint, we are not required to perceive people's activity exclusively in terms of the satisfaction of their desires. That our actions make us better off does not imply that they cannot be assessed as valuable by others, too (here I refer to strictly ethical valuation, different than that in catallactics). Helping others can be very satisfying and make us happier, but we should remember that we are not the only ones who can evaluate our actions and benefit from them. Other people also observe our actions and judge us according to what we do. There are no obstacles to our believing that people who help others do better than those who do not. The fact that they make others happier as well as themselves does not make it impossible to regard their actions as much better than, for instance, laughing at the poor.
More importantly, we can say that people who enjoy helping others are on a high moral level, because, for example, they have spent their time on self-development, have flourished more and better, or have gained ethical knowledge. Thanks to this, they now have a better developed system of values and can be seen as doing better than others. So, we can accept both Mises's conception of human action and a sound ethics/morality, so that there is still a place for right and wrong. And we can still promote some values while condemning others.
Praxeology is not ethics. If we believe that there is an objective moral code to which we should adhere, we can still judge one human action as being better than another, even though we know that we cannot but prefer what we do. All in all, is it not good that we feel good when we do good?
Elisabeth Tamedly (Lenches), author of this wonderful treatise that we just posted, also contributed an interesting piece found here. She writes:
Church leaders often call on their flocks to live a life of service to God "regardless of cost." This exhortation flies straight in the face of economic thinking — and reality. Believers, to be sure, fully intend to live up to this ideal while in church, as reflected by their hymns and prayers. But their everyday behavior tells a different story. The connection between these two life spheres is often tenuous and sometimes non-existent. No wonder hypocrisy is the accusation most often leveled against Christians. Economists point to the inevitability of this conflict between idealism and reality, but they also offer ways to bridge the chasm between them.We live in a world in which our wants are greater than the available resources (land, labor, factories, etc.) to satisfy them. Economists call this fact "scarcity." Our plight B the "human condition" — forces us to cope with scarcity as best as we can, i.e. to "economize". This means that we are faced with alternatives and must constantly choose between them. We tend to choose the options that bring us the greatest satisfaction. The value of the next best alternatives that we have to give up represents the costs that we incur whenever we make a decision. Economists refer to them as "opportunity costs." So every choice involves a comparison between benefits and costs. Our wants may be material (buying a car) or immaterial (helping the homeless); what counts is that their fulfillment requires scarce resources that have alternative uses. Economists study how we make these unavoidable trade-offs.Nations as well as individuals are plagued by scarcity. When a country wishes to increase its means of production, it can do so only by diverting resources that could otherwise be used to satisfy its citizens' everyday wants (consumption). Developing countries, for example, can build up their capital stock only by channeling resources away from an already low level of consumption. This is why poor nations seem to become even poorer before they can begin to enjoy the fruits of economic development.We as individuals experience scarcity by not having enough time and money. When we go to a movie, the dust on our furniture remains undisturbed; when we take that dream vacation, we must do without the home video system we also crave. We just can't "have it all." So we are forced to make choices and incur unavoidable costs. Economists view a "rational" choice as one for which the expected benefits to the decision maker are greater than the expected costs. There are no objective costs — and benefits, for that matter. Both depend on our valuations. Even if costs can be expressed in monetary terms, such as prices, the true cost to us is the value of what we sacrificed by spending our money — or time — one way rather than another. Both suppliers and consumers respond predictably to changes in benefits and costs. This predictability is the basis of the law of supply and demand.Human conduct is therefore an incessant sequence of choices: big choices and small choices, conscious and unconscious ones. The way we choose is, to repeat, determined by our valuations, not by some absolute, calculable standard. It may come as a surprise to learn that economics is about people's valuations, not about physical quantities.What, then, determines our valuations? One thing and one thing only: our "self interest." At this point some believers may want to part company with economists. Isn't the Bible teaching precisely the opposite: to disregard our self-interest in the service of God? How, then, can a committed Christian like myself also be an economist?That's because economic science, the study of self-interested choices in an environment of scarcity, accurately describes and predicts the broad outcomes in all human spheres, including religious ones. Churches, after all, require their members to contribute money and time, which have alternative uses and are therefore scarce. They can thus be provided only at a cost, which limits the amount of both that believers are willing and able to "supply." When Christians refuse to think in the "unholy" terms of the economist, they pay a high price, because they are giving up a proven, indeed the only proven, method of understanding and explaining human behavior. What gives?We need to specify the meaning of "self interest." Much confusion is caused by debates in which key words are left undefined, especially when everyone "knows" what they mean. Isn't self-interest synonymous with selfishness and greed? Doesn't it follow (just think about all the folks who regularly donate to charities!) that the economists' contention that human behavior is guided by selfishness and greed cannot be generally valid?No, it does not, when we use a broader and more realistic definition. Our self-interest is ultimately governed by the goals (both short-term and long-term) that we have set ourselves and the projects that we wish to accomplish to reach these goals. But how are these goals and projects determined? For answers to this important question, we must look beyond the realm of supply and demand and consider such factors as the families individuals grew up in, as well as their cultural, moral, and religious backgrounds. Many of us are, indeed, consumed by the goal of making it in this world; but others are motivated by compassion for their fellow humans (and even animals) and are thus willing to use their resources to alleviate their suffering (Mother Theresa). We are all at different points on the continuum between these extremes. Our self-interest is a mixture of selfishness and the willingness to share our resources with others, a mixture that is changing and evolving.When the Bible admonishes us to accumulate treasures in heaven, it does not negate our self-interest. In fact it appeals to it by promising us future rewards. In the here and now, Christian life is a process in which we are asked to continuously re-evaluate our self-interest; to keep nudging our goals toward becoming more loving and compassionate, to attach an ever greater value to giving and sharing and an ever smaller value to what we have to sacrifice. However, we cannot abolish scarcity and therefore costs. They will continue to limit our ability and willingness to live a life in the service of God.Only if we accept this reality as God-given, only if we integrate its constraints into our daily lives, will we be able to experience the joy of our Christian faith and avoid the charge of hypocrisy. Because the ultimate truth for a believer — and the one which connects biblical with economic thinking — is the insight that living in accordance with the teachings of Christ is in our long-term self-interest.Elisabeth Tamedly Lenches, Ph.D. San Marino, California, June 2003
Conscription, also known as "the draft," is typically justified with appeals to values like partriotism, public service, and "sharing the burden." That's in peacetime. In times of war, of course, government claims conscription is necessary to provide the manpower needed for military victory.
Apologists for the draft keep all of these claims ready, just in case. The US, of course, has never really let go of the draft and continues to maintain the Selective Service, just in case.
Is Conscription Good for the Economy? But sometimes, is it even claimed that conscription is an economic-development tool.
In the latest attempt at making conscription more popular among politicians, Elizabeth Braw of the Atlantic Council this week announced in the Financial Times that the benefits of conscription are "economic as well as military."
Braw proceeds to argue that even though many young people might "view military service as a burden" the state is nevertheless justified in forcing them into military service for their own good. According to Braw, involuntary servitude in the military "helps their careers" and because "military service develops general skills useful “in any sector, such as adaptation, managing and social skills."
Braw even goes so far as to call conscription an "investment" in the way that pro-tax politicians have taken to calling tax increases "investments" in recent years.
This sort of Orwellian double-speak probably sounds impressive to some policymakers in search of technical-sounding economics buzzwords to help them justify reintroducing the draft. However, when governments force people into military service and confiscate 100% percent of their labor for a period of years, it's nothing more than just another tax and another burdensome regulation. As I noted in an article titled "Conscription and Other Draconian Taxes":
“Conscription is slavery,” Murray Rothbard wrote in 1973, and while temporary conscription is obviously much less bad — assuming one outlives the term of conscription — than many other forms of slavery, conscription is nevertheless a nearly-100-percent tax on the production of one’s mind and body. If one attempts to escape his confinement in his open-air military jail, he faces imprisonment or even execution in many cases.
Conscription remains popular among states because it is an easy way to directly extract resources from the population. Just as regular taxes partially extract the savings, productivity, and labor of the general population, conscription extracts virtually all of the labor and effort of the conscripts. The burden falls disproportionately on the young males in most cases, and they are at risk of a much higher tax burden if killed or given a permanent disability in battle.
And, like all other types of taxation, conscription is not an "investment" or an opportunity to build wealth. It is merely a transfer of wealth away from private individuals and into the hands of public-sector central planners.
A Typical "We Know Best" Attitude The central conceit of Braw's argument is that the government knows better than young people as to what is the best way for them to spend their time. Some people think their early 20s are best spent working at the family business or building job experience in a specific field? Braw disagrees: They're wrong, and they don't know whats' good for them.
Instead of allowing young people to determine for themselves how they might best contribute to their own careers or to their families, the government will decide for them how to spend their time and their energy.
RELATED: "What's the Correct Number of Women Commandos?" by Matt McCaffrey
Braw dresses this reality up in the language of economic development. Conscription means conscripts can (eventually) "boast impressive skills on their CVs" and "the economy will win too."
In other words, Braw claims it is justifiable to force young people into military service because "the economy" benefits from the time, and opportunities extracted from young people as conscripts.
It is fitting that Braw is framing this as an economic development issue, because this is the same faulty argument that politicians employ when they claim that taxpayer should be forced to cough up more in taxes because an imaginary entity known as "the economy" will benefit from a shiny new taxpayer-funded sports stadium or convention center or light-rail system.
In that case, the attitude is this: "you rubes don't know how to spend your money properly. What this town needs is a new convention center to help the economy. You people will just blow that money on your families if we let you keep it."
The same is true of any other sort of central planning as well. Governments will claim that the taxpayers don't know how to spend their money properly, so taxation is necessary to fund scientific research, or high-speed rail, or a mission to mars, or a transcontinental railroad.
A Net Loss in WealthThe problem with all of these schemes is the some problem that has always plagued central planning schemes. Instead of allowing countless market participants to use their time and talents freely — in a myriad of different ways — central planners will decide for them.
By taking money away from plumbers, office workers, and computer programmers — and handing it over to a government-funded project — the state is forcing the taxpayers to fund a project they would not have otherwise funded. That is, they've been forced to spend their money on a sub-optimal use of wealth. Had it been optimal for the taxpayers, they would have spent that money on a similar project voluntarily.
The same is true of conscripts, of course. Instead of allowing young people to engage in the activities they value most, conscription forces them to serve in the military instead. Those young people might have wanted to build a business during that time, or engage in scientific study. Instead, they're forced to devote their time and energy to projects and activities that are suboptimal to them. Had military activities been optimal, those people would have enlisted in the military voluntarily.
The net outcomes of all of this is a sizable decline in real wealth within the affected society. When plumbers, office workers and computer programmers are allowed to keep their money — and spend it on things they value — they build real wealth. Yes, that wealth remains largely invisible because politicians can't point to a shiny new facility that's allegedly good for the economy. It may be the plumber bought a new van for his work. Or the office worker installed a new water heater at home.
That's pretty un-sexy stuff, so central planners think they know how to spend that money better.
The same is apparently true with Elizabeth Braw and her ideas for helping the economy by forcing young people to forgo years of earning potential and skill-building outside the military because she decided that being in the military is best.
There is no better sign of the NFL’s domination of the American sports landscape like the phenomenon of the NFL draft. The event, which is essentially a glorified business meeting, has evolved from a one day affair held in a smoke-filled single hotel conference room into a made-for-TV spectacle. Not only does it annually dominate the competing NBA playoffs in television ratings, but in 2014 more people watched the first round of the draft than either Game 7 of the World Series or any NBA championship game.
In America, democracy may be a failing god -- but NFL is king.
The NFL draft also happens to be my favorite time on the sports calendar, in part because it is also a great illustration of many foundational economic concepts relevant to Austrian economics.
Subjective Theory of ValueFor those who may be unfamiliar, the NFL draft is the process in which NFL teams take terms selecting new players entering the league – mostly made up of former college football stars. While the process itself takes place over the course of three days, the real action happens in the prior months as teams of scouts, coaches, and front office executives go around the coaching watching games, testing players, and conducting in depth investigations into the lives of the people their franchises are considering making a significant financial investment in.
What’s important to note here is that, for the most part, every team has the potential to access most of the same information about each player. All teams can look at how fast a player can run a 40 yard dash, see the same game film, have the ability to interview potential players, etc. While each franchise has equal access to this raw data, it is how teams are able to interpret it that separates the Cleveland Browns from the New England Patriots.
Or, as Ludwig von Mises put it in Bureaucracy:
There are no such things as absolute values, independent of the subjective preferences of erring men. Judgments of values are the outcome of human arbitrariness. They reflect all the shortcomings and weaknesses of their authors.The subjective values of each team leads to a wide variety of opinion on almost every player in the draft. Prior to, each organization builds a draft board reflecting the internal rankings of how each team evaluates the prospects. Some of these differences stem directly from team strategy. For example, a defensive lineman may fit a 4-3 defense scheme better than he would fit a 3-4 front. Some running backs are better equipped for a zone blocking scheme over others. Some teams have firm requirements on physical measurements, refusing to draft a player at a certain position who doesn’t reach a specific height or have a specific 40 time. Just as consumers in the market have their own unique preferences when it comes to purchases, each franchise has their own list of what they look for in a player.
Every year you can count on a draft story involving a team drafting a player much higher than draft pundits or the rest of the league values them. The late legendary Raiders owner Al Davis became infamous for drafting players early based on their 40 time or other prized physical attributes. In 2009, ESPN’s Mel Kiper ripped the Raiders for drafting a safety, Mike Mitchel, he considered undraftable in the 2nd round. Mitchel has gone on to have a strong NFL career, a vindication of Davis’s evaluation process.
Of course sometimes factors that have nothing to do with the football field can have an impact on the value a team places on a player.
Legend has it that a key factor in the Cleveland Browns decision to draft quarterback Johnny Manziel during the 2014 draft was that the owner, Jimmy Haslam, was approached by a homeless man who begged for him to draft the former Heisman trophy winner. To Haslam, the excitement from the public to bring in the scintillating “Johnny Football” was too great a value for the team to pass up – even though the team’s own scouting department had identified Teddy Bridgewater as a better professional prospect. Two years later, Johnny Manziel currently is out of the league – demonstrating that Haslam’s valuing of factors outside of the game of football was an example of bad entrepreneurial judgment.
General Managers as EntrepreneursOf course entrepreneurship is what the draft is really all about.
As Peter Klein writes in The Capitalist and the Entrepreneur:
Entrepreneurs rely on judgment, or what Mises calls understanding. Understanding is intuitive, subjective, and qualitative, and thus inherently imperfect.Whether it be the owner, the general manager, or the head coach, whoever has the final say on draft day is making a judgment in the face of uncertainty that they hope will benefit their organization.
Every draft selection carries risk. Some have been mentioned above – scheme fit, or the having the physical talents necessary for pro ball. Injury history is important, with accomplished players sometimes watching their draft stock fall due to concerns over chronic health issues. Some players have red flags for off the field behavior, and each team has their own judgment on how many red flags they are willing to overlook in selecting a player.
In his book The War Room, Michael Holley looks at the draft process of Bill Belichick and compares it to that of two of member of his Patriots staff that went on to become NFL GM’s, Scott Pioli and Thomas Dimitrioff. The entire book is a fascinating look at the evaluation process of three competing entrepreneurs and the unique way each men evaluating talent, including their willingness to take on risk. As Holley wrote:
When Dimitroff was with the Patriots, he could watch the same film as Scott Pioli and Bill Belichick and sometimes the three of them would walk away seeing different things. He had learned a lot of football and management from them both, but becoming them was never the point; he was an extension of a Belichick Tree, not a Belichick Monolith.The book highlights, for example, how Bill Belichick was willing to select a player with a history of red flags that caused him to be removed from the draft board of Thomas Dimitrioff. The player in question was Aaron Hernandez, a talented tight end who had a highly productive NFL career before being convicted of murder.
A proper understanding of entrepreneurial judgment also demonstrates the nonsensical nature of trying to “grade” a draft class immediately. As Peter Klein puts it:
Final judgments about success and failure can be made only ex post, as the market process plays itself out.In the case of football, the market process happens when the actual games are played. It’s humorous to see draft pundits fall guilty of their own "fatal conceit" by pretending to be able to predict the future performance of new professional players. Mel Kiper, along with a variety of other sports media, was highly critical of the Seattle Seahawks 2012 draft class. Two years later, the Seahawks won the Super Bowl in large part due to the performance of quarterback Russell Wilson and linebacker Bobby Wagner – both members of what is now considered an elite draft class.
All of this is a reminder that economics is all around us and, as Mises wrote, “must not be relegated to classrooms and statistical offices and must not be left to esoteric circles.” It doesn’t matter if it is trying to create a start-up, building a professional sports team or trying your luck at romance, we are all entrepreneurs in life and all can benefit from thinking like an economist.
Especially if you’re a Cleveland Browns fan.
Gentrification gets bad press. It would appear that the gentrifier (he who engages in gentrification) is a malign exploiter, a bully, someone who takes advantage of the weak and the poor. And these are the nice things said about him.
What is the case against this practice? First and foremost, it pushes previous residents out of their homes. These people may have lived in their neighborhoods for years. They may be the third or fourth generation to occupy these premises. But when someone comes along, flashing big bucks, it is game over: the occupants have to vacate. What is the means through which the gentrifiers do their evil deeds? They simply try to purchase real estate in the target area, or attempt to rent accommodation there, thus bidding up rents and sale prices higher than would otherwise exist. The locals cannot compete with these hyped up rates, and are forced to retreat. Where do they go? Who knows? But wherever it is, they now occupy less preferred real estate. We know this since if they liked their new domiciles more than their previous ones, they would have already moved there, without any pressure being placed on the market by the new gentry. And it not only homes those forced to leave lose out on. These houses are part of neighborhoods, communities, associations. They have a history there. Their children are wrenched away from their friends.
Who are the main guilty parties in this sad story? College students who often have more money than the people they replace (or at least their parents do). When the Olympics come to town, people are moved en masse to make way for the new stadiums, swimming pools, ball fields, etc. Ditto for the World’s Fairs. They, too, export inhabitants with a long history, willy nilly. They, too, eradicate cultures and communities that were thriving before the rampage took place. Although this will not be politically correct, and we shudder to even mention it so beholden are we to the modern dictates and proprieties: urban-affluent homosexual men are also often offenders in this regard.
There are grave problems with the account offered by opponents of gentrification. Before we begin with our analysis, let us make one important distinction, that between owners and renters in the target area. The former are in a far better position than that latter. Yes, when this process occurs, they, too, will leave the neighborhoods they have come to treasure over the years, but it will be “voluntary.” That is, they will have so much money thrust down their throats that they will prefer their new digs to their old ones. Otherwise, they will stay put, and not be “run out of town” by the newcomers. Community, togetherness, history, culture, neighborhood, are not the be-all and end-all of life, as opponents of gentrification would have us believe. At least some owners in target areas consider themselves lucky to be bought out at elevated prices.
The renters are in a far more precarious position. When their leases are up, the prices asked by the landlord will skyrocket out of their reach. They will be “forced” to depart, whether they like it or not. So, let us focus on those who lease real estate in the target area, not those who have taken up ownership positions there.
In order to put this into context, let us consider other arenas apart from real estate. For, something very much like gentrification occurs all throughout the economy. Take automobiles for example. The rich get the pickings and the poor the leavings. The former walk away, or, rather, ride away, in cars such as the Mercedes, the Rolls Royce, the Cadillac; the latter have to content themselves with the vastly inferior Fords, Chevrolets, Hondas, Toyotas. The only difference between this case and the former is that the poor were never “pushed out” of luxurious vehicles, and into inferior ones. They never had the better cars in the first place. Otherwise, the story is the same: the rich eat high off the hog, the poor take the hind quarters. Ditto with food: it is lobster and steak for the wealthy, spaghetti and peanut butter for the impoverished.
But is this unfair? Certainly not. Assume that the rich came by their wealth in an honest way, not through government grants of special privileges, subsidies, bail-outs, a la crony capitalism, but via laissez faire capitalism. Thus they have contributed more to everyone else than the poor. If anything would be unfair, it would be that the well-to-do would have to take the leavings and those without much honestly earned wherewithal get the lion’s share. Or, that everything gets divided equally. We can see that opposition to gentrification is at least in part a disguised demand for equality. But this comes with particular ill-grace from those, for example, with two eyes. Were they to give up one of them to a blind man, they would lose depth perception. This fades into nothingness compared to the benefits of imperfect sight to someone totally without. And, yet, these egalitarians have the nerve to prate on about income inequality.
There is also more than just a little bit of economic illiteracy involved in the case against gentrification. First of all, economic freedom, as Adam Smith so clearly saw in 1776, creates the Wealth of Nations. Those so concerned with the poor and with eradicating poverty, as we all should be, must realize that opposition to gentrification is an attack on the marketplace. To the degree that people are not free to buy and sell, to “barter and truck” is the extent to which the economy is more impoverished than it need be. The free economy is in a continual state of flux. People are being outbid every day for resources, up to and including housing they would otherwise prefer to keep to themselves. Outlaw gentrification, and if we are logically consistent, we must prohibit this entire process of bidding for goods and services, which implies, yes, outbidding some, disproportionately the poor.
Those ignorant of economics also fail to appreciate the distinction between residential housing ownership and tenancy. If real estate prices go down, and they sometimes do, it is the former, not the latter, who take the major hit. Owners are risk bearers, in a way that tenants are not. But, there are also benefits to investing in this way: when gentrification occurs, they benefit in a way unavailable to those who merely rent.
Forget housing, for the moment. Consider the plight of a person who frequents a restaurant for many years. All of a sudden this establishment raises it prices because they can now attract a more affluent clientele. Our man can no longer afford to eat there. According to the anti gentrifiers, this diner has rights that are now being abridged. But no. Engaging in a commercial interaction, even over the long haul, does not give either party any special dispensation to continue it on the same terms. One could with equal logic argue that if the diner shifts his custom to a competing restaurant, the eatery that had long served him would have a legal case against him. Stuff and nonsense. Both sides have for years benefited from this long-standing arrangement, otherwise they would not have continued to partake in it. If one of them wishes to discontinue, either one, he has a right to do so.
It is the same with a person who rents an apartment. His long tenure there avails him nothing as a matter of justice, if the landlord wants to raise the rent and substitute a richer tenant for him. And the opposite, too, holds true. If a long standing tenant wishes to depart for greener pastures, the owner may not compel him, in law, to remain where he is.
[Originally published February 9, 2015]
Robert E. Lucas Jr. won the Nobel Memorial Prize in Economic Sciences in 1995 for one of the most celebrated contributions in modern macroeconomics: the Lucas Critique. His article on econometric policy evaluation, originally published in 1976, according to many leading economists sparked a genuine methodological revolution in macroeconomic analysis.“Econometric Policy Evaluation: A Critique,” in Theory, Policy, Institutions: Papers from the Carnegie-Rochester Conference Series on Public Policy, eds. Karl Brunner and Alan Meltzer (North-Holland: Elsevier Science Publishers B.V.), pp. 257–84. He emphasized that the underlying coefficients of traditional econometric models are not constant. Hence, these models were inadequate for counterfactual policy evaluation. In other words, these models were inadequate for scientific predictions of the effects of political interventions into the economy, and thus incapable of prognostic comparison of alternative political interventions.
The Limits of MacroeconomicsThe traditional Keynesian and Monetarist models of the 1960s and 70s could not scientifically predict whether, for example, an expansion of the money supply would really lead to lower unemployment rates — not to mention the extent of the effect. The problem is that correlations between macroeconomic aggregates like price inflation and unemployment are constantly changing. When a certain correlation has been observed for the past, one cannot simply assume that this correlation will hold for the future, especially when policymakers try to exploit the correlation. The political environment has an impact on human action and can itself lead to changes in the observable correlations between economic variables.
In order to solve the problem of counterfactual policy evaluation according to Lucas one would have to identify “structural equations” whose coefficients remain constant over time. Only when the coefficients are constant, can econometric methods of estimation and testing be applied adequately. It has been argued that the microfoundation of macroeconomic models established as a result of the Lucas Critique has accomplished exactly this. The so-called dynamic stochastic general equilibrium (DSGE) models postulate representative households and firms, whose behavior is derived mathematically in consideration of the political environment. The behavior of the household is a constraint on the profit maximization problem of the firm and the firm’s decisions are constraints on the utility maximization problem of the household. The authors of these models claim that all relevant feedback effects are incorporated. DSGE models thus form a closed system in which the effects of any political intervention, such as a cut in interest rates, can be estimated sufficiently well. It is claimed that the new models have overcome the Lucas Critique.Jordi Galí, and Mark Gertler, “Macroeconomic Modeling for Monetary Policy Evaluation,” Journal of Economic Perspectives 21, no. 4 (2007): 25–45. But is this claim justified?
In a recent publication I argue that it is not.Karl-Friedrich Israel, “Modern Monetary Policy Evaluation and the Lucas Critique,” Political Dialogues: Journal of Political Theory 19 (2015): 123–45. The fundamental problem indicated by the Lucas Critique has not been solved by modern modeling methods. The problem of inconstancy of observable relationships between economic variables, that is variables that are the outcome of human action, cannot be solved. As long as modern macroeconomics follows a positivistic-econometric approach it will be exposed to it. It is so fundamental and pervasive that it cannot be avoided. Hence, it is of utmost importance to openly admit that the problem exists, instead of sweeping it under the rug, and in fact to question and challenge the common methods of modern macroeconomics thoroughly.
Economics Is Not Like the Physical Sciences A more detailed analysis of the problem can be found in the epistemological and methodological writings of Ludwig von Mises and Hans-Hermann Hoppe.Hans-Hermann Hoppe, Kritik Der Kausalwissenschafilichen Sozialforschung - Untersuchungen Zur Grundlegung von Soziologie Und Ökonomie (Opladen: Westdeutscher Verlag, 1983).Ludwig von Mises, The Ultimate Foundation of Economic Science - An Essay on Method. New York: D. Van Nostrand, 1962).—. Theory and History: An Interpretation of Social and Economic Evolution (Auburn, Ala.: Mises Institute, 2007). According to Mises, a proponent of methodological dualism, there are no constants in human action that would justify a natural scientific approach to economics. The search for “structural equations” must thus be seen as a futile endeavor.
For example, in order to falsify a hypothesis on the basis of empirical data, we must assume the constancy principle to hold. It implies the following principles of causal empirical research: “equal cause, equal effect” and “unequal effect, unequal cause,” and it categorically excludes the possibility of contingencies in the way causes exert their effects.Hans-Hermann Hoppe, Kritik Der Kausalwissenschafilichen Sozialforschung — Untersuchungen Zur Grundlegung von Soziologie und Ökonomie (Opladen: Westdeutscher Verlag, 1983), p. 11. When we observe the same characteristics for the explanatory variables A, B and C for two different data samples, but different characteristics for the explained variable Y, then we could only conclude that there must have been at least another explanatory variable D that can account for the difference if the constancy principle is actually satisfied. The hypothesis can then be adapted and tested against another data sample. Hence, the constancy principle, if satisfied, allows a gradual convergence towards the truth. When it comes to natural sciences the assumption of the constancy principle is rather unproblematic. However, is it also reasonable to assume constancy for social phenomena?
The crucial questions are the following: Can we reasonably assume that human action follows the constancy principle, i.e., does a certain configuration of causal factors always exert the same effect on human action? Or can human action be different given the same configuration of observable causes?
No and yes, respectively. The constancy principle cannot be justified for social scientific phenomena, and humans can act differently under apparently identical conditions. Hoppe has given this intuitive insight a rigorous foundation. Ironically his argument builds on Karl Popper’s critique of historicism.Karl R. Popper, The Poverty of Historicism (London and New York: Routledge Classics, 2002).
Popper argued that we cannot scientifically predict the future state of our knowledge, precisely because humans are capable of learning. Yet our knowledge shapes the course of history. Hence, there can be no scientific theory of the course of history and no scientific predictions of the future course of history. In particular, Popper opposed the views of Marx and Spengler.
The capability of learning, however, also implies that human action in general cannot be predicted scientifically as knowledge influences action. “Structural changes” that completely mislead a hitherto well-functioning econometric model are always possible.
The traditional Keynesian and Monetarist models had not predicted the structural change of stagflation in the 1970s and 80s. But also the modern DSGE models did not predict the Great Recession of 2008. There are studies showing that the modern models would not have made any better predictions, had they been used instead back in the 1970s.Samuel Hurtado, “DSGE Models and the Lucas Critique,” Economic Modelling 44 (2014): S12–19. In light of this result the actual advances in macroeconomic modeling do not seem to be as big as its most outspoken proponents would have us believe. In particular, the Lucas Critique has not been overcome. Of course, Lucas was by no means a Misesian. Yet, rightly understood, we can find a Misesian core in his celebrated contribution: “There are no constants in human action.” The constancy principle is not satisfied when it comes to social scientific phenomena, which are the result of human action. This claim is valid from the point of view of learning human beings. Since presumably we all belong to that category it carries some weight.
But Mises also writes:
Mortal man does not know how the universe and all that it contains may appear to a superhuman intelligence. Perhaps such an exalted mind is in a position to elaborate a coherent and comprehensive monistic interpretation of all phenomena.Theory and History: An Interpretation of Social and Economic Evolution. Page 1.
Hence, the dualism between natural and social sciences that Mises advocates must not be understood as a claim to absolute truth, but as a methodological necessity.
Karl-Friedrich Israel is a lecturer at the University of Angers; a PhD candidate studying with Jörg Guido Hülsmann at the University of Angers; and a 2016 Mises Institute Fellow. Contact: email.
Last week, I examined how obesity among low-income households cannot be explained by simply claiming that low-income people don't have access to healthy food. It is claimed that supermarkets and other places that sell food are too far away from low-income neighborhoods for households to access them. It is assumed that low-income people will eat fast food instead. This is known as the "food desert" concept in which some places are devoid of food choices.
In that article I quoted sources which concluded that there is not actually compelling evidence that low-income neighborhoods have fewer grocery stores than other neighborhoods.
Now, it appears that the USDA (as of May 2016) has recently caught up with a multitude of other sources and found that "the effect of food store access on dietary quality may be limited" and in many cases, is "negligible." When the USDA report says "limited" they mean very limited. The study concluded that when food choices are less constrained (i.e., when low-income shoppers experience an increase in choices for food stores) "low-access consumers purchased 0.42 percent more fruits, 0.55 percent more vegetables, 0.61 percent more low-fat milk products, and 0.33 percent less nondiet drinks."
The study did find, not surprisingly, that people will travel further to stores they believe to offer lower-prices. But, this further travel did not lead to significantly improved dietary habits. Indeed, two recent studies showed that putting a new grocery store in the neighborhood did nothing to improve diets:
In a 2015 study, researchers at the Rand Corporation and at collaborating universities interviewed households in a Pittsburgh neighborhood before and after a supermarket opened in 2013 and compared their food purchases and dietary intake with those of households in a Pittsburgh neighborhood similar in demographics and income but without a new store. Residents in the neighborhood with the new store consumed fewer calories overall, less added sugars, and fewer calories from solid fats, alcohol, and added sugars than residents in the neighborhood without a new store.
However, the changes were not associated with regular use of the new store—residents who regularly used the new store had similar diets as residents who did not. The study also found that fruit and vegetable consumption decreased slightly in both neighborhoods.
A similar study of two neighborhoods in Philadelphia—one where a new supermarket opened in 2009 and a similar neighborhood without a new store—was published in 2014 by researchers at the London School of Hygiene and Tropical Medicine and Penn State University. Residents’ perceptions of food accessibility in the neighborhood with the new store improved relative to the control neighborhood, but consumption of fruits and vegetables did not improve.
By the end of the study, the USDA concluded: "These results suggest that improving access to healthful foods by itself will likely not have a major impact on consumer diets or generate major reductions in diet-related disease."
Of course, there may be numerous characteristics common among low-income households that increase one's risk of obesity. Knowledge about nutrition, for example, is likely a real factor. However, even with this, we cannot simply blame low-income status. After all, immigrants — many of whom are very low-income — tend to eat healthier than the native population.
It's time to get rid of the "food desert" argument.
Indeed, if a "food desert" is defined as a place where low-income houses are unable to physically access presumably far-away grocery stores, then we're left doubting whether or not food deserts exist at all. As the USDA report admits:
The FoodAPS data revealed that about 9 of 10 households in the 2012-13 survey usually shopped for groceries at a supermarket or supercenter, regardless of their participation in food and nutrition assistance programs or their food security status. Roughly 90 percent of households that participate in USDA’s Supplemental Nutrition Assistance Program (SNAP) or the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC) did their primary grocery shopping in a supermarket or supercenter.
FoodAPS data also show that households often bypass the nearest supermarket to obtain groceries. The average straight-line distance to the nearest supermarket was 2.1 miles, but households traveled an average of 3.8 miles to get to the store in which they do their usual shopping. This behavior was consistent across transportations modes; even those who walk, bike, or take public transit traveled, on average, farther than the distance to the nearest supermarket to do their primary food shopping. This study suggests that most U.S. households are not limited by the food stores in their own neighborhoods.
One of the cornerstones of the science of economics in its post-marginalist-revolution period is the realization that the necessity of ‘economizing’ – i.e., maximizing individual desire satisfaction whilst minimizing the exploitation of productive resources – stems from the fact that the said resources are not sufficient to satisfy all of the desires entertained by the totality of purposive agents (Menger 1976; Mises 1996, p. 93; Rothbard 2004, pp. 5-6). A further conclusion sometimes deduced from this realization states that if a given entity is to remain a purposive agent throughout its life, its desires have to be essentially unlimited, since as soon as all of them are satisfied, the entity in question becomes permanently passive, frozen in the state of final contentment. From this, in turn, it follows, among other things, that as long as the world is populated by purposive agents, the concept of persistent, long-term economic equilibrium is bound to remain purely hypothetical and imaginary (Mises 1996, pp. 247-51; Rothbard 2004, pp. 320-8; Klein 2008, p. 174).
An interesting question to ask in this context is whether the above description paints an accurate picture of human psychology vis-à-vis the concept of desire satisfaction. It seems to me that asking this question of a thymological nature and grounding it in the insights of Austrian value theory offers a rare opportunity to advance our understanding of praxeology by means of exploring its reciprocal relationship with other sciences of human action. While such opportunities for interdisciplinary intellectual cross-fertilization are few and far between, they usually provide important, sometimes crucial, insights into relevant disciplines. Just as the physico-empirical observation that goods are scarce informs the fundamentals of the logic of choice, and just as the biologico-psychological observation that human beings differ in terms of their physical attributes and mental qualities informs the Ricardian Law of Association, I believe that a logical reflection on the nature of desire satisfaction may further illuminate our understanding of certain fundamental aspects of price theory, in particular in the context of the issues raised as part of the so-called “dehomogenization debate”. Thus, in the first part of what follows I shall elaborate on the concept of desire satisfaction and present what I believe to be its psychologically most plausible interpretation, and then connect it to the price-theoretic issues mentioned above by means of further elucidating the essence of what makes the market process uniquely efficient in terms of satisfying consumer desires.
Let us start our inquiry by asking whether it is plausible to say that human desires are unlimited, or should it rather be said that they are limited, but unsatisfiable. The former claim seems to suggest that at any given moment each of us entertains a set of clearly specifiable desires, such as the desire for apples or the desire for iPads, which, upon being satisfied, give way to a new set of this kind, and so on ad infinitum. The latter claim, on the other hand, which I personally find more convincing, appears to suggest that each of us permanently entertains a limited and largely unchanging number of vaguely specifiable desires associated with particular, oftentimes overlapping sensations and values of material, intellectual, moral, aesthetic, or interpersonal nature (power, love, belonging, gratitude, knowledge, the comfort of living space, culinary pleasure, visual pleasure, etc.), the point being that none of them can ever be really satisfied.
Thus, as I see it, it is not the case that as civilization progresses, more and more of our desires are being satisfied, only to give way to new ones, but that our essentially unchanging desires are being satisfied more and more effectivelyThis contention does not in any way suggest that it is inadmissible or inadvisable to represent preference scales as composed of specific, ordinally ranked goals (desires), such as going to a concert or playing bridge. It only hints at the thought that these individual, specific goals (desires) can be reduced to a small number of more general, ultimately unsatisfiable goals (desires), such as the desire for aesthetic pleasure and the desire for competitive achievement. – for instance, the invention of the Internet resulted in our desire for efficient communication being now much more satisfied that it was prior to that event, rather than in replacing our already-satisfied desire for telephone communication with the desire for electronic communication.
As I indicated earlier, what I would like to propose here is that the above observation provides yet another avenue for making a cogent analytical distinction between Hayek’s “knowledge problem” (Hayek 1945, 1948) and Mises’ “calculation problem” (Mises 1990; 1996, part 3), i.e., it allows for further elucidating the nuanced differences between these two authors’ views on the efficiency (or lack thereof) of centrally planned economies, thus making a contribution to what has become known as the “dehomogenization debate” within the Austrian School.
To summarize briefly the debate in question, one side of it (Salerno 1993, 1994, 1996; Herbener 1996; Hoppe 1996) articulated and defended the view that even if a hypothetical central planning bureau were in possession of the totality of relevant information pertaining to a vast, locally heterogeneous and dynamically changing economic system, it would still be unable to convert the information under consideration into a single scale of exchange value expressible in terms of cardinal numbers and reflective of socially meaningful utility appraisals. Absent private property rights and free exchange of private property titles, no such scale can emerge, and thus rational allocation of resources becomes literally impossible, no matter how much knowledge about the supply of and demand for any given pool of resources one might have. The other side of the debate (Kirzner 1996; Yeager 1994, 1996, 1997), on the other hand, defended the view that the apparent difference pointed to by the above authors is more verbal than substantive.
By drawing on the concept of desire satisfaction delineated in the earlier paragraphs, I would like to offer an argument in support of the former group, thus suggesting that, while most usefully thought of as complementary, Mises’ and Hayek’s views on the allocative limitations of centrally planned economies are in important respects different.
Let me start by pointing out that if the “knowledge problem” described by Hayek is to be applicable to genuine concerns of economic theory, it needs to be restricted to what is logically (even if not practically) knowable. Hence, as I see it, it is applicable to the putative central planner’s knowledge concerning the supply of consumer goods, producer goods of various orders, and the available technological possibilities (since this kind of knowledge constitutes a finite set of data), but not to his knowledge concerning consumer desires (since, as I argued above, these can be satisfied in a literally infinite number of ways, thus being infinitely translatable into more specific desires for particular consumer goods, and the infinite is necessarily unknowable to any finite mind).
This, in turn, implies that if in a given economy only one will acts with respect to the disposal of producer goods, then, as Mises remarks, even if the finite mind behind it knows everything that is logically knowable to it (i.e., everything about the available supply of consumer goods, producer goods of various orders, and the existing technological possibilities), it is still bound to lack any intersubjective benchmark for assessing the extent to which its decisions satisfy the desires of the consuming public as compared with the extent to which they could be satisfied by the decisions of all those who would be eager to acquire the available factors of production and use them in an entrepreneurial manner were it not for the central planner’s prohibition.
It might be suggested here that my point is irrelevant to the dehomogenization debate, since it can be interpreted as saying that the central planner would lack particular data, viz., information about people’s infinite efforts to satisfy their desires, which might seem to be just another formulation of the Hayekian knowledge problem, whereas the debate is about whether a planner who had all relevant data would face an additional problem, since in the absence of markets he would have no prices and thus could not calculate. My reply is that it does not seem to me to be logically objectionable to describe such a planner as lacking precisely a certain crucial kind of information, i.e., information as to how to transform the data concerning the available supply of consumer goods, producer goods of various orders, and the existing technological possibilities into a single, intersubjective scale of exchange value expressible in terms of cardinal numbers. However, such a formulation of the issue still allows for distinguishing between the Hayekian knowledge problem and the Misesian calculation problem, since it allows for distinguishing between finite data, which the central planner could theoretically possess, and the compass for assessing these data against an infinite number of their possible uses, corresponding to an infinite number of ways to satisfy consumer desires, which only the free market price system can furnish.
In other words, while the extent to which we are in possession of dispersed information associated with specific circumstances of time and place can be measured on a strictly finite spectrum, the calculation of profits and losses in the free enterprise system allows us to determine how closely we approach a literally infinite horizon (that is, the horizon of efficiency measured against a literally infinite number of results).
This observation allows us to see even more clearly that the market, together with its institutional manifestations of the price system and the free exchange of capital goods, is not just one of the alternative systems of economizing on the use of scarce goods, but a necessary prerequisite of such economizing. In other words, while there is no logical incoherence in viewing capitalism, socialism, and interventionism as alternative systems for aggregating decentralized information, only the first of these (even assuming that the amount of relevant information is finite) is capable of giving the information in question a form that makes it usable in the context of allocating resources rationally, i.e., in accordance with the criterion of consumer sovereignty.
Furthermore, this way of viewing things offers a novel avenue to dispose of the Galbraithian (1958) notion that the market satisfies primarily those consumer wants that it artificially creates in the first place. If, as was argued earlier, the most plausible picture of human psychology suggests that, instead of developing ever new desires upon the satisfaction of the old ones, we permanently entertain a limited and largely unchanging number of general desires that can be satisfied in ever new ways, the idea that new desires can be manufactured through motivational advertising makes no sense at all. And though distinct from Hayek’s (1961) argument against the “Dependence Effect”, the approach in question reinforces his claim that no logically meaningful distinction can be made between “original” and “contrived” wants. There are just wants and an infinite number of ways to satisfy them, and only the unhampered market process can discover and rationally evaluate their respective effectiveness in this regard.
The resulting conclusions can be summed up by paraphrasing Arthur C. Clarke and Mark Twain: given that any sufficiently advanced ability is indistinguishable from magic, I suppose the reports of the “magic of the market” have not been greatly exaggerated.
[This article was originally published in Ekonomia - Wroclaw Economic Review 21, 1 (2015), 63–8.]
References Galbraith, J. K. (1958), The Affluent Society (Boston: Houghton Mifflin).Hayek, F. A. (1945), ‘The Use of Knowledge in Society’, American Economic Review, 35, 519-30. Hayek, F. A. (1948), Individualism and Economic Order (Chicago: University of Chicago Press).Hayek, F. A. (1961), ‘The Non Sequitur of the ‘Dependence Effect’’, Southern Economic Journal, 27 (4), 346-8.Herbener, J. (1996), ‘Calculation and the Question of Arithmetic’, Review of Austrian Economics, 9 (1), 151-62.Hoppe, H-H. (1996), ‘Socialism: A Property or Knowledge Problem?’, Review of Austrian Economics, 9 (1), 143-9.Kirzner, I. M. (1996), ‘Reflections on the Misesian Legacy in Economics’, Review of Austrian Economics, 9 (2), 143–54.Klein, P. G. (2008), ‘The Mundane Economics of the Austrian School’, Quarterly Journal of Austrian Economics, 11 (3), 165-87.Menger, C. (1976) [1871], Principles of Economics (New York: New York University Press).Mises, L. (1990) [1920], Economic Calculation in the Socialist Commonwealth (Auburn, AL: Ludwig von Mises Institute).Mises, L. (1996) [1949], Human Action. 4th edition, revised. (San Francisco: Fox and Wilkes). Rothbard, M. (2004) [1962], Man, Economy, and State: A Treatise on Economic Principles with Power and Market, Scholar’s Edition (Auburn, AL: Ludwig von Mises Institute).Salerno, J. T. (1993), ‘Mises and Hayek Dehomogenized’, Review of Austrian Economics, 6 (2), 113–46. Salerno, J. T. (1994), ‘Reply to Leland B. Yeager on ‘Mises and Hayek on Calculation and Knowledge’’, Review of Austrian Economics, 7 (2), 111–25. Salerno, J. T. (1996), ‘A Final Word: Calculation, Knowledge, and Appraisement’, Review of Austrian Economics, 9 (1), 141–2.Yeager, L. B. (1994), ‘Mises and Hayek on Calculation and Knowledge’, Review of Austrian Economics, 7 (2), 93–109.Yeager, L. B. (1996), ‘Rejoinder: Salerno on Calculation, Knowledge, and Appraisement’, Review of Austrian Economics, 9 (1), 137–9.Yeager, L. B. (1997), ‘Calculation and Knowledge: Let’s Write Finis’, Review of Austrian Economics, 10 (1), 133–6.
An argument that is often used to support government intervention relies on “negative externalities.” People’s behavior, it is claimed, sometimes generates avoidable costs for others in this way: you do something in order to gain an advantage over someone else. But that person may try to do the same thing to you. Even if he doesn’t, he will at least take measures to counter what you did to him. Your attempt to gain an advantage thus fails, and you would both be better off if you were put back at your starting point.
An example will clarify this. Suppose you are watching a football game. You stand up to get a better view of the action. If everybody else stayed seated, you would in fact get a better view of the action. But they won’t. If enough people stand up, this will block everybody else’s view. The rest of the people will also rise so that they can still see. The result will be that you don’t get a better view, and you and the others are worse off than before you got up, because you are now standing rather than sitting.
How does the government get into this? People can usually handle the football case by themselves. If after a few plays they see that standing up doesn’t help them get a better view, a norm of behavior will develop for them to stay seated. But, it is claimed, many cases where people get into such self-frustrating situations can’t be handled by voluntary restraint. An external force, the government, needs to restrain people for their own good.
I’d like to elaborate on this line of thought, and what I think is wrong with it, by discussing Robert Frank’s account of it in his influential book Luxury Fever (The Free Press, 1999). Frank thinks that people spend too much on luxury goods that don’t make them happy and that the government can make us all better off by imposing high consumption taxes on this spending. The key to Frank’s argument is that everyone is made better off by the high taxes, and this will be the point at which I challenge him.
Frank sets the stage for his argument by belaboring the obvious point that the rich have extravagant tastes. The Calibre ’89 Patek Philippe wristwatch sold for a minimum of $2.7 million. For the less financially secure, bargain Patek Philippes can be had for $17,500. In Beverly Hills, California, seventeen mansions with more than ten thousand square feet of living space were sold in 1997 Yachts can cost over $1.5 million per year to maintain. And so on and so on. The book came out twenty years ago. From his point of view, luxury spending has gotten worse since then.
Why is luxury spending a problem? If rich people spend their money in a way that Frank considers wasteful, isn’t that their business? Frank answers that the luxury spenders are making a mistake. They think that buying these items will make them happier, but after an initial thrill their level of satisfaction will go back to its previous level.
The assured results of modern psychology, he says, tell us this. "What the psychologists call subjective well-being is a real phenomenon. The various empirical measures of it have high consistency, reliability, and validity." These measures bring bad news for luxury spenders. "One of the central findings in the large scientific literature on subjective well-being is that once income levels surpass a minimal absolute threshold, average satisfaction levels within a given country tend to be highly stable over time, even in the face of significant economic growth."
This appears paradoxical but in fact is not. How can it be that if you get the goods you want, you do not continue to feel subjectively better? The answer, Frank thinks, lies in the fact that people quickly adjust to a higher standard of living. If you sell your three thousand–square foot home and purchase one twice as large, you may at first feel elated. Soon, though, you will treat the new conditions as normal, and the extra space will give you no special thrill. You will have gone to a good deal of trouble and expense to wind up about as happy as you already were.
Frank has resolved his paradox only to raise another in its stead. If the pursuit of material wealth beyond a certain point does not lead to greater happiness, why do people continue to seek more and better things? If "the more we have, the more we seem to feel we need," won’t at least some people after a while realize that the quest for more leads nowhere? If so, won’t they rest content with what they have?
A further fact explains our getting and spending, Frank points out. People become happier by improvements from their position in the recent past. To an even greater extent, they dread a reduction in their standard of living. "The economist Richard Thaler coined the term loss aversion to describe this tendency. Loss aversion means not just that the pain of losing, say, $1,000, is larger, for most of us, than the pleasure of winning that same amount. It means that it is much larger." People don’t want to weaken their positions compared to others who increase their luxury spending.
Once more, Frank has resolved a difficulty only to confront an even more formidable obstacle. If he is right, he has explained luxury spending: people wish to beat out others in the battle for prestige and power. They may find, once they have gotten their Patek Philippe watches, that these items produce no long-lasting pleasure. Nevertheless, the struggle counts more than the arrival, and people always act to increase their happiness.
But here precisely is the problem for him: there appears to be no issue that requires government action. If people did not have rivalrous impulses, maybe they would find it much easier to be happy. But it would be futile for Frank to suggest a program to extinguish these desires, since he holds that evolution has implanted them firmly within us. What, then, can an interventionist like Frank do?
Here is where the negative externalities argument enters the scene. Like me, Frank gives a football example, but in his example the problem is more severe than people’s inability to get a better view by standing up. Among offensive linemen in professional football, it is an advantage to weigh more than your rivals. “Other things being equal, the job will always go to the larger and stronger of two rivals. Because size and strength…can be enhanced by the consumption of anabolic steroids, individual players confront compelling incentives to consume these drugs. Yet if all players take steroids, the rank ordering by size and strength–and hence the question of who lands the jobs—will be largely unaffected." Given the danger of steroids, wouldn’t players all be better off if the drugs were banned? In fact, they are now banned.
Frank generalizes the point of his example: a progressive tax on consumption will cut out much of the wasteful spending that rivalrous luxury spending involves. Once more, the spending is wasteful not just because he disapproves of it, but because people engage in it only to forestall their rivals.
I don’t think that Frank’s ingenious analysis gives us a good reason to institute the consumption tax he favors. He has made without evidence a crucial and questionable assumption. Let us return to his football example. He assumes that the rank order of players remains the same whether or not they take steroids. Resources devoted to steroids are then a deadweight loss.
But why assume this? We have no grounds to assume that the ban leaves everything besides access to the dangerous drug as it otherwise was. Maybe, if people were free to take the steroids, some would gain more weight and get stronger than others. They would still be at an advantage even when the other players took the drugs. And some players would give up the battle after the dosages increased, leaving those willing to take more risks at an advantage.
You might object that I’m missing something essential. Even if some players did get an advantage from steroids, isn’t it still better for them to maintain their health unimpaired? Aren’t they risking too much? If you say this, though, you are not going where Frank wants to go. You have a different value judgment from that of the players, and Frank doesn’t want to rely on that. He wants an argument that shows that everybody is better off from his own point of view.
Like Frank, we may generalize our conclusion. Frank has not shown that a consumption tax will affect all rivals equally. Absent this showing, he has failed to show that rivalrous consumption generates pure waste. His argument collapses.
Alex Tabarrok has a fun post calculating the monetary value of a Powerball ticket. He estimates that, as of the most recent drawing, each $2 ticket carries an expected monetary value of roughly $2.73. Superficially then, it’s worthwhile to buy one. However, Tabarrok also points out this is only true for a simple expected value calculation; after accounting for taxes and the possibility of a shared prize, a ticket’s monetary value is actually substantially lower (around $.75), making it a poor investment.
So why do people buy them? Are consumers hapless rubes throwing away their hard-earned money in exchange for nothing? Not necessarily.
The reason is simple: there’s much more to valuation and choice than expected monetary value. In fact, I suspect almost no one buys a ticket with any such calculation in mind. Rather than a cold estimate of the probability of future returns, the Powerball actually illustrates the subjective theory of value.
There are many ways for people find value in the Powerball beyond its expected monetary payoffs. Tabarrok observes, for example, that people find pleasure in anticipating the drawing. Such excitement is actually a major attraction of games of chance, where players have no control over the outcome.
In fact, I doubt most people playing the Powerball seriously believe they’ll win. Instead, people treat a ticket as the price of daydreaming about what they’d do with an enormous pile of cash. You can’t win without playing, so people pay a small amount as a way to justify spending their scarce time imagining their own Scrooge McDuck scenarios. For these people, the benefit of the ticket is greater than its cost.
These are just two reasons people might find value in lottery tickets, but there are countless others. Incidentally, value subjectivity doesn’t imply anything about whether the values people actually hold are morally acceptable or even economically sensible; just because our values are subjective, doesn’t mean they’re above criticism. But it does mean they’re about more than a simple expected monetary return.
My point is that although it may be convenient to reduce value to a simple, objective measure, doing so can never capture the complexity of what, how, and why people value the things they do.
By the way, I don’t have a problem with the idea of calculating expected value, as it’s a useful way of thinking about how to place present monetary value on a contingent event. I do, however, take issue with the idea that expected value calculus is the way for an economist to think about these problems. Focusing too much on objective calculations of worth drains the richness from economics and helps turn it into a mechanical exercise inapplicable to actual human behavior.
If anything, the economic way of thinking should stress the diversity and complexity of human values. Economists would be better off taking a humble approach, acknowledging that we can’t always fit human decisions into neat little boxes for economists to analyze, much less to build policy proposals on.
Public policy is actually one important reason these seemingly simple examples matter quite a bit. It’s a short few steps, for example, from defining value as the expected monetary return of a ticket, to claiming that buying a ticket is irrational, and finally, to insisting consumers not be given a choice to buy one at all. (As a side note, this isn’t an endorsement of public lotteries.) Although it might seem odd, this kind of argument is increasingly common among behavioral economists. Human errors and biases are open doors waiting for paternalism to rush through. Subjectivity is a way to slam them shut.
I heard several days ago from my friend Larry Beane that people in Walter Block’s seminar who had been reading Theory and History wondered whether Mises is a moral relativist. As I’ll try to show, the answer depends on what you mean by “moral relativist,” but in the way the term is usually understood in contemporary philosophy, he isn’t. I’d like to dedicate this article to the memory of Leo Beane, an outstanding young man of great character and intelligence who was not a moral relativist.
When Mises talks about any question in philosophy, a fundamental rule should be kept in mind. His primary objective is always to defend the free market against any doctrine that can be used to attack it. For example, he criticizes the logical positivists, because their view of meaning would undermine praxeology, and for the same reason he rejects various forms of what he calls “polylogism.”
In ethics, Mises follows the same strategy. He says that almost everybody values peace and prosperity. The way to achieve this is to establish and maintain a system of social cooperation through the free market. His argument, then, appeals to what Kant calls a hypothetical imperative, “If you want peace and prosperity, establish and maintain a free market.” Because almost everyone does want peace and prosperity, almost everyone thus has a reason to establish and maintain a free market. One more point needs to be added to grasp what Mises has in mind. He thinks this entire argument is strictly scientific and value-free. It isn’t that he is making the value judgment “I like the free market,” although he certainly did like it. Rather, he is saying, “People in fact do prefer peace and prosperity, and this is the way to get it.”
Here is where the strategy I mentioned comes in. Some philosophers such as Franz Brentano say that there are objective values. Besides the subjective preferences people have, there are also absolute values. Mises characterizes the position in this way:
This distinction between a field of science dealing exclusively with existential propositions and a field of judgments of value has been rejected by the doctrines that maintain there are eternal absolute values which it is just as much the task of scientific or philosophical inquiry to discover as to discover the laws of physics. The supporters of these doctrines contend that there is an absolute hierarchy of values. They tried to define the supreme good. They said it is permissible and necessary to distinguish in the same way between true and false, correct and incorrect judgments of value as between true and false, correct and incorrect existential propositions. Science is not restricted to the description of what is. There is, in their opinion, another fully legitimate branch of science, the normative science of ethics, whose task it is to show the true absolute values and to set up norms for the correct conduct of men.
You can see why Mises is suspicious of this. What if people say that the absolute values require that people reject, or at least modify, the free market? Many people who supported absolute values, such as the philosopher Max Scheler and various Austrian clerical thinkers of the 1930s, did just that. Mises gives two arguments against absolute values: people disagree about these values and the defenders appeal to unsupported “intuitions” about them. But couldn’t advocates of the position respond that even though many people disagree with praxeology, Mises does not take that as a good reason to throw praxeology into doubt? Mises certainly doesn’t say that because the logical positivists disagree with his account of meaning it is not objectively true: quite the contrary. Does Mises have a double standard? Disagreement doesn’t always show that there’s nothing more to be said.
Some defenders of objective values might say to Mises: “You’re wrong that there is no ground for our judgments other than unsupported intuitions. Natural law grounds ethics in the requirements of human nature.” Mises is not convinced: “It is useless to emphasize that nature is the ultimate arbiter of what is right and what is wrong. Nature does not clearly reveal its plans and intentions to man. Thus the appeal to natural law does not settle the dispute. It merely substitutes dissent concerning the interpretation of natural law for dissenting judgments of value.”
Mises does respect the appeal to reason by natural law thinkers, but he thinks his own appeal to the benefits of social cooperation removes the defects of classical natural law theory:
Yet all these deficiencies and contradictions of the doctrine of natural law must not prevent us from recognizing its sound nucleus. Hidden in a heap of illusions and quite arbitrary prepossessions was the idea that every valid law of a country was open to critical examination by reason. About the standard to be applied in such an examination the older representatives of the school had only vague notions. They referred to nature and were reluctant to admit that the ultimate standard of good and bad must be found in the effects produced by a law. Utilitarianism finally completed the intellectual evolution inaugurated by the Greek Sophists.
Does this make Mises a moral relativist? He doesn’t think that there is anything to the concept “value” other than subjective preferences, so if this is what you mean by a relativist, he was one. But this isn’t the way most philosophers today use the term. A moral relativist is someone who, as the name suggests, thinks that morality is relative to something, usually a person’s society or culture. A relativist might hold, for example, that slavery was morally right in ancient Greece and Rome, because it was accepted there, but wrong in America today. This isn’t subjectivism, because the relativist isn’t saying it’s a matter of arbitrary preference whether slavery is right or wrong: he is saying that slavery is objectively right (or wrong) relative to a particular society. A variant of moral relativism holds that what is morally right is relative to the individual, but even this isn’t subjectivism. The defender isn’t saying that what’s right is nothing more than persons’ subjective preferences. Rather, he is saying that it is objectively the case that what is right for each person is what he prefers.
In this way of understanding relativism, Mises was not a moral relativist. He thought that social cooperation through the free market resulted in peace and prosperity, regardless of whether people or societies accepted this or not.
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One of the primary justifications given for state provision of a good or service is that it is a “public good,” meaning that it is sufficiently costly to exclude nonpayers from enjoying the good and that one person’s enjoyment of the good doesn’t interfere with anyone else’s. Provision of such goods through voluntary means is considered to be either impossible or, at the very least, inefficient compared to state provision. Rational individuals will choose to free ride by enjoying the good without paying for it. As a result, market provision of the good will result in underproduction, because any business providing such a good will produce a quantity in which marginal revenue equals marginal cost, but marginal cost will be unequal to marginal benefit. Furthermore, if the provider were to contract with all beneficiaries to get them to agree to pay before the good is produced, the transaction costs would still be prohibitive. As such, the state would be a more efficient mechanism of provision, as it can force all beneficiaries to pay for the public good, thus overcoming the free rider problem.
Rothbard rejected this analysis, denying that the state is capable of providing goods more optimally through coercion than are freely acting individuals through voluntary means (Rothbard 1956, 1961, 1962). Individuals voluntarily organize and contribute to all kinds of activities on the market, including common projects that benefit more people than the contributors themselves, i.e., which generate “positive externalities.”
Critics of Rothbard have consistently misread and misunderstood him, be they defenders of public choice economics (Frech 1973) or mainstream neoclassical economics (Caplan 1999). The majority of economists, to their detriment, sadly live in complete ignorance of Rothbard’s contributions in the field of public goods theory.
Robert Lawson and J.R. Clark (2017, 136), in a paper in the Review of Austrian Economics, have taken on the Rothbardian position and accused him of being a “public goods denier” and “intellectually sloppy” for “ridiculing” the ideas of public goods and externalities. Although they acknowledge that “we should take seriously the … Misesian and Hayekian concerns about the limits of knowledge in the absence of market price signals,” (137) anyone who fully appreciated these concerns would not dismiss Rothbard so quickly.
Lawson and Clark present two scenarios of public goods and externalities where individuals who want some good are collectively willing to pay more than would be needed for its provision. In their first example, the inhabitants of a city are collectively willing to pay more than would be needed for the construction of a public park. In the second scenario, a group of hobby astronomers are ready to pay more than is needed to get the rest of the city’s residents to turn their lights down to enable stargazing.
Based on the problems of free riders and transaction costs, the market fails to produce these desired goods. Fortunately, the state is able to tax free riders and make these trades happen. The fact that some people may not value these goods at all is no problem, because “so long as the total willingness to pay by the community exceeds the cost of construction, it is possible to design a system of taxes in which every single person is better off” (Lawson and Clark 2017, 134).
But this is purely an exercise in assuming the problem away. How, precisely, do economists know that individuals have a higher willingness to pay than they demonstrate in action? Rothbard (1962, 1036) states that they don’t—they simply substitute their own ethical views for those of the soon-to-be-mugged taxpayers and then clothe their views
in the “scientific” opinion that, in these cases, free-market action is no longer optimal, but should be brought back into optimality by corrective State action. Such a view completely misconceives the way in which economic science asserts that free-market action is ever optimal. It is optimal, not from the standpoint of the personal ethical views of an economist, but from the standpoint of the free, voluntary actions of all participants and in satisfying the freely expressed needs of the consumers.
The assertion that “tax-financed public goods can make us all, literally each and every one of us, better off” (Lawson and Clark 2017, 134) is just that: an assertion. Lawson and Clark are assuming what cannot be known except through the voluntary actions of individuals in the free market. There is no scientific way to demonstrate that people are made better off through taxation and state provision of goods.
Lawson and Clark say their argument is that private firms will underproduce public goods. But how can they know if a good is underproduced? How can they tell the difference between a situation in which individuals are unwilling to pay for more of a good versus one in which they would be willing to pay but don’t because of transaction costs? Even if people are unwilling to undertake a project because of the transaction costs involved, this simply demonstrates that the value to them of the project is lower than their opportunity costs. Economic science cannot demonstrate that a good is “underproduced,” which is why Rothbard states that economists claiming that state production or subsidization of goods would improve welfare are not doing so based in science. They are simply smuggling their own preferences into their supposedly value-free analysis under the cover of “public goods.” Rothbard reminds us that we cannot assume a can opener; in this case, we cannot assume to know individuals’ actual willingness to pay.
Unfortunately, Rothbard’s contributions in this matter are either ignored or misunderstood by many who would consider themselves free market economists yet accept the standard neoclassical treatment of public goods and the possibility of state intervention leading to Pareto improvements. They ignore the simple truth that the mere possibility of a tax-financed provision of public goods that makes “us all, literally each and every one of us, better off” is as much an argument for state intervention as the mere possibility of winning the jackpot is an argument for throwing coins into a gambling machine. You might personally prefer to do it for the kick of it, but do not expect to win. In fact, Lawson and Clark have it completely backwards. If the mutually beneficial provision of public goods is possible, there is no need for the state. In fact, unlike the gambler, who can at least tell if his winnings exceed his losses (and whether the pleasure of the game exceeds the loss of money), there is no way for the public goods–providing interventionists to know if the goods are valued more or less than the cost imposed on the public. Public goods analysis, if it is to be scientific, has to set out from Rothbard’s strictures.
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Contra Marx, Mises understood that human desires and needs are not determined merely by biology.
Karl Marx held that human interests are “uniquely and entirely determined by the biological nature of the human body.”Ludwig von Mises, Theory and History, (1957; repr., Indianapolis, IN: Liberty Fund Inc., 2005), p. 93–94. He thought that people were exclusively interested in gaining as many tangible goods as they could. Therefore, a person’s wants would not depend on his ideas but on his physiological condition. More is better.
The question Ludwig von Mises posed, on the other hand, is: More of what?
Economics is concerned with how this is decided. It is one thing to say that under socialism men enjoy their toil because they will find self-actualization in producing goods for each other. It is another thing entirely to demonstrate who, under socialism, will choose what is made for whom, how, where, with what, and by whom.
The basic economic problem, as it is sometimes called by economists, is that resources are scarce but human wants are unlimited. While primitive men faced with starvation (and animals) may well only be interested in the quantity of food the can secure, as soon as civilization reaches its early stages people are faced with the problem of choosing which one of their various competing desires they should satisfy. Given there are various ways of satisfying the same needs, they also have to answer the question of how they should satisfy them.
Mises defines human action itself as the employment of scarce means for the attainment of preferred ends. To act is to choose between two or more things that we cannot have both of, preferring one and setting aside the other.Ludwig von Mises, Human Action: A Treatise on Economics, scholar's ed. (1949; Auburn, AL: Ludwig von Mises Institute, 1998), introduction, section 7.
Under capitalism different business owners attempt to make competing products in all different ways, and the consumer will ultimately decide which of them get rich and which go out of business. Each of us, as customers, apply our scarce means, setting aside some products to buy others, and in doing so we decide what is produced and by whom. How is the same going to be determined efficiently in a moneyless society where wage labor has been abolished, such as Marx envisaged?
We Act Based on Our Idea of What Is Best for Us Ultimately, some authority must decide. This is unsatisfactory to Mises. For him, a free man gets to decide himself how he spends his income, but in a society where an authority supplies those things they think the people need—or ought to have—men are not free. Marxism does not differentiate between these two modes of want satisfaction and therefore does not apprehend the difference between freedom and slavery. The Marxian image of freedom looks more like this: “If a man who wants to get the bible gets the Koran instead, he is no longer free.”Mises, Theory and History, p. 94.
To Mises, people can only determine for themselves their own interests, and the authority cannot give the people what they choose according to their own values, but only according to what the authority thinks their values ought to be. If the “paltry” individual disagrees, so much the worse for him. Mises writes: “One does not serve the interests of a man who wants a new coat by giving him a pair of shoes or those of a man who wants to hear a Beethoven symphony by giving him admission to a boxing match. It is ideas that are responsible for the fact that the interests of people are disparate.”Ibid.
This remains an issue of contention to this day. Should the consumer decide what kind of healthcare they receive, or is it better if the government decides on their behalf and supplies it to them as a public service? While socialized healthcare is a popular idea, those who can afford private services usually avail themselves of the best they can buy. This reveals that most people accept that the private sector does a better job of providing healthcare than the state. Those who cannot afford private care in countries with socialized medicine have to accept whatever they are given. They cannot push administrators to improve the quality of services by threatening to “take their business elsewhere.” Similarly, politicians are sometimes the subject of scandals when the media unearths the fact they sent their children to a private school. It is roundly taken as an admission that they don’t believe the services provided by government are good enough for their own children but are willing to impose them upon their constituents.
Mises says that even if we granted, for the sake of argument, that there was no uncertainty concerning what people wanted or how it should be produced, there would still remain the question of weighing people’s short-term interests against their long-term ones. Everyone has to evaluate for himself how much he values the health that comes from strict exercise and diet, for example, against the enjoyment of leisure and tasty snacks. This depends on one's own, individual ideas and subjective evaluations.
The same applies on a larger scale for production in society. Should we save more so that more can be invested in machines and technology that will make society wealthier in the long term, or should we enjoy increased material standards of living in the here and now? There is no correct, objective answer to such a question. A subjective evaluation has to be made by someone or some people. Under capitalism individuals make their own decisions as to how much to consume and how much to save, and the aggregatation of those individual decisions forms the final answer. Under socialism—who knows? Usually it is left to a government department to guess and impose their will upon the people. Invariably this leads to mass overproduction of certain commodities and underproduction of others. Sadly too often it has led to famine: in the Soviet Union from 1921–22 and 1946–47, as well as in the Ukraine (1932–34), China (1958–62), Cambodia (1979), Ethiopia (1983–85), and in North Korea (1995–99). To Mises these famines were not chance occurrences that could have happened under any system. They were a direct result of the fact that under socialism central planners have no reliable means of calculating what to produce or how to produce it, and were completely predictable by economic theory.This was the thesis of Mises's famous 1920 essay "Economic Calculation in the Socialist Commonwealth," which I will soon cover in another essay.
Marx does not attempt to solve this problem. Perhaps he never even considered that it might actually be a problem. He simply claimed that socialism, as the next stage in history, would be an earthly paradise in which questions such as these would settle themselves and everyone would get all they needed. The Land of Cockaigne, as Mises likes to refer to it.
How to Achieve the Socialist Paradise? Of course, if this were true, then no one could deny that socialism was in everyone’s interests. Who could oppose it? The problem begins when any discussion of how they will get what they need is dismissed as “unscientific.” This may well be why all attempts at communism have so far not only failed but resulted in death and misery for countless victims. The primary reason these regimes fail is not merely because their leaders were evil, although they may have been, or because America intervened to undermine the regime—as it certainly did, for example, in Nicaragua, Venezuela, Cambodia, East Timor, and many other places. The fundamental reason was because of a failure to organize production.
In a hypothetical paradise people would no longer need any ideas. They wouldn’t have to make judgments and evaluate which course of action is likely to secure their needs. All would be given. However, in reality, ideas determine what people consider to be their interests. A person’s interests cannot be independent of their ideas. It is ideas that determine what people consider their interests to be. You can say it is in my interests to eat well, but that’s only if I want to live and be healthy. If I choose to die, or am already dying and want to eat chocolate cake until I finally pop off, then who can dispute my evaluation of my interests? Free men do not act in accordance with their interests, because what their interests are are an arbitrary questions of judgment. We act invariably upon what we believe our interests to be.
Why do individuals pay much higher prices for some goods versus other goods? The common reply to this is the law of supply and demand. What is behind this law? To provide an answer to this question economists refer to the law of diminishing marginal utility.
Mainstream economics explains the law of diminishing marginal utility in terms of the satisfaction that one derives from consuming a particular good. For instance, an individual derives vast satisfaction from consuming one cone of ice cream.
The satisfaction he will derive from consuming a second cone might also be big but not as big as the satisfaction derived from the first cone. The satisfaction from the consumption of a third cone is likely to diminish further, and so on.Case, Karl E., and Ray C. Fair. Principles of Microeconomics (7th Edition) (Case/Fair Economics 7e Series). Amsterdam: Prentice Hall, 2003.
From this, mainstream economics concludes that the more of any good we consume in a given period, the less satisfaction, or utility, we derive out of each additional unit.
Consequently, if the additional utility of a product declines as we consume more and more of it; the price that we are willing to pay per unit also declines.
Utility in this way of thinking is presented as a certain quantity that increases at a diminishing pace as one consumes more of a particular good.
Given that utility — presented as some total quantity also labeled as total utility — it becomes possible to introduce mathematics here to ascertain the addition to this total labeled as additional utility or marginal utility.
By the mainstream way of thinking, the law of declining marginal utility is derived from so-called diminished satisfaction of consuming a particular good. After consuming several ice cream cones, an individual feels that he is satiated.
On this way of thinking, human action is not navigated by reason but by biological needs. According to Ludwig von Mises,
It is impossible to describe any human action if one does not refer to the meaning the actor sees in the stimulus as well as in the end his response is aiming at.Ludwig Von Mises The Ultimate Foundation of Economic Science. Chapter 2 Mises Institute website.
The Menger Explanation According to Carl Menger, the founder of the Austrian School of Economics, individuals rank various goals that they wish to achieve by their importance in maintaining life.
Various ends that individuals consider as the most important for the maintenance of life are assigned the highest ranking.Carl Menger, Principles of Economics, chapter 3. The less important ends are assigned lower ranking.
Consider John the baker, who has produced four loaves of bread. The four loaves of bread are his resources or means that he employs to attain various goals.
Let us say that his highest priority or his highest end, as far as his life is concerned, is to have one loaf of bread for personal consumption.
This means that out of the production of four loaves of bread John will retain for his personal consumption one loaf of bread. (If John will not consume the loaf of bread this could endanger his life).
The second loaf of bread helps John to secure his second most important goal, as far as life is concerned, and that is to consume five tomatoes.
Let us say that John was successful and finds a tomato farmer that agrees to exchange his five tomatoes for a loaf of bread.
John uses the third loaf of bread to exchange it for the third most important end, which is to have a shirt. Finally, John decides that he will allocate his fourth loaf to feed wild birds.
Observe that to attain the second and the third end John had to exchange his resources — loaves of bread — for goods that would serve to achieve his ends.
To secure the end of having a shirt John had to exchange his loaf of bread for the shirt. The loaf of bread is not suitable by itself to fulfil the services that the shirt provides.
The suitability of the means is what gives it value as far as a particular end is concerned. From this, we can infer that a given end dictates or establishes, so to speak, the specific means or resources that individual selects for the attainment of that end.
For instance, to secure the end of having a shirt John must decide whether it is going to be a leisure shirt or a work shirt.
John will have to select among various shirts the most suitable for his specific end — let us say to have a work shirt. Being a baker John may conclude that the shirt must be of white color and made out of thin rather than thick material to keep him comfortable while working next to a hot oven.
As far as John's life is concerned, feeding wild birds is ranked the lowest among the ends that John is aiming at given his pool of resources — four loaves of bread.
Note that the first loaf of bread is employed to secure the most important end, the second loaf of bread the second most important end and so on. The grading of various ends is done with respect to their usefulness in maintaining life and wellbeing.
Observe, that the end assigns the importance to the resource employed to secure the end.
This implies that the first loaf carries much higher importance than the second loaf because of the more important end that the first loaf secures as far as John’s life is concerned.
The Least Important End Sets the Standard of Valuation Now, John regards the four loaves of bread in his possession as interchangeable. This implies that each loaf will have the same value as far as John is concerned. How does this fit with the fact that each loaf accommodates ends that are valued by John in a descending order? This contradiction is resolved once it is realized that John assigns to each loaf of bread the importance as imputed from the least important end, which is feeding wild birds. Why does the least important end serve as the standard for valuing the loaves of bread?
Imagine John uses the highest end as the standard for assigning value to each loaf of bread. This would imply that he values the second, third, and fourth loaves much higher than the ends he secures.
If this is the case, what is the point of trying to exchange something that is valued more for something that is valued less? (We have seen that to satisfy his second end to obtain five tomatoes he would exchange one loaf of bread. However, if John values a loaf of bread higher than five tomatoes obviously no exchange will take place).
The fourth loaf of bread is the last unit in John's total supply. It is also called the marginal unit, i.e., the unit at the margin.
This marginal unit secures the least important end. Alternatively, we can also say that as far as John’s life is concerned, the marginal unit provides the least benefit.
If John had only three loaves of bread this would mean that each loaf would be valued according to the end achieved by the third loaf — having a shirt. This end is ranked higher than the end of feeding wild birds.
From this, we can infer that as the supply of bread declines the marginal utility of bread rises. This means that every loaf of bread will be valued much higher now than before the supply of bread has fallen.
Conversely, as the supply of bread rises, its marginal utility falls and each loaf of bread is now valued less than before the increase in the supply took place.
Note that the law of declining marginal utility was derived here from the fact that individuals use means to secure various goals or various ends.
Also, note that the ranking of various goals is determined by their usefulness in maintaining individuals’ life and wellbeing.
In John the baker’s case, the least important loaf of bread determines the value of bread out of a given supply of bread.
As the supply of bread increases, its value will decline because the marginal loaf of bread serves the least important goal as far as life maintenance is concerned.
Again, the first loaf of bread will permit to attain the most important goal as far as John the baker’s life is concerned. The second loaf of bread will permit to attain the second most important goal, etc.
Individuals Do Not Set Goals Arbitrarily Note that ends are not set arbitrarily but graded in accordance with their importance in maintaining life and wellbeing.
Whilst it is true that valuations are done by the subject i.e. an individual, they are however, not arbitrary. Individuals are valuing available means at their disposal against the goals that will enable them to maintain their life and wellbeing. In this sense, subjective valuations are in accordance with the facts of reality i.e. not arbitrary.
If John had ranked his ends randomly then he would have run the risk of endangering his life. For instance, if he had allocated most of his resources to clothing and feeding wild birds and very little to feeding himself he would run the risk of weakening his body and becoming seriously ill.
Furthermore, marginal utility is not, as the mainstream perspective presents, an addition to the total utility but rather the utility of the marginal end.
There is no such thing as addition to total utility because of the additional unit of a good. Utility is not about quantities but about priorities or the ranking that each individual sets with respect to his life.Murray N.Rothbard, Man,Economy,and State with Power and Market pp 302-310
Obviously one cannot add priorities. Since total utility does not exist as such, various mathematical methods that were introduced in economics and in the modern portfolio theory (MPT) to deal with total utility and marginal utility are questionable.
According to Rothbard,
Many errors in discussions of utility stem from an assumption that it is some sort of quantity, measurable at least in principle. When we refer to a consumer’s “maximization” of utility, for example, we are not referring to a definite stock or quantity of something to be maximized. We refer to the highest-ranking position on the individual’s value scale. Similarly, it is the assumption of the infinitely small, added to the belief in utility as a quantity, that leads to the error of treating marginal utility as the mathematical derivative of the integral “total utility” of several units of a good. Actually, there is no such relation, and there is no such thing as “total utility,” only the marginal utility of a larger-sized unit. The size of the unit depends on its relevance to the particular action.Ibid pp 305-306.
Summary and Conclusions The heart of price determination is the law of declining marginal utility. According to mainstream economics, this law is linked to the intensity of individual’s satisfaction with respect to a particular good. The satisfaction declines with the greater supply of a particular good. On this way of thinking, the intensity of satisfaction is the key in determining the price of a good.
The alternative approach of what gives value to a good is the usefulness of the good to secure individuals’ ends. The importance of various ends is established in accordance with their importance in maintaining individuals’ life and wellbeing.
In the Austrian view, every individual is seen as employing the resources or means at his disposal in order to secure various ends. The use of resources is not done haphazardly but in accordance with an individual's priorities. The individual ranks various ends or goals that he wants to attain.
The Menger Explanation of How Valuations Are Formed According to Carl Menger, the founder of the Austrian School of Economics, the heart of an individual’s valuations is his life. An individual assigns values to goods in accordance to the importance of those goods to his life maintenance. Various ends that an individual finds important to his life maintenance are then valued accordingly in a descending ranking.
On this Menger wrote,
As concerns the differences in the importance that different satisfactions have for us, it is above all a fact of the most common experience that the satisfactions of greatest importance to men are usually those on which the maintenance of life depends, and that other satisfactions are graduated in magnitude of importance according to the degree (duration and intensity) of pleasure dependent upon them. Thus if economizing men must choose between the satisfaction of a need on which the maintenance of their lives depends and another on which merely a greater or less degree of well-being is dependent, they will usually prefer the former.Carl Menger, Principles of Economics, chapter 3.
Consider John the baker, who has produced four loaves of bread. The four loaves of bread are his resources or means that he employs to attain various ends.
Let us say that his highest priority or his highest end is to have one loaf of bread for himself. This means that John will retain for his personal consumption one loaf of bread.
The consumption of a loaf of bread is of utmost importance as far as his life maintenance is concerned.
With regards to his second loaf of bread, John exchanges it for five tomatoes, which help John to secure his second most important goal. For John, the five tomatoes are going to enhance his life and wellbeing.
John then uses a third loaf of bread to exchange it for a shirt — his third most important end.
Finally, John decides that he will allocate his fourth loaf to feed wild birds. Feeding the birds is ranked as number four on John’s priority list as far as his life and wellbeing is concerned.
The End Determines the Importance of Means Observe that to attain the second and the third end John had to exchange his resources — loaves of bread — for goods that would serve to achieve his ends.
To secure the end of having a shirt John had to exchange his loaf of bread for the shirt. The loaf of bread is not suitable by itself to fulfill the services that the shirt provides.
The suitability of the means is what gives it value with respect to a particular “end”.
For instance, in securing the end of having a shirt John must decide whether it is going to be a leisure shirt or a work shirt.
John will have to select among various shirts the most suitable for his specific end — let us say to have a work shirt.
Being a baker, John may conclude that the shirt must be of white color and made out of thin rather than thick material to keep him comfortable while working next to a hot oven.
Note that his selection is not arbitrary but based on the facts of reality – he requires for working purposes a comfortable shirt. In this sense, the shirt chosen promotes John’s life and wellbeing.
As far as John is concerned, feeding wild birds is ranked the lowest among the ends that John is aiming at given his pool of resources — four loaves of bread.
Observe that the first loaf of bread employed to secure John’s most important end, the second loaf of bread to secure the second most important end, etc.
From this, we can infer that the end also assigns an importance to the resource employed to secure this end. This implies that the first loaf carries much higher importance than the second loaf because of the more important end or goal that the first loaf secures.
Why the Value of Goods Are Determined by the Least Important End Now, because John regards each of the four loaves of bread in his possession as interchangeable he assigns to each loaf of bread the importance as imputed from the least important end, which is feeding wild birds.
Why does the least important end serve as the standard for valuing the loaves of bread?
Imagine John uses the highest end as the standard for assigning value to each loaf of bread. This would imply that he values the second, third, and fourth loaves much higher than the ends he secures. (Remember the second loaf of bread helps John to secure his second most important goal, the third loaf of bread the third most important goal and the fourth loaf of bread the fourth important goal).
However, if this is the case, what is the point of trying to exchange something that is valued more for something that is valued less?
We have seen that to satisfy his second end to obtain five tomatoes he would exchange one loaf of bread.
However, if a loaf of bread is valued by John higher than five tomatoes, obviously no exchange will take place.
Since the fourth loaf of bread is the last unit in John's total supply, it also called the marginal unit — the unit at the margin.
This marginal unit secures the least important end. Alternatively, we can also say that the marginal unit provides the least benefit as far as life maintenance is concerned.
If John had only three loaves of bread this would mean that, each loaf would be valued according to the end number three — having a shirt. This end is ranked higher than the end of feeding wild birds.
From this, we can infer that as the supply of bread declines the marginal utility of bread rises. This means that every loaf of bread will be valued much higher now than before the supply of bread has fallen.
Conversely, as the supply of bread rises, its marginal utility falls as each loaf of bread is now valued less than before the increase in the supply took place. Note that the law of declining marginal utility is derived here from the fact that individuals use means to secure ends.
Ends Are not Set Arbitrarily Also, observe that ends are not set in arbitrary way, but graded in accordance with their importance in maintaining life.
While it is true that valuations are subjective — they are not formed regardless of the facts of reality. They are not formed mechanically by some valuation scale but are formed consciously and purposely.
If John had ranked his ends arbitrarily then he would have run the risk of endangering his life. For instance, if he had allocated most of his resources to clothing and feeding wild birds and very little to feeding himself he would run the risk of weakening his body and becoming seriously ill.
We have seen that by choosing a particular end an individual also sets a standard of evaluating various means. For instance, if my end is to provide a good education for my child, then I will explore various educational institutions and will grade them in accordance with my information regarding the quality of education that these institutions are providing.
Observe that my standard of grading these institutions is my end, which is to provide my child with a good education.
We have also seen that another limitation for attaining various goals is the availability of suitable means. Thus to quell my thirst in the desert, I require water. Diamonds in my possession will be of no help in this regard.
There Is no Such Thing as Total Utility Marginal utility is not, as the mainstream perspective presents, an addition to the total utility but rather the utility of the marginal end.
There is no such thing as adding to total utility because of an additional unit of a good. As we have seen, utility is not about quantities but about priorities or the ranking that each individual sets with respect to his life.Murray N.Rothbard, Man,Economy,and State with Power and Market pp 302-310 Obviously one cannot add arithmetically priorities as such. Since total utility does not exist as such, various models in economics that based on the view that such total exists are questionable. According to Rothbard,
Many errors in discussions of utility stem from an assumption that it is some sort of quantity, measurable at least in principle. When we refer to a consumer’s “maximization” of utility, for example, we are not referring to a definite stock or quantity of something to be maximized. We refer to the highest-ranking position on the individual’s value scale. Similarly, it is the assumption of the infinitely small, added to the belief in utility as a quantity, that leads to the error of treating marginal utility as the mathematical derivative of the integral “total utility” of several units of a good. Actually, there is no such relation, and there is no such thing as “total utility,” only the marginal utility of a larger-sized unit. The size of the unit depends on its relevance to the particular action.Ibid pp 305-306.
Despite the name of this government agency, Canada’s Competition Bureau lacks an appreciation of the nature of competition. Moreover, the Bureau’s actions can be seen as an insult to Canadians, as it fails to acknowledge the ability of discriminating consumers to recognize uncompetitive offerings. As the Bureau pretends to be the consumers’ guardian angel, it wastes taxpayers’ dollars on counterproductive activities.
The Hudson’s Bay Company (HBC) operates numerous department stores in Canada. They say they have spent more than US$425,000 and invested more than 6,500 person-hours to produce 37,000 documents in response to the Competition Bureau's complaint made last February. According to The Canadian Press, the Competition Bureau
is suing Hudson’s Bay Co., alleging that the retailer engaged in deceptive pricing practices for four years ...
The Competition Bureau claims HBC misled customers over the prices of mattresses and box springs sold together since at least March 2013 ...
“The regular prices of the sleep sets were so inflated above what the market would bear that sales at the regular price were virtually non-existent,” reads the filing.
HBC listed a Mount Royal tight top queen sleep set at $1,998 and then a sale price of $788 in 2014, for example, but never sold one at the regular price, the agency says.
So, HBC supposedly “engaged in deceptive pricing practices” which the Bureau defines as misleading customers about prices. Nonsense. The Bureau reveals its own bureaucratic idiocy when it contradicts itself by admitting that no sales were made at the inflated price.
Consumers are WiseConsumers were not misled, as evidenced by their decisions not to buy! Why did they not buy? Because they know the market. They shop around. They have done their homework. They know the prices of the Bay’s competitors. They are well informed. And just as consumers were not misled by a ‘high regular price,’ they also would not eagerly embrace a ‘sale price’ unless they find the price more appealing than the prices of HBC’s competitors.
Though the government would have us believe this is a mortal sin, there is nothing wrong with HBC pricing its products far above the market. That is their right. Remember, they cannot force consumers to buy their products. All transactions rely on mutual consent.
In contrast, we must never forget that the government is the only institution that has the legal power to force consumers to buy things (via taxation and government spending) at outrageous prices.
If anyone at HBC employs physical force to prevent competitors from entering the market, then legal action is justified, but this is not what the Bureau is alleging.
More Bureaucratic MeddlingFrom the Canadian Press:
The agency also alleges HBC misled consumers by suggesting it was selling its remaining inventory during clearance and end-of-line promotions, which implies the low price is permanent until all remaining inventory is sold. But HBC is alleged to have replenished its inventory during such sales by ordering new sleep sets from manufacturers.
So what? I have seen other retailers do this. It doesn’t matter. Consumers know a genuine sale when they see it, just as they readily detect an inflated price. Consumers are not motivated to buy because of a “sale” or “clearance and end-of-line promotions.” Such advertising may entice them into the store, but they will not be fooled. They will not buy the product if they don’t like the price. And if HBC is replenishing its inventory, that is a clear indication of consumer satisfaction, which is economically beneficial.
In another recent case, “The Competition Bureau is investigating allegations that prices on some merchandise were marked up ahead of the liquidation sales at Sears Canada ...” However, later in the article, we read that “After the sales began, several customers posted pictures to social media suggesting prices had been raised.” More proof that consumers are savvy!
Consider ‘price matching,’ a common practice in many stores. Come to the store with evidence of a lower price offered by a competitor, and the store will match the price. Why do stores do this? I will tell you why, and I hope the bureaucrats are listening. Stores do this because they know consumers compare prices, without any handholding by the government.
Consumers Call the ShotsConsumers are buyers of goods, but they are not at the mercy of sellers. In fact, the reverse is true. Businesses know they operate at the mercy of consumers. Consumers shop elsewhere when businesses fail to satisfy them. That’s why Sears is bankrupt! As Ludwig von Mises wrote in 1944 in Bureaucracy (pp. 20 – 21):
... The real bosses, in the capitalist system of market economy, are the consumers ...
... If the consumers do not buy the goods offered to them, the businessman cannot recover the outlays made. He loses his money. If he fails to adjust his procedure to the wishes of the consumers, he will very soon be removed from his eminent position at the helm. Other men who did better in satisfying the demand of the consumers replace him.
We must have the freedom to associate with whomever we choose, and to enter into voluntary exchanges with these people. Coercive acts are banned. This is the definition of an unhampered market, which is the only path to the highest level of prosperity achievable by humans. If the government really wants to facilitate this prosperity, it must not interfere with these voluntary acts — but take action only when one or more persons uses force to compel one or more other persons to complete an exchange to which they did not voluntarily consent. The government has violated this principle in its coercive dealings with HBC and Sears, thereby limiting the freedom of individuals to interact with one another, which limits economic growth.
It is truly mindboggling that government bureaucrats think consumers are helpless without their paternal guidance. On the other hand, maybe this is not what the bureaucrats think at all. Perhaps they are fully aware their activities add no economic value — that their activities are actually counterproductive. For example, as a consequence of the Bureau’s activity, some resources at HBC have been allocated to the investigation, whereas these resources could have been more efficiently allocated elsewhere in the company.
Who Benefits from this Nonsense?According to the government, the purpose of the Competition Act “is to maintain and encourage competition in Canada in order to,” in part, “provide consumers with competitive prices and product choices.” In this regard, as we have seen, consumers do not benefit from the government’s intervention in the market.
Who does benefit?
The government insists that consumer welfare is a high priority, but this is nothing more than propaganda intended to justify taxing the public to support a counterproductive bureaucracy. Money (taxes) is taken out of the pockets of productive workers and placed into the pockets of unproductive bureaucrats. The government benefits as the economy suffers. The moral solution would be to lower taxes and dissolve the bureaucracy, thereby forcing the bureaucrats to seek employment in the productive economy in order to earn a living.
Sadly, the parasitic nature of the bureaucracy doesn’t stop with coercive taxation:
The bureau said it wants HBC to stop such practices and pay an administrative monetary penalty of an unspecified amount. For a first occurrence by a corporation, that can be up to $10 million, said Marie-France Faucher, a bureau spokeswoman.
Thus, we have a distinct possibility of more benefits flowing to the bureaucracy at the expense of productive economic activity.
Perhaps this is one of the many reasons Canadians have so little trust in their government.
According to a relatively new field of economics called behavioral economics (BE), emotions play an important role in an individual’s decision-making process. On this the Nobel laureate Vernon Smith writes,
People like to believe that good decision making is a consequence of the use of reason, and that any influence that the emotions might have is antithetical to good decisions. What is not appreciated by Mises and others who similarly rely on the primacy of reason in the theory of choice is the constructive role that the emotions play in human action.Vernon L. Smith “ Reflections on Human Action after 50 years.” Cato Journal 19, no. 2 (Fall 1999): 200.
For example, if consumers become more optimistic regarding the future, then this is going to send an important message to businesses regarding investment decisions. According to BE followers, whether consumers are generally patient or impatient determines whether or not they are inclined to spend or save today. Behavioral economists emphasize the importance of personality. An emphatic person is regarded as more likely to make altruistic choices. Impulsive people are more likely to be impatient and not so good at saving up for their retirement. Venturesome people are more likely to take risks—they will be more likely to gamble.Michelle Baddley, Behavioral Economics: A Very Short Introduction (London: Oxford University Press, 2017).
But can individuals ascertain the facts of reality by means of emotions? According to Ayn Rand, emotions are not the tools of cognition.
An emotion as such tells you nothing about reality, beyond the fact that something makes you feel something. Without a ruthlessly honest commitment to introspection—to the conceptual identification of your inner states—you will not discover what you feel, what arouses the feeling, and whether your feeling is an appropriate response to the facts of reality, or a mistaken response, or a vicious illusion produced by years of self-deception.Harry Binswanger, The Ayn Rand Lexicon: Objectivism from A to Z (New York: Meridian, 1986), pp. 142–43.
Various goods that support and enhance a man’s life are discovered by reason. Once individuals have established that a particular tool is likely to enhance their life and well-being, individuals have to figure out how to produce it. The figuring out is done by means of reason and not by means of emotions. By means of reason man can establish the relationship between things and their suitability to support man’s life. Reason therefore is the man’s means of survival.
Through various experiments the practitioners of BE have concluded that people do not always behave rationally. What the BE practitioners have discovered has nothing to do with whether people are rational or not, however. It has to do with the flawed premise of popular economics that people’s preferences are constant, the proposition that people are like machines that never change their minds. Obviously, people do change their minds, so it is not surprising that the BE practitioners have discovered that real people's behavior systematically deviates from that of the human machine as depicted by the mainstream economics.Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (1979).
Despite the criticism of mainstream economics, BE retains the constant valuation scale of individuals in its analysis. By introducing emotions, BE supposedly makes the human robot of mainstream economics more humane. Nevertheless, because of the constant valuation scale, it remains a human robot.
Observe that psychology is an important element in behavioral and experimental economics on the ground that human action and psychology are supposedly interrelated disciplines. However, there is a distinct difference between economics and psychology. Psychology deals with the content of ends and values. Economics, however, starts with the premise that people are pursuing purposeful conduct. It does not deal with the particular content of various ends.
According to Murray N. Rothbard,
A man's ends may be "egoistic" or "altruistic," "refined" or "vulgar." They may emphasize the enjoyment of "material goods" and comforts, or they may stress the ascetic life. Economics is not concerned with their content, and its laws apply regardless of the nature of these ends.Murray N. Rothbard, Man, Economy, and State: A Treatise on Economic Principles (Los Angeles: Nash Publishing, 1970), p. 63.
Whereas
Psychology and ethics deal with the content of human ends; they ask, why does the man choose such and such ends, or what ends should men value?Ibid., p. 63.
Economics deals with any given end and with the formal implications of the fact that men have ends and utilize means to attain these ends. Consequently, economics is a separate discipline from psychology. By introducing psychology into economics, one obliterates the generality of the economic theory.
Contrary to mainstream thinking, both Ludwig von Mises and Rothbard held that valuations do not exist by themselves (valuation scale) regardless of the things to be valued. On this Rothbard wrote, “There can be no valuation without things to be valued.”Murray N. Rothbard, "Towards a Reconstruction of Utility and Welfare Economics," in On Freedom and Free Enterprise: The Economics of Free Enterprise, ed. May Sennholz (Princeton, NJ: D. Van Nostrand, 1956). Valuation is the outcome of the mind valuing things. It is a relation between the mind and things.
The Misesian framework of consumer choices Following the Misesian framework of thinking labeled as praxeology, we can ascertain the distinguishing characteristic and the meaning of human action. For instance, one can observe that people are engaged in a variety of activities. Thus, they may be performing manual work, driving cars, walking on the street, or dining in restaurants. The distinguishing characteristic of these activities is that they are all purposeful.
Furthermore, we can establish the meaning of these activities. Thus, manual work may be a means for some people to earn money, which in turn enables them to achieve various goals like buying food or clothing. Dining in a restaurant can be a means of establishing business relationships. Driving a car may be a means for reaching a particular destination.
People operate within a framework of means and ends; they use various means to secure ends. We can also establish from the above that actions are conscious and purposeful.
Behavioral and experimental economists such as Vernon Smith reject the view that human action is conscious and purposeful. According to Smith,
He [Mises] wants to claim that human action is consciously purposeful. But this is not a necessary condition for his system. Markets are out there doing their thing whether or not the mainspring of human action involves self-aware deliberative choice. He vastly understates the operation of unconscious mental processes. Most of what we know we do not remember learning, nor is the learning process accessible to our conscious experience…. Even important decision problems we face are processed by the brain below conscious accessibility.Vernon L. Smith “ Reflections on Human Action after 50 years.” Cato Journal 19, no.2 (Fall 1999): 200.
Yet to object that human action is conscious and purposeful is itself purposeful and conscious action.
Means-ends and consumer choices Note again that by mainstream thinking individuals are presented as if a scale of preferences were hardwired in their heads. The valuation scale determines choices regarding goods and services.
Why have individuals decided to assign importance to a particular good versus some other good? The reply here is the valuation scale. The individual in this framework is reduced to a machine that automatically selects goods based on the valuation scale. This must be contrasted with the Mises’s framework of conscious and purposeful action, where reason determines individuals’ valuations.
In the framework of means-ends, individuals assess or evaluate various means at their disposal against their ends. Individuals’ ends set the standard for valuations and thus choices. By choosing a particular end, an individual also sets a standard of evaluating various means.
For instance, if my end is to provide a good education for my child, then I will explore various educational institutions and will grade them in accordance with my information regarding the quality of education that these institutions are providing. Observe that my standard of grading these institutions is my end, which is to provide my child with a good education.
Alternatively, if my intention is to buy a car, there are all sorts of cars available in the market, and as such, I have to specify to myself the specific ends that the car will help me to achieve. For instance, a factor I may need to consider is whether I plan to drive long distances or just a short distance from my home to the train station and then catch the train.
My end will dictate how I will evaluate various cars. Perhaps I will conclude that for a short distance a secondhand car will do the trick. Since an individual's ends determine the valuations of means and thus choices, it follows that the same good will be valued differently by the individual as a result of changes in his ends.
These ends and means change constantly as the world changes and as individuals change their minds about things. Hence, the various results obtained from laboratory experiments, or from questionnaires do not advance our understanding of human action as far as economics is concerned. It is impossible for a researcher ahead of time to determine what is "rational" for a person to pursue as a goal.
Implications for Public Policy Casting doubt on the notion that reason is the main faculty that guides human actions, behavioral economics in contrast emphasizes the importance of emotions as the key driving factor of human actions.
By means of psychological analysis, the practitioners of behavioral economics have supposedly demonstrated that people’s conduct is irrational. Consequently, the practitioners of behavioral economics may have unintentionally laid the foundations for the introduction of government controls to "protect" individuals from their own irrational behavior.
For instance, wide fluctuations in financial markets can be attributed to irrational behavior, which can damage the economy. Hence, it will make a lot of sense to restrain this irrationality by a dosage of restraining regulations.
The concept of economic cost seems to confuse people. It is not the price you pay for a good, but the reason you pay it.
The cost of one action is the value you could otherwise have gained from taking another action. In other words, if you have $100 and you have the choice to buy two goods, each at a price of $100, you'll naturally choose whichever is more important (valuable) to you. The cost of it is not the $100, which you give up to purchase it, but the value of the other good, which you can no longer purchase. That other good is the opportunity foregone by your action, the true cost of your action — the economic cost.
Why does this matter? Because our actions are intended to create value, and we always aim to maximize that (subjectively understood) value. The economic cost concept brings to our attention what we actually give up to get a value, and thus why we choose a certain course of action.
An economy, which is a system of economizing on scarce resources, is the systematic allocation of resources to maximize value. It is not about minimizing the price paid, which is something different. It is about value. While this may seem like an academic point, the implications are enormous.
Those who are ignorant of this concept focus on the outcome of action only — the "net gain" — rather than the cost. Doing so means we end up wasting enormous resources while not getting the value that was well within reach.
Examples of this include arguing that there were massive gains from, for example, World War II or the US space program in the 1960s. Both were enormously wasteful, but also generated tangible benefits. WWII led to the discovery of artificial rubber, freeing us from costly and time-consuming rubber production. Yes, that's a benefit. And there were plenty of technologies developed as part of the space program. Those were also benefits. But at what economic cost? That's the real issue: what other benefits did we never see because we instead pumped in enormous resources into war and the space race? What other discoveries and innovations were within reach had those resources been used differently?
The WWII example should be obvious, since the war itself was hardly productive. But the space program is exactly the same issue: what opportunities did we, as a society, forego because the government preferred to invest billions of dollars into the prestige program of beating the Russians to the moon? We don't know what we didn't get, of course.
But this doesn't mean we cannot say whether it was the right thing to do. The fact is that in a market system entrepreneurs compete with each other not to minimize cost, but to produce value. Naturally, this means net value: what actual benefit is provided in the eyes of the consumer. The entrepreneurs don't know what consumers will value, but they bet their livelihoods on what they think will benefit consumers most. The result is a variety of goods and services from which consumers can choose, and they will choose what is the best option from their point of view. What is not produced cannot be chosen. But what is not produced also does not seem to be worth it to the numerous entrepreneurs engaging in value facilitation for consumers.
Note that this is not a matter of whether entrepreneurs can "afford" the capital investment needed. It is about the rate of return: whether the value is high enough above the outlays necessary to produce the good/service (the production cost). With a sufficiently high ROI (return on investment), relative to other possible and attempted projects, entrepreneurs can always find the funds needed: investors are looking for a return on their funds, after all.
So the argument that "only the government can" invest in something because it requires capital is bogus. It asserts problems that don't exist, and often fails to properly apply the concept of economic cost (as in the examples above). Economic cost tells us what is expectedly most important to people, regardless of the capital investment magnitude. Higher ROI means greater value, which means a higher price can be charged — and more profit earned.
This is where economic cost is essential to understand the workings of the economy. Because if a project envisioned by an entrepreneur appears to be highly profitable, regardless of initial investment needed, she/he will pursue it. This means, at the same time, that other entrepreneurial projects, which are expected to provide a lesser return on investment, will not be pursued. What matters for society and the economy is that the greater value is pursued, because it makes all of us better off. This is why, through competition, the swift weeding out of entrepreneurs with projects that do not actually produce much value is important: they literally waste our resources because the value foregone — the projects that were not undertaken because the resources were bound up in these lesser projects — is higher than the value produced. It is an economic loss regardless of what benefits came out of it.
Consequently, we can conclude that the space program, just like war, was a wasteful act. The government stepped in because no entrepreneur was willing to undertake it, which is because its expected ROI (if any) was much lower than other projects entrepreneurs could pursue. We don't know what we lost, but it could have been cures for nasty diseases, doing away with poverty, or whatever. The fact that consumers were not expected to spend their own money on the space program, and the fact that no entrepreneurs expected that they would, at least not to the extent necessary, means it was not considered valuable enough. Its economic cost was expected to be higher than the economic value!
Now, does this mean that nothing good came out of the space program? Of course not.
There were innovations and technologies discovered that have served us well. But they were, at the time of investment, either not expected (at all) or not expected to sufficiently serve people. There are certainly examples of flukes that ended up creating beautiful things (like Arpanet becoming the Internet), but who in their right mind would argue that we should waste resources on grand government projects because there might be unintended consequences that we'd benefit from?
Considering the economic cost, what we could have gained from that investment was expected (by everyone!) to be higher than the project pursued by the government.
That's the reason the government did it. Government is in the business of wasting scarce resources at high economic cost, i.e., without sufficient expected value. No matter how one looks at it, this is wasteful. Unless, of course, one ignores the concept of economic cost: the higher-value opportunities that are foregone — lost — because we're instead pursuing the lower-valued ones.
To simplify, it is a matter of picking the low-hanging fruits first, because there is much higher return — greater "bang" for the buck — from doing so. It makes no sense climbing to the top branches "in case" there is some other and unexpected benefit from putting in the extra effort.
Formatted from Twitter, follow @PerBylund.
Although some capitalists and defenders of free markets believe that Ebenezer Scrooge has much to teach us about good economics, I have long found him to be less than inspiring in this respect.
Scrooge, for example, demonstrates a lamentably bad understanding of the subjective nature of value, nor does he understand the concept of psychic profits. He perpetuates the nonsensical myth of the "homo economicus" in which human beings are (wrongly) assumed to be always in pursuit of maximizing money profits. In Scrooge's mind, nothing has value unless it can be calculated on a ledger. He denounces his nephew Fred for enjoying the company of friends and family on Christmas, sarcastically telling Fred "Much good [Christmas] has ever done you!” Scrooge further concludes that anyone who derives pleasure from the experience of Christmas — something which, of course, cannot be calculated on paper — is a fool.
Scrooge vs. His Nephew From what we can glean from Dickens's text, it appears in Scrooge's mind, those who spend and consume are his moral and intellectual inferiors, quite incapable of good planning or astute observation.
In his extended condemnation of Christmas, expressed to his nephew, Scrooge rages:
What’s Christmas time to you but a time for paying bills without money; a time for finding yourself a year older, but not an hour richer; a time for balancing your books and having every item in ’em through a round dozen of months presented dead against you? If I could work my will,” said Scrooge indignantly, “every idiot who goes about with ‘Merry Christmas’ on his lips, should be boiled with his own pudding, and buried with a stake of holly through his heart. He should!”
These judgments by Scrooge, however, are apparently based on fantasy. At no point do we see any evidence that Fred is incapable of paying his bills or managing whatever debts he might have. On the contrary, everything we know from the text suggests that Fred enjoys a comfortable middle-class lifestyle. Fred, for example, has servants, he provides for a wife, and he has the means of entertaining friends at his home.
For Scrooge, this is all so much imprudent extravagance. Fred, it appears, might only gain his uncle's good favor if Fred were to ditch all his friends, his wife, and his servants in favor of living a live of austerity like Scrooge.
Moreover, we find that Scrooge can offer few examples of people for whom Christmas is primarily about "paying bills without money." Defaulting on debt is no doubt a reality for many people, but this fact hardly "proves" that Christmas is nothing more than a time for "wasting" money. In other words, it's unclear why he thinks imprudent spending by some, justifies an overall condemnation of spending in general.
Scrooge is free to take this position for philosophical reasons, of course. He puritanical moralism is his own business. But let's not pretend that his views are necessarily the result of sound economic analysis.
Saving Good, Consumption Bad? In economics, saving is not "good" and spending is not "bad." There is not moral vice or righteousness attached to either act.
Certainly, production is a good thing. Saving and investment are the most critical factors in economic growth. This is because saving and capital accumulation are key factors in increasing worker productivity. It's the savings that are used to create the tools, machines, computers, and vehicles that allow workers to produce more in less time. More productive workers are then able to buy more things, enjoy more leisure, and generally lead more comfortable lives.
This does not mean, however, that consumption has no purpose, or that consumption is a morally problematic activity.
Indeed, the purpose of production is consumption, and the value of the factors of production are determined by how consumers value the retail products and services they ultimately consume.
Scrooge Needs Consumers Although he fails to realize it, consumers are important to Scrooge personally. The text does not say so explicitly, but Scrooge has long been assumed to be a moneylender in his daily business. Whether or not he engages in wholesale or retail lending, it is the consumers — the people for whom Scrooge shows such boundless contempt — who provide him with a living. The money Scrooge lends is ultimately used to purchase consumer goods directly, or it is used by businesses to provide consumer goods or services to shoppers.
Without these consumers, Scrooge would be begging for a living, as his business activities would have no value in the marketplace. And if everyone lived like Scrooge does, he'd have few customers.
Moreover, Scrooge appears to be unaware that the people who consume his goods and services must themselves be producers — either as laborers or entrepreneurs — in order to have money to spend on his services.
Are some of these people unable to pay their bills? That is likely. This fact, however, hardly justifies Scrooge's raving about every person who decides to buy a slightly larger family meal for Christmas, rather than save every single penny.
Where Did Scrooge Get His Ideas? In his book An Austrian Perspective on the History of Economic Thought, Murray Rothbard examines the idea that saving and labor are morally superior to consumption — what Bob Cratchit would call "making merry."
As a case study, Rothbard points to differences in emphasis between some Catholic groups and some Calvinist groups in how they viewed saving and spending in the sixteenth century.
Rothbard writes:
A Calvinist emphasis on postponement of earthly gratification led to a particular stress on saving. Labor or "industry" and thrift, almost for their own sake, or rather for God's sake, were emphasized in Calvinism much more than in the other segments of Christianity. ... [A] rather grim emphasis on work and on saving began to be stressed in Calvinist culture. This de-emphasis on leisure of course fitted with the iconoclasm that reached its height in Calvinism — the condemnation of the enjoyment of the senses as a means of expressing religious devotion. One of the expressions of this conflict came over religious holidays, which Catholic countries enjoyed in abundance. To the Puritans, this was idolatry; even Christmas was not supposed to be an occasion for sensate enjoyment. (emphasis added.)
The popularity of these ideas in some parts of the world led many to assign a moral value to saving, which in turn often led to economic theories in which saving was necessarily superior to spending in nearly all circumstances.
The Catholic scholastics, on the other hand, took a more benign view of spending:
The focus, then, both in Catholic countries and in Scholastic thought, became very different from that of Calvinism. The Scholastic focus was on consumption, the consumer, as the goal of labor and production. Labor was not so much a good in itself as a means toward consumption on the market. The Aristotelian balance, or golden mean, was considered a requisite of the good life, a life leading to happiness in keeping with the nature of man. And that balanced life emphasized the joys of consumption, as well as of leisure, in addition to the importance of productive effort.
In Rothbard's view, these theories then filtered their way down into various views about society in general:
Particularly influential was the early-17th-century Cambridge University academic, the Rev. William Perkins, who did much to translate Calvinist theology into English practice. Perkins denounced four groups of men who had "no particular calling to walk in": beggars and vagabonds; monks and friars; gentlemen who "spend their days in eating and drinking"; and servants, who allegedly spent their time waiting. All these were dangerous because unsettled and undisciplined.
Rothbard's point is not that all Catholics and all Calvinists hold these respective views. There is no doubt significant debate within each group, both historically and today.
What Rothbard does well demonstrate, however, is that these strains of thought have, at certain times and places, been influential, and have colored the thinking of many.
While pre-conversion Scrooge appears to be decidedly un-religious in Dickens's text, it is nevertheless easy to see how Scrooge (or people on whom Dickens may have modeled the character) could have been influenced by the lopsidedly pro-work views labeled by Rothbard here as "Calvinist," while Fred appears to take the more Aristotelian view.
What Scrooge fails to realize is that production is not the end of economic activity. Consumption is. And saving is merely deferred consumption. The fact that not everyone wants to live a life of dour self-denial appears to trouble Scrooge greatly — even though he personally benefits from the consumption of others. Scrooge fails to understand that Fred was right, and that feasting with friends and family brings benefits that can't be calculated on paper, and which will never show up in any statistics about national income or economic growth:
though [Christmas] has never put a scrap of gold or silver in my pocket, I believe that it has done me good, and will do me good; and I say, God bless it!”
The widely understood libertarian environment has lately published a multitude of very eloquent articles about how to approach the global warming issue, what to think about "established science," and whether or not to be "agnostic." Those materials, however well written, fail to see the core of the scientific method — which is again understandable since their authors have been immersed in a different kind of science — that is, social science. The word "agnostic" does not fit in here, however. One can be an "agnostic" only towards what is untestable. But we can test the temperature in which water freezes, we can test how poisons affect human body, and we can test how certain layers of the atmosphere affect solar radiation. Those results are necessarily verified by nature itself. They leave no place for even the subtlest "polishing" of the results so that they fit the assumption — and if what climatologists say seem to leave a different impression, it is either due to the imperfections of human language or due to the fact that, sadly, they already tend to incorporate political agendas into their scientific commentaries. Let us note here however, that the carbon isotope 12C is way too primitive a structure to be plotting for worldwide socialism. (The ratio between 12C and 13C in the atmosphere serves as a geochemical argument for anthropogenic global warming).
Unfortunately, since global warming serves the government as justification for their plans for greater control of society, we are doomed to mix politics and science where it should never be mixed. This may be one of the symptoms of the declining level of public discussion. Again unfortunately, the reaction in which we rebel against our preconceived ideas is perfectly natural. Here it is linked, however, with the difficulty of distinguishing between scientific information and political beliefs. The question "what is going on?" is different than "what should be done?" If I provide a geochemical argument for manmade global warming, it does not automatically mean that I am an interventionist. After all, a lot of basic research underlying modern atmospheric physics is as old as 200 years — but the physics is not accused of bias, since back then no government was plotting to use it as a pretext for public policy. The magnitude of emotions linked with this issue is unsurprising given that it may affect all humanity in a relatively short time. I do have an impression though that those emotions stem from the fact that the whole discussion is politicized, not because of a genuine care for human life.
A Classical Case of "What Is Seen and What Is Unseen"The laissez faire position in environmental problems suffer from a serious and rather impossible to deal with image defect — it does not give easy answers and well calculated recipes. A statist will provide a detailed and nuanced answer with a graph, an emmission-reduction calculation, and a firm loud prescription for government intervention. The non-interventionist will not. We will say that we trust to the same innovation that has continually improved human living standards for centuries. That we trust that the human mind can break through a number of Mathusian traps is born from historical experience, and experience suggests we can — with accordingly big investments — create the technology level we need to adapt. In contrast, no such experience speaks to any success for global schemes of controlling the global economy.
In this light, interventionism is not only unethical, but also inefficient. In a public discussion this stance would loose, since we can only repeat after Hayek that we do not know what to do - and it is impossible for any individual to know:
It is through the mutually adjusted efforts of many people that more knowledge is utilized than any one individual possesses or than it is possible to synthesize intellectually; and it is through such utilization of dispersed knowledge that achievements are made possible, greater than any single mind can foresee. It is because freedom means the renunciation of direct control of individual efforts that a free society can make use of so much more knowledge than the mind of the wisest ruler could comprehend.
For an average listener of such a debate, it would be a choice between "I don't know" and "I calculated all, I know what the government should do, and I even have a photo of a sad seal to invoke your feelings." It's no wonder that freedom loses the advertising battle.
And yet, what sounds unconvincing in front of a TV, works much better in real life. What we need is technological progress in the energy sector and in the methods of waste storage and reduction. Would that progress be possible in a rich or in a poor country? How to cook up new technologies most efficiently, and then make them widely affordable and accessible?
That is why the answer to what the desirable role of the government with respect to global warming should be is the stuff of yet another classic Bastiat's essay. I am certain that the control of carbon dioxide emissions would be the last chapter of "That what is seen and that what is not seen," had he lived in our times to witness it.
Obviously, it is straightforward to calculate the expected temperature change given certain restrictions. It will be beneficial for the environment — short-term, that is what is seen. But how those restrictions would affect the prices of strategic resources, transportation, and, generally speaking, life? Wouldn't they hamper long-term investments in advanced research and development, that is — the only long-term solution to the problem? What if, to give an example, a company that studies cheap nuclear power plants that also extract carbon dioxide from the atmosphere goes bankrupt? What if a number of other similar initiatives do?
Will You Say "Yes" to Civilization?Poor societies cannot afford to care about the environment. They cannot afford research and development. The government wants people to believe it is the only means of addressing ecological problems. But the state can be counted on to just use any new powers as a means of control, and in the long run — to impoverish societies and block the progress of civilization. We are being told we must choose between the freedom of humans and the freedom of polar bears, convincing us that they trade-off with each other, while actually it may not be the case at all. (Here I omit the discussion whether polar bear protection should be subject to law or to ethics).
Statists here think in a very close-minded way — failing to see how dynamic our civilization is. Not long ago, we could not imagine having the internet or commercial flights. How are we so certain then, that in the next fifty years we wouldn't come up with a clean, cheap and efficient way of obtaining solar energy, or a routine and inexpensive procedure of reducing carbon dioxide particles to carbon and oxygen? The assumption that this will not happen, and if it will, it will by state coercion, only makes this progress slower. And going deeper into this assumption would eventually lead to creation of a totalitarian monster which controls not only our energy use, but also birth rates or meat consumption. How immoral and terrifying would be the reduction of a human being under such inhumane conditions! And how could we escape a Malthusian trap while being trapped by the state?
And if someone, anyone claims that "capitalism destroys the Earth," show them any pollution or ecological-catastrophes map. They speak for themselves.
Trump's $1-trillion infrastructure spending plan continues to be one of his less controversial proposed policies. In Washington, and even among many in the general public, there is a consensus that government spending on more roads and bridges is always necessarily a slam dunk.
This is stated matter-of-factly in a recent CNN article about the president's plan:
Infrastructure spending is a proven winner for the economy: It creates jobs, fuels growth and allows Americans to get from point A to B faster, making them more productive.
This statement is not a quotation from any supporter of the the plan. The author of the article is simply stating what he believes to be an indisputable fact.
The fact that statements like this are made in such a blasé way should not surprise us.
This attitude goes back at least to the early nineteenth century when it was assumed that government infrastructure programs were all necessarily "proven winners" for the metaphorical construct known as "the economy."
200 Years of Boondoggles Perhaps the most famous example of this is the transcontinental railroad which is still held up as the great "proof" that massive infrastructure projects are indisputably net gains for the nation.
In reality, the transcontinentals were never "proven winners" and were actually huge engines of debt and corruption in nineteenth century America. They siphoned off vast amounts of wealth from other uses where money would have been better spent.
Even worse, the railroads — like all infrastructure — required constant upkeep. Thus, the creation of new infrastructure was really a creation of future government commitments for more government spending.
In his huge study of the intercontinental railroads, historian Richard White noted:
[The transcontinental railroads] were less an asset that one generation passed on to the next than a debt that the past imposed on present and future. I mean this quite literally. The seeming durability of the iron, steel, and stone that made up a railroad was, if not an illusion, then largely relative. The wind and rain, the ice and the snow, the flood and the landslides, the rust, the rot, and the fire that ate away at railroads meant that they had to be constantly repaired and rebuilt, or they ceased to function. When nineteenth-century editorialists proclaimed that the fraud, deception, and loss of capital that the railroads entailed ultimately did not matter, because Americans now had the railroad, they did not know what they were talking about. Without constant new investment and labor, the railroads would have been useless...
All of the watered stock, the money siphoned off into private pockets, waste, and fraud that characterized the building of the railroads created a corporate debt that had to be paid through higher rates and scrimping on service. A shipper in 1885 was still paying for the frauds of the 1860s.
Thus, infrastructure spending is not some one-time thing that blesses the nation with new wonderful things that everyone can use indefinitely. It is often a commitment to simply spend much more money in the future. So, you'd better be sure you're buying exactly what you need.
White also observed that shipping through the railroads did not become competitive with sea-based shipping for decades. Western states did not become wealthier in the wake of railroad construction across the frontier. In fact, incomes in Western states went down during the same period. So much for the economic slam dunk.
In spite of it all, we continue to ignore the true costs of this sort of spending. Charles Hugh Smith observes:
Building bridges to nowhere isn't just a waste of money in the present; it saddles the economy with productivity-draining costs for decades to come.
If there is anything the political left, right and center can agree upon, it's the lasting benefits of spending more (borrowed) money on infrastructure: roadways, rail lines, airports, seaports, pipelines, dams, electrical lines and so on: the physical networks of advanced civilization.
That Roman roadways constructed 2,000 years ago are still visible illustrates the longstanding value of reliable infrastructure: Roman political control and trade depended on roadways and sea transport to tie the sprawling empire together.
This is the basic assumption behind the notion that virtually any and all infrastructure spending will create value far into the future.
But is this really true? Does rebuilding and/or adding infrastructure create economic value?
To answer, we need to look at two issues: productivity and cost-benefit.
Infrastructure creates new value when it boosts productivity, generally by lowering costs of moving goods, energy, etc.
The value created by increased productivity must far outweigh the cost.
Consider the classic "bridge to nowhere" infrastructure project: a bridge is constructed between a sparsely populated island and the mainland. The payoff is a handful of residents are spared the time and inconvenience required to ship their vehicles between the island and mainland on a ferry.
Does this time savings translate into increased productivity, or merely extra leisure? And what was the cost to gain this very modest increase in leisure/productivity? Spending tens of millions of dollars on the bridge actually reduces the productivity of the entire economy due to the opportunity cost: the millions of dollars could have been more productively invested elsewhere, and spending the money on a low-value-creating bridge deprived the economy of the capital, labor etc. that could have been better invested in productivity-generating projects.
This is especially true of new projects, of course. Building a new bridge or a new road brings totally unproven or hypothetical benefits, especially — as the railroads proved — in less industrially dense areas. What's worse, the promoters of such spending do not take into account the opportunity cost of the spending.
After all, this sort of spending requires that the money must first be removed from the pockets of taxpayers. It is assumed that this is justified because it creates "stimulus." It creates new jobs in building highways, and makes roads everyone can use. But what would the taxpayer and the worker have done in the absence of that spending?
Patrick Trombly wonders:
The government, via taxation, produces something that the consumers have not already chosen to buy. If they were already producing and buying such things, no government intervention would be “necessary.” Thus, whenever the government spending program — on infrastructure or anything else — ends, we end up with workers who took the “stimulus” jobs instead of the jobs that would have been created by the private economy’s spending or investing the same money. Those workers will have invested their time and energy in the development of skills not actually in demand by the consumers. This is a form of malinvestment, and it impacts employees of these firms in a manner similar to the workers who were misled by Fed-created malinvestment booms into the home construction fields in the 2000s or the oil drilling fields in the 2010s. Of course, workers need not worry about other employment if interest groups can convince politicians to keep pouring billions into these industries indefinitely, even though the taxpayers couldn’t be bothered with voluntarily investing in those industries to the same degree.
"But we're only repairing the infrastructure we already have!" will be the refrain of some supporters of the new spending.
First of all, given the experience of the past, we can say that this claim is almost certainly untrue. Federal infrastructure plans designed for "repairs" have always tended to also result in bridges to nowhere, and shiny new expensive projects where far less extravagant spending would have sufficed quite well but for the easy access to federal largesse.
But even if spending were made merely on repairing existing facilities, the debt and cost that appears on the back end is usually ignored.
Smith continues:
Replacing existing infrastructure is also problematic. It may well be necessary, but since it won't boost regional productivity (since it's merely replacing existing structures), it acts as a tax on the regional economy: if the replacement costs $1 billion and generates no real gains in productivity, it is in essence a tax that bleeds capital from the economy that could have been productively invested elsewhere.
Rebuilding a bridge generates higher spending on materials and wages, but if it doesn't generate additional productive capacity equal to its cost, this additional spending (in our world, always paid for with borrowed money that accrues interest for decades to come) runs out once the project is complete, but the costs of paying for the replacement continue on for decades.
As a rule of thumb, if a replacement bridge costs $1 billion, it will cost users and taxpayers $3 billion over the life of the loan/bond that funded the project.
Borrowing immense sums to spend on infrastructure that doesn't boost productivity actually cripples an economy by channeling scarce capital and tax revenues into projects that only boost spending for a few years at best, while the costs of borrowing the money pile up for decades to come.
In other words, building bridges to nowhere isn't just a waste of money in the present; it saddles the economy with productivity-draining costs for decades to come.
This high future cost for no-productivity gain infrastructure effectively bleeds the economy of income and capital for decades, for the temporary sugar-high of infrastructure spending today.
A rigorous cost-benefit analysis might conclude that some aging, marginal infrastructure should be torn down rather than replaced. If self-driving vehicles will reduce vehicles on the roads significantly — and some estimates range as high as an 80% reduction in traffic — perhaps we should wait for this technology to mature before spending trillions of dollars on infrastructure that is about to be under-utilized.
We should instead ask: where are the big gains in productivity going to come from going forward? The answers to that question should guide our public and private investment decisions.
In the meantime, we should question whether proposed infrastructure spending is actually an "investment in our future" or just another bureaucratic boondoggle designed to enrich crony-cartels and justify rising bureaucratic budgets.
Indeed, the tactics of the infrastructure-spending enthusiasts are very similar to that of the global-warming zealots. They put forward massive government spending plans, while ignoring the opportunity cost of the spending or the economic realities involved. But who needs to consider costs when the benefits of the spending — in the minds of supporters — are 100% completely and obviously good?
Anyone who raises questions of cost is simply dismissed as a hopelessly small-time thinker, or a "denier" of reality.
As Always: DecentralizeIf a new highway is needed in Peoria, let the Peorians pay for it, either with a toll road or local taxes. If the benefits of infrastructure spending is so abundantly obvious, then it will pay off for every metro area that builds a new road. The great benefit of federal spending on infrastructure, however, is that the new spending can be forced on the taxpayers with much less political effort than would be required to obtain a new local tax. Members of Congress — who are far more insulated from voters than state and local policymakers — need not sorry about how it will be paid for. They can simply rely on the central bank to help the Feds go more deeply into debt to spend another few hundred billion dollars.
The current terms of the debate over immigration might as well be a full-employment plan for government planners. From both sides, the talk is constantly of either taxpayer-funded barriers to immigration, or of government subsidies employed to promote immigration.
On the left, we repeatedly find demands that immigrants be provided with every manner of taxpayer-funded amenities, from schools, to health care, to income supports, and more. Even those who merely wish to limit tax-funded freebies — while leaving the borders themselves more or less open — are denounced as intolerant monsters.
On the other side of the debate are calls for more taxpayer-funded walls, more government agents, and more federal power. Those who oppose these measures are denounced as anti-American or as tools of a corporate elite "exploiting cheap labor."
Rarely mentioned is the fact that both types of intervention distort markets, and end up putting economic planning in the hands of politicians in Washington, DC. After all, what is the "correct" number of immigrants? What are the "correct" countries or origin? To think that government agents can answer these questions is akin to assuming that governments can properly determine the correct number of automobiles or tomatoes or personal computers. Government bureaucrats often attempt to answer these questions, but for reasons explained by Ludwig von Mises, they consistently fail in the process.
Only individuals acting in the private sector can determine the correct amount of goods and services (including labor) by demonstrating their preferences through their own actions. This, in turn, forms the basis for prices which tell us how goods and services are valued. Government regulations, on the other hand, involve arbitrary "policy goals" and reflect only the preferences of certain interest groups and government officials.
Those who have already made their peace with government planning, however, will have no problem with telling us what is the proper number of workers or immigrants or anything else. The bureaucrats will compile some government statistics, produce some studies, and then turn to "public policy" to impose a one-size-fits-all solution on every one of the 320 million inhabitants of the United States. A government quota will then be said to be the "correct" number of immigrants.
Unfortunately, the economic hardships imposed by this type of government planning will be carefully ignored.
Immigrants are HeterogeneousAt the heart of the calculation problem in this case is the fact that immigrants are not homogeneous. This should be obvious, but public policy is written with the assumption that people fit into convenient categories.
The assumption of the government planner is largely that people are interchangeable. While there is some attention given to a handful of characteristics such as criminality (i.e., felons should presumably be refused entry), no type of government evaluation can even begin to really address the sheer diversity in skills, backgrounds, and personal characteristics that make each person unique.
Fortunately, we already have a mechanism that allocates resources — such as housing and employment — to immigrants based on personal relationships and individual characteristics. This mechanism is called the marketplace. In the marketplace, individual owners and households will distribute resources in a manner that owners think will best serve consumers or be acceptable to neighbors and the community overall. Each customer or employee is evaluated individually.
Government bureaucrats, on the other hand, view immigration "planning" in terms of quotas and regulations. Government regulations will then dictate to employers and owners who can be hired or housed in accordance with arbitrarily selected numbers and types of immigrants.
Naturally, these interventions get in the way of allowing consumers and property owners the ability to decide for themselves which immigrants will be able to be successful in a new country by obtaining income, housing, and other essentials. In a society without either government subsidies for immigrants or government barriers to immigration, it would be fully up to property owners and employers to determine whether immigrants can find employment or live within the community. Private families or charitable organizations would, of course, also be free to offer housing and amenities to family members and sponsor other immigrants who may not, for whatever reason, be able to support themselves financially. Owners and households would be free to refuse to do these things as well.
Decision-making would thus be decentralized and up to the local community members to determine who will be able to reside there.
The Effects of Market Interventions: Picking Winners and LosersSimilarly, if a landlord wishes to rent or sell property to immigrants, but is prohibited from doing so, this distorts markets while impoverishing property owners. Owners will be unable to legally sell or rent to their preferred customers (who may be the highest bidders), and the overall effect will be to artificially reduce the demand for the owners' goods, and thus the price will fall. The landlord is made poorer to satisfy the government planners and their supporters.
As with any government intervention in the marketplace, regulating and/or subsidizing immigration benefits some people at the expense of others.
In the case of subsidies for immigration via government benefits, the taxpayers are punished while the receiving immigrant benefits. Certain employers will also benefit in this case since the subsidies allow households to subsist on lower wages, thus allowing employers to negotiate lower wages.
On the other side of the equation, prohibitions on immigration benefit domestic workers while punishing consumers, employers, and entrepreneurs. This is why Cesar Chavez was vehemently in favor of government restrictions in immigration. The restrictions benefited his unionized farm workers while punishing the employers Chavez opposed politically. A side effect, however, was an increase in the price of food for consumers.
People Are Punished for Peaceful ExchangesGovernment's interventions in the marketplace are often glossed over by supporters of regulation, claiming that they are "common sense" laws or "democracy in action" or some other innocuous-sounding term. In fact, any law or regulation that is enforced by sanctions relies on violent interventions such as fines and jail time.
When combined with government subsidies of immigrants, taxpayers, property owners and others are then hit with a double sanction. They're forced to pay to subsidize immigrants on the one hand, and then, should they find some immigrants with which they choose to do business, they are punished a second time for not doing business exclusively with the special government-approved variety of immigrant. In his article, "The Tragedy of Immigration Enforcement," Lew Rockwell noted the reality of these regulations for many ordinary people:
The owners of Chuy's Mesquite Broiler in Phoenix and 13 other locations around western states have been kidnapped from their popular restaurants and dragged to jail. This will be followed by trial, and certain personal bankruptcy. They could face 80 years in prison. In the raid, "Homeland Security" stole their computers, their accounting and employment records, and walked out the door — just like a gang of thieves. The only difference is that these thugs operate under the cover of the law.
And what evil did these restaurateurs do? Were they poisoning people, stealing customers' wallets, secretly running an assassination conspiracy, sending in the predator drones against people they hate, or what? To lock anyone away for life is a shocking sentence, so surely the punishment must fit the crime. Psycho sniper murderers have gotten less.
What they are alleged to have done is to hire people who don't have the proper bureaucratic forms filled out for them.
And why are these bureaucratic forms necessary? Because many Americans have embraced the idea that it is perfectly legitimate for government agents to decide for themselves how goods should be produced, who should be employed, and how businesses should be run, all without any ability to evaluate the nature of the work or the nature of the employees.
The Link with Free TradeEverything said here about the movement of labor applies equally well to the matter of restrictions on the movement of goods. Like workers, goods are heterogeneous and government agencies are in no position to dictate which goods should be used, how goods should be used, or by whom. When governments intervene in these markets, they enter into the business of picking winners and losers while creating bubbles and distorting markets.
Markets are then cut off from innovations while peaceful and efficient entrepreneurs, managers, and ordinary people are punished with government sanctions for engaging in unauthorized trade.
And yet, those who advocate for more government intervention insist that the economy and even society in general can be planned and manipulated by government bureaucrats to reach an arbitrarily selected outcome. On the other hand, those who actually produce the wealth, who know first-hand the realities of labor markets and prices for goods, are simply expected to obey.
A common way of understanding the history of welfare economics goes something like this. The British economist A.C. Pigou in his The Economics of Welfare (1920) argued that progressive taxes increase social welfare. By the law of diminishing marginal utility, as you accumulate more dollars, each new dollar is worth less to you than the previous one. Doesn’t it follow, then, that that if money is taxed away from a rich person and given to a poor person, total social welfare will go up? Consider, on the one hand, Jeff Bezos with his billions of dollars, and, on the other, someone who is starving and homeless. Isn’t it obvious that if the government transfers a few thousand dollars from Bezos to the poor man, there will have been a gain in utility?[[{"fid":"94553","view_mode":"default","fields":{"format":"default","alignment":"center","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":"https://mises.org/giving/campaigns/i-want-help-mises-institute-14"},"type":"media","field_deltas":{"1":{"format":"default","alignment":"center","field_file_image_alt_text[und][0][value]":false,"field_file_image_title_text[und][0][value]":false,"field_caption_text[und][0][value]":"","field_image_file_link[und][0][value]":"https://mises.org/giving/campaigns/i-want-help-mises-institute-14"}},"attributes":{"class":"media-element file-default media-wysiwyg-align-center","data-delta":"1"}}]]
According to the common understanding, another British economist, Lionel Robbins, pointed out that Pigou’s reasoning rests on a fallacy. Pigou is assuming that you can measure utility interpersonally. A dollar is valued as so-and-so many units of utility by Bezos and as another number of units of utility by the poor man, and the latter number is greater. But this calculation isn’t valid. Utility is ordinal, not cardinal. You can say that a person ranks his tenth dollar higher than his 10 millionth dollar on his preference scale, but there aren’t measurable units of utility that underlie this comparison. If you can’t measure a person’s utility, it makes no sense at all to measure one person’s utility against that of another. You can’t legitimately say, then, that a dollar gives the poor man more utility than it does Bezos. Interpersonal comparisons of utility have to be banned from welfare economics. They are unscientific. This is in fact the Austrian view of Mises and Rothbard, and it is in defense of this view that Robbins is alleged to have argued.
In fact, Robbins doesn’t say this. In his article “Interpersonal Comparisons of Utility: A Comment” (Economic Journal, December 1938), he doesn’t rule out as meaningless interpersonal comparisons of utility. He says that “My own attitude to problems of political action has always been one of what I might call provisional utilitarianism….I do believe that, in most cases, political calculations which do not treat them as if they were equal are morally revolting.”
He thus viewed with great sympathy Pigou’s proposals about taxation. But a problem confronted him. As long as we stick to one person, we can make utility comparisons that can be verified. “The assumptions of the propositions which did not involve interpersonal comparisons of utility were assumptions which had been verified by introspection or observation, or, at least, were capable of such verification.”
But this isn’t true for interpersonal comparisons. You can’t introspect someone else’s mind, and here Robbins quotes Jevons: “’I see no means, Jevons had said, whereby such comparison can be accomplished. Every mind is inscrutable to every other mind and no common denominator of feeling is possible.’”
What follows from this? Here is where the myth arises. Robbins does not say that because we can’t prove the validity of interpersonal comparisons of utility, that we therefore shouldn’t make them. To the contrary, he says that we should continue to make them. But in doing so, we should recognize that we are introducing the value judgment that we take people to have equal capacities for satisfaction. “All that I [Robbins] proposed to do was to make it clear that the statement that social welfare was increased, itself involved an arbitrary element—that the proposition should run, if equal capacity for satisfaction on the part of the economic subjects be assumed, then social welfare can be said to be increased.”
Robbins, contrary to the myth, does not want to ban proposals like that of Pigou from economics. “I confess that I was very much surprised when I found myself held up for advocating for economists the impossible and sterile virtue of never attempting to apply their conclusions---rapt astronomers of the social universe deigning no aid to navigators in search of the desired haven. All that I had intended…was that they might better realise the exact connection between the normative and the positive, and that their practice as political philosophers might be made thereby more self-conscious.”
Robbins sums up his difference from economists such as Roy Harrod in this way: “They think that propositions based on the assumption of equality are essentially part of economic science. I think that this assumption comes from outside, and that its justification is more ethical than scientific. But we all agree that such assumptions should be made and their implications explored with the aid of the economist’s technique.”
An example will serve to show the myth about Robbins in action. The philosopher Hilary Putnam says in his book The Collapse of the Fact/Value Dichotomy and Other Essays (Harvard, 2002), “it was during the depths of the Depression that Lionel Robbins, certainly one of the most famous economists in the world, persuaded the entire economics profession that interpersonal comparisons of utility are ‘meaningless.’”
Putnam thinks he is countering Robbins when he asks, isn’t it plausible “that the marginal utility of say, a thousand dollars to someone at the point of going hungry…is greater than the marginal utility of a thousand dollars to, say, Bill Gates?” Putnam admits that we can’t measure interpersonal utility scientifically, but can’t we achieve a democratic consensus relevant to policy about comparisons like that between Gates and the starving man? But that is just what Robbins thinks. Putnam, contrary to what he imagines, is defending Robbins, not attacking him. And that is a positive and not a normative judgment.
In recent months, the cry of 'black power!' has been heard resounding in the land. As usual, both Conservatives and Liberals have reacted violently and on the wrong side, each for their different and characteristic reasons. The Conservatives, in their mindless racism, can only react in paranoid visions of nameless "Reds" and of black violence against person and property. The more sophisticated Liberals have reacted, again typically, no more nobly and with considerably more hypocrisy.
Volume 2, Number 3; Autumn 1966
The authors who joined the discussions from which this volume resulted were invited on the basis of their earlier work, which had shown an awareness of the consequences of modern psychiatry for the character, values, and future form of our society.
From Harper's Introduction:
Wages are of prime importance in any advanced economy such as ours. They affect us all far more than seems evidenced in our concern about them.I shall deal with the wage problem in a manner that may seem oversimplified. Basic principles always have a way of seeming simple. Yet if they be principles, they can no more be oversimplified than can the law of gravity or the listing of chemical elements be oversimplified. What is needed in our complex society of millions of products sold by millions of business units to over a hundred million traders through billions of transactions each year is to get back to simple economic principles. These are working tools for solving problems that seem more complex than they really are.
Mises discusses the origins of the subjective theory of value. As developed by Menger, value theory was in a position to solve problems that the British classical economists could not answer.
Frank A. Fetter was a leading American follower of Carl Menger and the early Austrians. He was the first economist to develop a complete statement of the pure time preference theory of interest, and he revolutionized the theory of rent which had been developed by David Ricardo and the classical economists and was still accepted by economists 100 years later.
Both Ludwig von Mises and Murray Rothbard were heavily influenced by Fetter's writings. Economic Principles is the culmination of Fetter's work and provides a complete and systematic exposition of economic theory based on the Austrian subjective-value approach. Murray Rothbard mentioned it as one of the great economics treatises written before the First World War.